Has Gold Mine Cost Cutting Gone As Far As It Can Go?

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Includes: AU, GG, GOLD, KGC, NEM
by: Lawrence Williams
Summary

The world's biggest gold miners have gone just about as far as they can go in terms of further cost reductions.

ABX Q1 2015 costs up 10.6% year on year.

NEM Q1 2015 costs down year on year, but guidance is up.

GG Q1 costs up 6.2% year on year, but figures distorted through selling much more gold than it produced.

Cost reductions due to huge drop in oil prices and local currency decline against the U.S. dollar will likely fade away in 2015 and beyond.

The past three years have seen a concerted effort by producing gold miners to cut costs but has this now run its course with all those costs that are within the control of the mining companies already slashed perhaps as far as they can be? Indeed over the past year, the miners have been able to claim falling costs primarily through beneficial factors outside their own control.

Think on it. Much of the actual cost cutting over the past two to three years has come from dropping capital projects, reducing exploration expenditures, laying off surplus staff, cutting out layers of administration and a small amount from improvements in mining technology. Disposals of less profitable operations to leaner and meaner rivals and the closure of the least economic mines have also been playing their part in company boards being able to point to better cost figures all round. These figures have also been enhanced by mining to higher grades - thus producing more gold without increasing basic operating procedures, so costs per ounce of gold produced have appeared to fall as a consequence. But are these measures at the expense of mine lives, new project development and overall longer-term corporate viability?

Take nearly all these factors. Reducing exploration expenditures and cutting back on capital projects is bound to affect the longer-term potential of the company making the cuts. High grading reduces overall ore reserves and mineral resources. The only real 'cost cuts' are those achieved via permanent labor and administration reductions, changes in the mining plan and processing efficiencies to improve figures and the removal of loss making and marginal operations through sale or closure. Once these have been made, one might argue there is little further the companies can do (apart perhaps from reducing some of the over the top pay packages commanded by senior executives, but in truth these have little overall effect on the bottom line for the bigger companies).

But many mines have been able to report some good 'cost cuts' over the past year due to specific external factors over which the companies themselves have little control - firstly the huge drop in oil prices which have been extremely beneficial to those with big diesel powered truck fleets and, most importantly, those operations which have to provide their own generating capacity where connection to grid power is not a viable option.

The second major factor affecting those with mines outside the U.S. has been the surge in the value of the greenback against most other currencies. Gold miners receive payment for their product in dollars, but incur many of their input costs in the local domestic currency. While the soaring dollar is likely, ultimately, to lead to faster rising local inflation, this lags well behind the initial benefits.

But, I would argue, these particular benefits which have filtered through to the bottom line in terms of apparent cost improvements, are merely transient, and may quickly reverse at which point unit costs will appear hugely under pressure yet again. Indeed a return of the oil price to earlier levels, and a depreciation in the value of the dollar, will have a hugely adverse effect on the corporate bottom line for many gold miners.

The latest GFMS gold survey, for example, broke down apparent cost savings across the board, and while the mines on average benefited hugely from the fall in oil prices and currency fluctuations, it was perhaps disturbing for the gold investor to note that the biggest constituent of true operating costs - mine labor - had risen, and risen quite sharply. Maybe at best oil prices have fallen as low as they are likely to and any further dollar appreciation will be significantly more limited - in which case we are likely to see a scenario where the only way costs can go is up - and up sharply as the inflationary effects of a declining local currency filter through to the domestic economy. This puts particular pressure on labor costs and for locally purchased goods and services.

Let's take some of the world's biggest miners and look at their latest financials to see what is happening in this respect already.

Barrick Gold (NYSE: ABX) - the world's biggest gold miner - Q1 All in Sustaining Costs (AISC) 2015 were $927/oz. Q1 2014 AISC $838/oz - an INCREASE of 10.6%. And this is a company which has been perhaps the most aggressive supposed cost cutter of all the majors. It is still in cost-cutting mode with further administrative staff cuts planned, and has already offloaded, or is in the throes of offloading, some of its more marginal mines. True, its target for the year is an AISC figure of $860-895/oz - rather lower than the Q1 figure but it says Q2 will be the highest cost quarter of the year which will make it increasingly tough to meet its annual target.

Newmont Mining (NYSE: NEM) - the world's No. 2 gold mining company. Here it is seemingly showing a good AISC improvement year on year achieving a Q1 2015 figure of only $849/oz - fully 18% down on a year earlier, but it looks like Q1 this year was an exceptional quarter with AISC guidance for the full year of $960-$1,020 which suggests its cost cutting options moving forward are rather more limited.

AngloGold Ashanti (NYSE:AU) - world No. 3. AISC in Q1 this year came out at $926/oz as against $993 a year earlier, so it has again been successful in cutting costs year on year, but AISC guidance for the current year is to rise to $1,000-$1,050, and it is facing major above-inflation wage demands for its still significant South African operations.

Goldcorp (NYSE:GG) - No. 4. Q1 2015 AISC $880/oz. Q1 2014 AISC $828/oz. Guidance for the full year $875-950/oz. Indeed, given the AISC calculation is based on gold sold rather than gold produced, and it sold 98,800 ounces more than it produced in Q1, the increase in AISC year on year would have been considerably higher if they had been based on production alone.

Kinross (NYSE:KGC) - No. 5. Here again AISC fell year on year from $1,001 in Q1 2014 to $964 in the latest quarter, but given the significance of its Kupol operation in Russia and the huge fall in the value of the Russian ruble against the U.S. dollar, that is hardly surprising. The ruble has recovered somewhat, so some of these cost benefits are now falling away. Kinross has nearly all its mines in countries which also have seen their currencies deteriorate sharply against the U.S. dollar over the past year. AISC guidance for the current year is $1000-$1100, once again demonstrating that cost cuts may well have reached their maximums.

The above provides a snapshot of the current costs situation at the world's five largest gold producers and while it is apparent that in some cases AISC has fallen over the past year, although never significantly, the guidance figures for 2015 in virtually all cases suggest the likelihood of any further falls as being low. There are still some options available to the mining companies in terms of disposals and closures of some higher cost operations, but mostly those options within the mining company's control have become more and more limited. And should the dollar stutter, and oil prices recover, those beneficial extraneous factors which have distorted costs downwards in the latest quarters may become liabilities moving forwards. Indeed it may be surprising if these major miners can remain within their cost guidance for the year ahead. In short, don't expect to see further significant cost falls from now onwards - indeed prepare for cost rises. The miners have gone about as far as they can go in terms of further cost reductions.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.