EXPLORATION ’93 — South African gold output up despite low

The recent production pattern of South Africa’s leading gold operation has defied the simple logic that declining gold prices should lead to the closure of high-cost mines and therefore a contraction of gold output. Based on the performance of the top 30 producers monitored, investment firm S.G. Warburg estimates that South African output actually rose by 2% to 612 tonnes in 1992.

And, after declining continuously in the late 1980s, the industry’s total after-tax earnings have been rising steadily since the low point in mid-1990. These achievements are all the more remarkable in the light of a further 5% drop in the U.S. dollar gold price last year, when South Africa’s working costs averaged US$287 per oz. and total (that is, working plus maintenance capital) costs were US$320 in 1992.

The key to this enhanced overall performance lies in the improvement in the relationship between working costs and revenues in rand terms. The rate of working cost escalation has come down dramatically in the past two years, while revenue per tonne treated has risen steadily over this period. The effect on profitability is equally striking, with average unit operating margins of R30-40 per tonne achieved consistently since 1990. The endemic problem of inflationary cost rises — which led to average increases to working costs per tonne of more than 15% per year throughout the 1980s — has been tackled firmly and comprehensively. The challenge to the industry lay in tackling the mines’ rigid cost structures.

With the exception of the few underground mines amenable to trackless mining methods, South Africa’s gold mines employ conventional, highly labor-intensive mining techniques. Where operating efficiently, they offer seemingly little scope for significant cost reduction. Typically, labor costs make up 50-55% of total operating costs, the remainder divided between stores, equipment, power and other services.

During the late 1980s, the annual round of pay negotiations had resulted in inflationary wage increases for the back labor force. The successful introduction in 1991 of performance-related bonuses linked to below-inflationary wage rises has had a material effect in containing wage-cost inflation. In 1992, when South African inflation averaged 12%, the overall increase in black wages (including basic rises of around 5%) was below 10%.

Containing increases in the costs of stores and other equipment has been achieved by bringing in tougher inventory policies and mine accounting systems designed to minimize wastage and delays, plus highly competitive equipment purchasing policies. The strong traditional ties (often through corporate links) of major suppliers to the mining houses have been replaced by competitive tendering.

Within individual mining operations, the greatest impact on costs has been achieved via rationalization programs which have led to the closure of a large number of unprofitable shafts and sections. This has been accompanied by extensive retrenchments. During the past two years, more than 100,000 jobs have been shed by the gold mining industry, which now employs a workforce of around 300,000.

In spite of these cutbacks, gold output has actually risen progressively during the past eight quarters. In only a few cases (such as Kloof and Elandsrand) has this reflected genuine expansions. In most cases, it has been the consequence of the requirement to mine to the ore reserve grade, which is a condition of the mine lease agreement. For established mines, flat or falling rand gold prices dictate progressively higher pay limits and ore reserve grades.

This is not high grading, merely the obligation to mine as closely as possible to the rising ore reserve grades determined by cost-price relationships . . . In the late 1980s, the industry’s average break-even grade (that is, the grade below which it would operate at a loss) and the actual recovery grade were converging at an alarming rate but after 1990 the average recovery grade began to rise — reversing the downward trend in place for more than a decade.

While these same relationships normally give rise to a corresponding fall in ore reserve tonnages, a feature of recent quarters’ operating performances has been the steady pattern of tonnages treated.

The net result has therefore been the increase in gold output. This unusual combination of stable tonnage throughput and rising grades cannot last indefinitely, as ore reserves become depleted. However, the drive to lower unit costs is being matched by the drive to maximize treatment rates, and the mines have demonstrated considerable resourcefulness in maintaining these rates in recent quarters. It should not be surprising therefore to see South African gold output maintained at around 610 tonnes per year for at least two more years.

The 1980s were characterized by steadily rising rand gold prices. During this period, the U.S. dollar gold price was locked in a bear trend but, through the erosion of the rand-dollar exchange rate, the local gold price continued to rise. . .

As the U.S. dollar gold price continued to weaken after 1990, the currency-induced surge in rand receipts of the late 1980s came to an end. Since 1990, however, the rand gold price has been remarkably stable at around R32,500 per kg.

While spot prices have been relatively firm, average received prices rose in each quarter in 1992 — a clear demonstration of the recent success of South African hedging policies.

The extent of forward selling is difficult to gauge. While some groups (Gencor, Anglovaal) have published details of their forward sales receipts, others (notably Anglo American, JCI) reveal only that part of their output is hedged. Until recently, GFSA emphatically had avoided selling forward. We estimate that more than 200 tonnes of projected 1993 South African gold output of 615 tonnes will be sold forward. To date, the houses have used relatively simple flat-rate stabilized contango techniques to take advantage of the U.S. dollar contango on gold and on the rand.

There are wide variations within this broad picture. Warburg believes that JCI mines are roughly 60% hedged, followed by AAC with up to 50%. More than 25% of Gencor’s current production is sold forward.

The hedged proportion of total output has grown rapidly during the past two years, as illustrated by the surge in the premium element of receipts obtained through forward sales. However, the South Africans have a long way to go to catch up to other major producers. In 1991 (according to Green Fields Mineral Services) some 60% of North American production of 500 tonnes and 80% of Australian output of 225 tonnes were sold forward. At that stage, the proportion committed by South Africa was barely 15% . . . For the industry as a whole, the outlook for 1993 is not particularly auspicious. We do not anticipate much improvement in the U.S. dollar gold price, although the rand is expected to weaken further against the U.S. dollar, to bring some relief. Unit cost inflation is expected to remain well contained, helped by the better local inflation news.

— From a recent edition of International Mining Outlook of S.G. Warburg Securities, New York.