Instability could place Peru in peril

Lima, Peru — As soaring oil prices and equipment delays push miners’ operating costs to record levels, bullion is offering some insurance, and mining companies in Latin America are gratified that the price of gold offers generous compensation, even as production of the precious metal slows in the region.

Gold miners, industry experts and bullion bankers predict gold prices, which are already breaking through 25-year highs above US$700 per oz., will reach US$850 over the next 18 months and could eventually top the US$1,000-per-oz. level, as demand from investors, jewelry makers and scientists putting bullion to medical uses looks set to rise strongly.

“In all probability, we are witnessing a once-in-a-lifetime bull market,” Leanne Baker, managing director of the U.S.-based Investor Resources consultancy, told the seventh biannual gold symposium in Lima, Peru in early May, underscoring the 35% rise in gold prices so far this year.

Also at the conference, John Hathaway, a senior portfolio manager at the U.S.-based Tocqueville Fund, said it’s “no big deal” that gold is likely to go beyond US$1,000 an ounce sometime in 2008, while Newmont Mining (NMC-T, NEM-N) president Pierre Lassonde said he sees bullion at US$850 in the short term.

The gold price has risen almost 150% since April 2001, as mine supply cannot keep pace with growing demand. Global gold production was 2,519 tonnes in 2005, but purchases for jewelry alone were 2,712 tonnes; Indian jewelry production has already risen above 600 tonnes in 2005 compared with 250 tonnes in 1990, according to GFMS’ chief executive Paul Walker.

“Definitely, demand will continue to grow,” Walker told delegates.

China, which is rapidly becoming a global economic power, expects its demand for gold to increase to 14 million tonnes by 2010 compared with 9 million tonnes in 2005, said Chen Jinghe, chairman of Zijin Mining Group, China’s biggest gold producer. China produced some 215 tonnes of gold in 2005.

Meanwhile, investors and financial markets are only just reawakening to gold as an asset class, which is expected to pressure supply and drive up prices. Exchange-traded gold funds (ETFs), a new mechanism that allows small investors to buy a tenth of an ounce of gold with the ease of buying shares without actually receiving bullion, have so far purchased 450 tonnes of gold, or about US$10 billion. The gold ETFs, which are set up like mutual funds, but trade on the London, New York, Sydney, Paris and Johannesburg stock exchanges, hold the equivalent amount of bullion as the world’s eleventh-largest central bank. Tocqueville’s Hathaway predicted the ETF market would be worth $100 billion in a decade.

Low-risk asset

The new interest in gold, the ultimate low-risk asset because of its inherent value, comes as investors move out of a weak U.S. dollar and worry about geopolitical volatility, a weakening global economy, Iran’s nuclear plans and the ongoing war in Iraq. It also comes as investment banks such as HSBC predict stagnation in gold mine production. According to HSBC’s Victor Flores, world gold production hit a peak in 2001 and is now on a downward path, as global miners such as Newmont Mining and Barrick Gold (ABX-T, ABX-N) struggle to find low-cost gold mines to develop and current mines are exhausted.

In Peru, the world’s fifth-largest gold-producing nation, Barrick says it plans to close its Pierina mine in 2009 at a cost of $70 million as it depletes its reserves. Newmont’s Yanacocha pit, the largest gold mine in Latin America, forecasts a steep fall in output over the next three years after a production record of 3.3 million oz. in 2005; the company is struggling to develop its deposits due to local resistance by farmers who fear exploration will damage their water supplies.

“Production is falling because we are not exploring as we should be,” said Newmont’s vice-president for South American operations, Carlos Santa Cruz.

A willingness to search for gold does not appear to be lacking, however. China’s Zijin is aiming to develop an overseas mining project in South America, according to Chen. Peru’s energy and mines minister, Glodomiro Sanchez, said 44 companies are currently exploring for gold in his country. South Africa’s Gold Fields (GFI-N, GOF-L) meanwhile, aims to sell gold to Japan, South Korea and Germany beginning in October 2007 from its US$227-million Cerro Corona project in Peru. Peru’s top precious metals producer Campaa de Minas Buenaventura (BVN-N) says it is looking for gold projects in Argentina and Mexico, breaking out of its Peruvian base after plans to explore in Spain failed on environmental grounds. The miner also aims to begin production at three small gold deposits in Peru this year. Porocota, in southern Peru, is on track to start production within months and should reach 100,000 oz. in 2008.

Peruvian politics

But privately, miners and mining consultants say that such projects are small fry compared to Peru’s real potential and that the Andean nation is being held back by political instability, the government’s inability to calm anti-mining movements and unfriendly mining policies.

According to Fred McMahon at the Fraser Institute, a Canadian think-tank, Peru ranks no. 44 out of 64 mining countries in terms of its position as an attractive mining nation, down from 15th place in 2003, and compared with fourth place for Chile and 19th for Brazil.

“Peru has one of the world’s largest untapped mineral resources, so it is the government policies that are the problem,” McMahon said. The outgoing government of President Alejandro Toledo began charging a mining royalty on companies last year, overriding stability contracts that lock in tax rates for years, while the country has been shaken by often-violent anti-mining demonstrations since 2003, causing some projects to be frozen or scrapped altogether.

Miners say they are concerned about the two left-leaning candidates running for president in Peru’s elections on June 4. Both ex-president Alan Garcia and retired lieutenant colonel Ollanta Humala pledge a windfall tax on mining companies’ so-called excessive profits. Newmont’s Lassonde said up to US$2 billion in planned investment in Yanacocha could be frozen if a new president is hostile to an industry that drives Peru’s economy.

“We need stability and the confidence to know that governments are going to stay the course,” Lassonde said. “Do not change the rules in mid-course if you want to attract investment.”

Newmont aims to open its Minas Conga deposit within the Yanacocha complex in Peru by 2011 at a cost of at least US$1 billion.

In Peru and beyond, rising operating costs are worrying gold miners as higher diesel and other consumables costs have added to the cash cost of extracting each ounce of gold.

“This is a very challenging time for gold producers,” said Baker of Investor Resources.

Richard Graeme, head of Gold Fields in Peru, said tires are also rising in price. “We pay three times more today for a loader tire than we did two years ago, and that’s if you can find one,” he said at the conference.

A weak U.S. dollar is also hurting miners in Latin America as they lose money when dollar-denominated sales are converted into the local currency, an issue affecting Goldcorp (G-T, GG-N), the world’s fifth-largest gold miner, in Brazil, for instance. The Brazilian real has risen 15% against the U.S. dollar since the start of the year.

— The author is a freelance writer based in Lima, Peru.