Integrated Annual Review 2012 Annual Financial Report 2012 Mineral Resources and Mineral Reserves Regional overview  
 

3.1.6 Issue 6: Gold trends

Issue

Gold prices have remained on a rising trend for years – from less than US$300/oz in 2001 to an average of US$1,669/oz in 2012.1 During 2012 the gold price was trading in a narrow range of between US1,550/oz – US$1,800/oz, ending the year 7% higher at US$1,676. Despite current signs that they may now be stabilising, average gold prices in 2012 were 91% higher than in 2008.2

Nonetheless, the gold mining sector has not fully capitalised on historically strong gold prices due to its failure to deliver optimal leverage over the gold price to investors.

Drivers

We believe that the fundamentals behind the current gold price remain solid. For example, the World Gold Council reported that 2012 saw an all-time high in gold demand by value of US$236 billion.3 This reflects:

  • Maintenance of the ‘safe haven’ status of gold due to the sovereign debt crisis in the Eurozone, low interest rates and monetary stimulus in the developed economies, instability in the Middle East, and strong central bank balance sheets
  • Ongoing demand being created by Exchange Traded Funds (ETFs) – with investment demand estimated at 279 tonnes in 2012 (2011: 185 tonnes)
  • Potential demand for gold from fund managers, as gold only accounts for around 1% of global funds under management
  • Increased gold demand from central banks – with notable new buyers such as Brazil, Paraguay, Iraq and Venezuela adding to existing demand. According to the World Gold Council, central banks purchased 536 tonnes in 2012 – a 48-year high4
  • Fundamentally firm and consistent consumer demand from China and India – despite signs of a short-term softening in the market

Furthermore, there appears to be little prospect of a significant expansion in supply in the short- to medium-term, due to the fact that:

  • The discovery of large, high quality new deposits is becoming increasingly rare – with ore grades from primary gold discoveries greater than 1 million ounces falling by 3% a year for the last 30 years, and by 4% a year between 1998 and 2008
  • Existing production grades are falling – with average yields dropping by 5% a year over the last five years
  • Costs are getting higher – with many of the major mining companies predicting an overall increase of 20% in 2013
  • Capital expenditure requirements are rising – with capital spend per ounce increasing by 32% a year over the last 10 years (primarily driven by capital expenditure on greenfields projects, which showed further escalation of 50% a year on a per ounce basis between 2006 and 2011)
  • Recycling of gold is becoming an ever-greater component of supply

In addition, gold mining companies face other pressures on production growth, including resource nationalism, skills shortages and more challenging socio-economic operating environments. Many companies are therefore putting planned growth projects on hold – restricting potential future supply.

In this context, the price of gold is more likely to either maintain or increase on its current levels. We believe the fundamentals for gold remain strong and promising. Even so we are positioning our business to offer leverage to varying prices.

Implications

The gold mining sector is not delivering optimal leverage over the gold price to investors – primarily due to the high costs involved in extraction, Mineral Resource and Mineral Reserve replacement, and growth (p96).

As a result, investors are increasingly seeking to profit from Exchange Traded Funds (ETFs), which provide straightforward access to the gold price ‘upside’. Unfortunately, this is diverting away investment that would otherwise be targeted at gold mining companies.

The challenge – as identified by Gold Fields CEO Nick Holland in his July 2012 keynote speech to the Melbourne Mining Club5 – is to prove to investors that gold mining companies can provide optimal gold price leverage. This means adding value by:

  • Optimising operations, achieving sustainable production growth and expanding production margins
  • Leveraging balance sheets, achieving positive ‘multiplier’ effects and returning free cash flow to investors via dividends

Strategic response

We continue to ‘believe in gold’. This means:

  • We are – and will remain – a gold miner: We will not dilute our existing ‘gold premium’ by diversifying into base metal production
  • We believe in our product: We believe that the fundamentals behind the price of gold remain strong – and will base our decision-making on this basis
  • We do not – and will not – hedge the price of gold: Although we expect other operators to take up hedging again, we believe this is the wrong thing to do. Empirical data shows that in the long run, the spot price for gold will beat hedging – despite periodic shorter-term exceptions

Nonetheless, we recognise that we must offer investors true leverage against the gold price if we are to command the kind of share price that we believe our business warrants. This means we need to demonstrate our ability to generate and deliver cash.

We will do so by:

  • Focusing on cash generation and pay-back: This includes: (1) A review of our portfolio to optimise cash generation; (2) Ongoing management of our ‘true’ costs, using NCE; (3) Prioritisation of low-risk, high-return near-mine growth opportunities; and (4) The pursuit of greenfields growth opportunities only if they offer truly attractive returns
  • Delivering South Deep: This includes: (1) The 2013 transition from the construction phase of the mine to the ore body development and production build-up phase; (2) The achievement of 700,000 oz/year production by 2016
  • Optimising our financial gearing: This includes the leveraging of our balance sheet to ensure growth on a per share basis
  • Maintaining a strong dividend policy: This includes: (1) The prioritisation of dividends to ensure they have first call on available cash flow; and (2) The paying out of between 25% and 35% of normalised earnings

Figure 3.3: World Gold Council: Gold demand by category (tonnes) and the gold price (US$/oz)6

Gold jewellery   Figure 3.3: World Gold Council: Gold demand by category (tonnes) and the gold price (US$/oz)6
Gold jewellery   World Gold Council: Gold demand by category (tonnes) and the gold price (US$/oz)6

1 1 World Gold Council, Gold Demand Trends: Full Year 2012, February 2013, http://www.gold.org/download/pub_archive/pdf/GDT_Q4_2012.pdf
2 2 PwC, 2013 Global Gold Price Report, http://www.pwc.com/en_CA/ca/mining/publications/pwc-global-gold-price-survey-results-2013-01-15-en.pdf
3 World Gold Council, Gold Demand Trends: Full Year 2012, February 2013, http://www.gold.org/download/pub_archive/pdf/GDT_Q4_2012.pdf.
4 World Gold Council, Gold Demand Trends: Full Year 2012, February 2013, http://www.gold.org/download/pub_archive/pdf/GDT_Q4_2012.pdf.
5 Nick Holland, CEO Gold Fields, What do Investors Want from a Gold Mining Stock?, July 2012, http://www.bullioninternational.com/images/uploads/images/ powerpoints/Melbourne.pdf
6 LBMA, Thomson Reuters GFMS, World Gold Council (from World Gold Council, Gold Demand Trends: Full Year 2012, February 2013)