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Optimists vs cynics on gold firms' prospects

Journalist: Brendan Ryan

THE CEOs OF Gold Fields, AngloGold Ashanti and Harmony are all confident about two things, judging by their recent September quarterly briefings: the gold price will go up next year and their operations will perform better in 2009.

Well, they would be – wouldn’t they? After all, they’re gold company CEOs and if you aren’t an optimist you shouldn’t be in the mining business. The trouble is the gold price isn’t currently performing and analysts’ opinions are split on whether it will continue to underperform next year.

Gold Fields CEO Nick Holland says gold will go above $1,000/oz and stay there, primarily due to falling production from existing mines. He adds a number of projects being brought on stream by junior miners are going to be shelved or postponed because they can’t find the funds to develop them because of the world financial crisis, which has dried up all sources of credit.

Holland estimates the “all-in” cost of production at around $800/oz for the global gold mining sector.

That calculation includes money spent on exploration, development work and capital expenditure required to maintain current output levels. Those amounts are left out of the lower “cash cost” of production that most gold companies emphasise in their results. That means much of the gold industry is losing money at current levels and must chop back on operations and/or defer new projects.

Holland reckons world gold production will drop 5% this year and another 5% in 2009. His estimate on SA’s gold output is that it will drop to around 210t this year. SA produced 376t in 2003. AngloGold Ashanti CEO Mark Cutifani holds a similar view, pointing out the world gold industry has been in decline for the past seven years, He expects another five years of decline to come, during which world gold production will drop at an average rate of around 3%/year. Cutifani says a price of $1 000/oz is a “long-term sustainable target”.

Harmony CEO Graham Briggs says: “With economic deposits in mining locations harder to come by – and exploration and development budgets under extreme pressure – supplies of new gold into the market are likely to continue to shrink.”

Gold analyst David Davis, of Credit Suisse Standard Securities, supports the industry’s executives. In a recent report Davis commented: “We believe the current floor price is around $850/oz, as we calculate this price represents the ‘all-in’ cost of 50% of global production. This means that, at current gold prices of around $753/oz, much of global production is at breakeven levels.”

Davis says falling mine supply – combined with lower central bank sales and producer de-hedging – will reduce overall gold supply while investment demand from exchange-traded funds (ETFs) will rise. He expects jewellery demand to be “volatile” but only over the short term. “We believe the upswing in the gold price will only be a matter of time.”

Davis does cover his bets on the short-term outlook, saying: “On the downside, we think a fall in jewellery demand and/or disinvestments in gold ETFs year-on-year would very likely lead to a fall in the gold price.”

Cutifani says the recent strength in the US dollar had forced some withdrawals from ETFs, although “post quarter-end that liquidation had all been recovered and holdings of gold ETFs had reached an all-time high of 35m oz”.

Holland reckons the recent strength of the US dollar was overdone and the greenback must weaken. However, that’s where the opposition disagrees. UBS analyst John Reade says gold will remain under pressure during 2009 from a combination of slowing demand for jewellery and disinvestments as inflation slows and the US dollar continues to strengthen.

“Dr Doom” (New York University economist Nouriel Roubini, who predicted the current financial crisis a year in advance and believes there’s worse still to come) reckons the US and global economies face the prospect of stag-deflation. That’s a recession associated with deflationary forces in which commodity prices collapse and inflation vanishes due to the overall drop in demand.

That’s bad for gold – on two counts: given gold’s dual role as a commodity and as the ultimate investor protection against inflation. Roubini last week gleefully highlighted a 180-degree swing in position by JPMorgan in its latest economic review.

“So the leading supporters of the view that the global economy risked rising inflation, rising growth reflation and sharply higher policy rates to fight this inflation are now predicting a global recession, global deflation and sharply falling policy rates. What a difference a year makes,” says Roubini.

Looking at the results of SA’s “Big Three” gold mining groups, all are claiming progress in their various turnaround programmes but all face specific problems.

Briggs says Harmony is now “well embarked on its organic growth phase” but as JP Morgan analysts Steve Shepherd and Allan Cooke point out, “more effort will be required to fix some of the problem children in SA. Elandsrand has been placed on intensive care and, together with Target, will take six months to restructure.”

Cutifani, who took over from former CEO Bobby Godsell a year ago and embarked on major restructuring of the group, says he’s now “got the car roadworthy and it’s time to work on the engine”. His intention is that AngloGold Ashanti will “be the number one value creator in the gold industry over the next 18 months”.

AngloGold Ashanti’s most pressing problem is financial, in the form of the US$1bn convertible bond that must be refinanced by end-February 2009. Before the current financial crisis that would have been a simple exercise. Cutifani comments: “We’re focused on nailing the refinancing as our top priority.” Options being looked at include sale of assets, bridge financing, lower capital expenditure spend and further debt financing.

At Gold Fields, Holland “bit the bullet” in the September quarter taking a bad knock in gold production through the closure of the main shaft at Kloof for repairs, plus rehabilitation work on two main access ramps at South Deep. His message is Gold Fields will be back to normal producing at a rate equivalent to 4m oz/year from the March quarter 2009 and doing that at markedly lower cost levels.

But Gold Fields also has its problem children, such as perennial underperformer Beatrix, which Holland reckons is being fixed and from which he says “Gold Fields will make a lot of money”.

We’ll see.

What the SA mines do have going for them in common is the benefit of the weakening rand, which boosts revenues – unlike mines operating in “dollarised” economies. Those benefits will be short-lived if the mining groups don’t keep their costs under control. Although, as Holland and Cutifani point out there’s now relief in sight on costs, in particular because of dropping oil prices.

Share prices of all three groups have recovered from their recent 12-month lows, with AngloGold Ashanti and Harmony outperforming Gold Fields.

What happens next will depend on how well their managements deliver on their promises, along with movements in the US dollar gold price and dollar/rand exchange rate.

Annual report

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Investor brief

Harmony Investor brief, Sep 2017
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Harmony Investor brief

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