2.4 Operating context

Strategic trends

Like other companies, Gold Fields is subject to a range of external strategic dynamics that inform decision-making, and influence both current and future business performance. Analysis of three of these key strategic issues – and how Gold Fields is responding to them – is set out below.

Gold supply and demand

Issue
The price of gold has fallen by around 45% between 2011 and 2015. Since then it has recovered and in early March 2016 was trading at levels of around US$1,200/oz – US$1,250/oz. More than any other variable, the gold price is the key dynamic informing our business strategy and the volatility of the price over the past few years has been one of the key reasons for the restructuring journey on which we have embarked.

Much of the traditional investor case for gold as a safe haven has come under pressure over the past four years. In 2012, investor demand eased as it became apparent that many of the feared economic worst-case scenarios were unlikely to materialise. The gold price subsequently retreated to sub-2011 levels – just as the equity and real estate markets started to offer stronger returns. As a result, many investors sold their physical gold holdings in 2013 and 2014 – resulting in a sharp drop in the gold price.

Central banks’ net gold purchases Global gold mine production

The gold price continued to decline in 2015 by 8% year-on-year amid slowing demand and fears of an interest rate hike in the US – which did not materialise. On balance, the negative supply and demand trends have seen the average gold price received by Gold Fields decline to US$ 1,140/oz in 2015 from a high of US1,656/oz in 2012.

While much of the gold price’s short-term movements are the result of market sentiment, the longer-term movements remain underpinned by supply and demand fundamentals. An analysis of these fundamentals confirms our belief that the gold price will improve over the next few years though it will undoubtedly experience more short-term volatility.

According to the World Gold Council, gold demand was little changed last year declining from 4,414 tonnes in 2014 to 4,258 tonnes in 2015. However, in the longer term, key demand fundamentals are asserting themselves due to:

  • Ongoing growth in emerging market demand for physical gold – in China, India and other countries. Jewellery demand in both countries rebounded in the second half of last year continuing a long-term trend which confirmed the inherent affinity of consumers in those countries to gold
  • A continued build-up of gold reserves by the world’s central banks (or, at least, maintaining their current holdings) amid economic and political uncertainty and reserve diversification away from the US Dollar. Net purchases by central banks and other official institutions totalled 588 tonnes in 2015, in line with the strong purchases of around 600 tonnes per annum for each of the preceding three years
  • The continued need for a safe haven asset in times of economic and political uncertainty. Though this may not have been as prevalent a factor over the past five years as previously used to be the case, the gold price’s more recent recovery to levels of around US$1,250/oz has been driven amid investor uncertainty in global stock markets

Long-term gold supply issues will also act to support a recovery in the gold price, we believe. According to the WGC total gold supply declined by 7% in Q4 2015, due to an estimated 4% drop in global mine output, the largest quarterly reduction since 2008. Total mine production for 2015 at 3,176 tonnes was only 1% higher than 2014 production, its slowest annual increase since 2008.

This trend is set to continue. The GFMS consultancy predicts a further drop in mine production in 2016, due to lower production at more mature mines, a decline in average grades at most gold operations and a lack of new mines coming on stream. Many analysts believe peak mine production was reached in 2015 coinciding with a high in gold discoveries in the mid-1990s and assuming an average 20-year development cycle. Goldman Sachs has stated that there may be only 20 years of known mineable reserves of gold left.

Response
Gold Fields believes in gold. This means the Group will continue to focus on gold mining and will not hedge, on the basis that we believe:

  • The supply and demand fundamentals support a medium- to long-term recovery in the gold price
  • The Group’s portfolio approach and strategic and mining expertise should provide returns for gold investors now and in the future

Gold Fields’ ability to maximise value can be attributed to its strategic shift to cash flow generation by:

  • De-prioritising production volume
  • Setting cash flow targets and margins and linking short- and long-term management incentives to key deliverable criteria
  • Closing marginal mining operations at existing mines and selling non-strategic growth assets
  • Stopping all greenfields exploration and focusing on brownfields exploration

This strategy, conceived before the price of gold experienced a serious drop – means Gold Fields now enjoys a measure of resilience in the face of current market conditions. For example, all production is being planned around the delivery of a 15% free cash flow margin at a long-term planning gold price of US$1,300/oz. This means the Group is in a relatively strong position to weather a sustained low gold price and/or further falls in the price of gold (should they re-occur). It also means Gold Fields will be particularly well-positioned to capture future upside and deliver superior leverage to investors when the gold price recovers. In such circumstances, Gold Fields is committed to maintaining discipline when the market becomes more buoyant, and to avoiding the temptation of producing incremental ounces.

This builds on Gold Fields’ existing commitment to avoid ‘high-grading’ – due to the obvious negative impact this would have on the sustainability of its ore bodies. As such, Group guidance requires all operations to mine at or below their reserve grade. Gold Fields is also continuing to invest in the future of its mines. This includes the ongoing development of its ore bodies – and proactive near-mine exploration. These are strategic essentials that will in no way be compromised by the current price environment.

Social licence to operate

Issue
The nature of the extractive sector means the industry must pay particular attention to its social licence to operate. Unlike other companies, mining companies are dependent on their mineral deposits and cannot relocate to new locations when facing deteriorating local and/ or national operating environments. Furthermore, many mines’ lifecycles can span decades – and mines must be able to navigate complex social, economic and political dynamics over time.

To manage the potential risks, mining companies need to maximise their positive local impacts, minimise their negative local impacts and make sure that this is communicated to – and recognised by – host community stakeholders.

While many companies generate significant value for their host societies and governments – including through the generation of public revenues – this does not always benefit those host communities who bear the brunt of the direct negative impacts. Additional and targeted efforts need to be made to ensure host communities benefit directly from the presence of mines and have a direct interest in their continued and profitable operation.

Response
Gold Fields understands that it must satisfy immediate shareholder requirements for cash generation while securing the longer-term value of its assets. As a result, it also recognises that the long-term generation of value for shareholders will ultimately be supported by:

  • Responsibility: ongoing investment in responsible operational standards to avoid and mitigate negative social and environmental impacts. This includes effective water management, an increasingly material issue for most mining companies and that can, if poorly managed, have a serious impact on local communities (p97)
  • Trust: frank, two-way communication, realistic expectation management and visibly honouring commitments builds trust. This includes ongoing engagement on issues such as indigenous rights, employment opportunities (p110) and social transformation.
  • Understanding: investment in communities relies on a thorough understanding of the risks, community needs and community perceptions. Since 2014, Gold Fields has undertaken relational proximity studies at its South Deep mine, which have revealed a gap in the mine’s community investment programmes. This assessment survey is being extended to our Ghanaian and Peruvian operations.
  • Shared Value: the pursuit of cost-effective, mine-level business strategies that enhance the value of our own business and generate positive social impacts helps to ensure that interactions with local stakeholders are firmly based on mutual interest from the start. Gold Fields currently has four Shared Value pilot projects (p118). These are further supported by Gold Fields’ broader, ongoing efforts to recruit employees and contractors from local communities – and to source goods and services from local companies (p110)

These efforts are particularly important in the low gold price context, which has significant impact on employees due to the potential for retrenchments and on the ability of the Group to invest in community development projects.

Regulatory issues

Over the past four years the global gold mining industry has been severely impacted by falling commodity prices and rising input costs. Nonetheless, a forward-looking regulatory and fiscal environment should enable us to ride out these kinds of short-term fluctuations and achieve sustained returns over the 15- to 20-year average life of a mining project. In many jurisdictions, however, the legal and tax environment has become less conducive to the long-term viability of the mining sector, partly driven by continued government-backed resource nationalism.

This has been fuelled by the actions of governments all over the world, which views the industry as an easy target for higher taxes and other fiscal imposts. As a result the governments’ share of the ‘mining pie’ has grown at the expense of other stakeholders, especially workers and, crucially, the providers of capital.

Strategic response
The question is how the trust gap between mining companies and governments can best be bridged. Gold Fields on its own and in conjunction with its peers in the gold sector and the wider mining industry, has sought to address this trust gap in a number of ways.

  • In 2013, Gold Fields was one of the drivers in the World Gold Council (WGC) to adopt greater transparency about the real costs of mining, with the introduction of new cost metrics, namely All-in Costs and All-in Sustaining Costs. This cost reporting is now entrenched in the sector
  • A number of recent economic studies show that, far from being a sunset industry, the socio-economic impact of mining remains significant, particularly in developing countries. Mining tends to generate large numbers of indirect jobs and to enjoy significant economic multiplier effects
  • The impact of gold mining goes beyond economic growth and jobs. Gold Fields has adopted WGC methodology on total value distribution that shows the wider national impact mining has on the economy. Over the past three years, Gold Fields has consistently distributed between US$2 billion and US$3 billion to our wide range of stakeholders – accounting for around 90% of revenue on average (p11)
  • Increasingly, miners are seeking to have an impact not just on the national economy, but also on the local economy of the communities that live adjacent to the mines. These communities hold the mines’ social licence to operate and often do not feel they are receiving a fair share of the pie. Beyond traditional socio-economic development (SED) spend, Gold Fields is actively promoting employment and procurement from host communities. This is starting to have a positive impact on our host communities (p110)

Despite all of its perceived shortcomings, there can be no doubt that – if executed responsibly – mining can be a significant force for sustainable growth. However, this potential is currently not being realised, as the key stakeholders have failed to find common ground with each other and investors have fled, denying the industry the capital it needs to fund sustainable growth.

Gold Fields is actively engaging with its host governments in Ghana, Peru and South Africa in addressing the resource nationalism that, we believe, prevents the industry from achieving sustainable growth and broad-based value distribution.