PDAC 2017: Randgold’s Bristow on managing gold price cyclicality

Randgold Resources’ (LSE: RRS; NASDAQ: GOLD) chief executive Mark Bristow gave a talk on how to create and protect shareholder value in gold mining during the March 6 keynote session at the Prospectors & Developers Association of Canada’s (PDAC) annual convention in Toronto.

Bristow argues that a company’s share price, particularly reserve per share, is the best measure of value. He stresses the importance of investing in exploration and geologists, especially during a downturn, in order to find world-class deposits that can withstand the cyclicality of the business.

Over the past 20 years, Randgold has discovered the 7.5 million oz. Morila deposit, 7.2 million oz. Yalea deposit and 5.9 million oz. Gounkoto deposit, all in Mali; the 4.9 million oz. Tongo deposit in Côte d’Ivoire; and the 3.7 million oz. Massawa deposit in Senegal.

Randgold — which operates its flagship Loulo-Gounkoto mining complex and the Morila, Tongo and Kibali mines — notes its mines have been profitable since the first quarter of production.

The company has increased production for the sixth consecutive year in 2016, while trimming total cash costs per ounce. It recorded a 2016 profit of US$294 million, up 38% over 2015. Below are edited excerpts from Bristow’s talk.

China and the lost opportunity

I want to take, as my starting point, the year 2005. As you know, this point was the start of a truly world-changing sequence of events. China joined the global economy. Among other things, the sheer speed and scale of China’s consequent industrialization created an unprecedented boom in commodity prices, which we now commonly refer to as the super cycle.

This was a truly unique opportunity for mining companies to create value. Instead, most companies, looking back, squandered this very opportunity. This once-in-a-lifetime chance was lost because, lacking proper business platforms and long-term strategies, the industry was unprepared. Instead of taking prudent remedial measures, everyone snatched at short-term gains — mine managers, company managers and investors alike.

This short-term approach is doomed to fail in an industry, which by its nature is long-term. The starting point for success should always be a strategy, which has value creation as its long-term objective.

There are various ways of measuring value. Some of these can be impacted by accounting practices. For my money the best criterion is always the share price. All shareholders ask: “Is this stock worth more today than when I bought it?” And, “have there been dividends paid?”

Creating a good strategy

In devising a strategy, two considerations must be in one’s mind. First, you must take into account the inevitable cyclicality of the gold market. Second, as mining is a consumptive business, you must make adequate provisions for the replacement of the assets that are being depleted.

It is also important that you choose the area you are going to operate in carefully and select a team that is best equipped to deliver a winning result on the field. You have to bear in mind that mining is a complex business, often conducted in challenging domains. Your team will have to command the full range of managerial skills, as well as a mindset geared to this goal.

True value in the gold mining industry is created almost exclusively by discovering world-class deposits and funding their development into sustainable, profitable mines. There are various definitions. But in the simplest terms, it’s an ore body that will be valuable at any realistically conceivable gold price.

At Randgold, we define this as containing at least 3 million oz. mineable gold that will deliver a 20% internal real rate of return at a long-term gold price of US$1,000 per oz., at current spot input costs.

Randgold outperforms indexes 

Super cycle notwithstanding, the Philadelphia Gold Index has consistently underperformed the Dow Jones Industrial Average, the FTSE 100 Index (Footsie) and the bullion price.

In fact, the S&P/TSX Global Gold Index of gold companies is lower than it was in 2005.

If you have bought physical gold, it would have done better than the other three indexes. If you have invested in Randgold, your holding would have outperformed all the runners in the field: the Dow, the Footsie, the gold companies and the gold price.

Understanding the cycle

One of the interesting things about this cycle is that it offers opportunities at any stage. If you make a major discovery in the cycle’s trough, for example, it will deliver extraordinary value at its peak. That’s why it is so misguided to cut back on exploration in a downturn.

I’m not a great enthusiast for mergers and acquisitions, although they can create value, if you buy low at the bottom of the cycle and add something substantial to the asset, for example, expanding the reserve, introducing significant efficiencies and/or cutting costs. Otherwise, you find that you will be back where you started or perhaps even worse, as you come into the next trough in a gold cycle.

Sadly, the industry still does not seem to learn from experience and fails to plan for the future. Instead of focusing on investing and profiting, it oscillates constantly between growth and survival.

In the good times, it is often fixated on production growth, maybe through acquisition, which offers little or no returns to shareholders. In the lean times, as we’ve witnessed in the last three years, it has to sell often at a discount what it bought at a premium, incurring the inevitable impairments and writedowns, and sometimes even forcing to shelve development projects because no one wants to buy them.

Impairments destroy value

Often, the industry and its investors or fund managers seem to have accepted the view that impairments don’t really matter, because they are often classified as non-cash.

That sounds more like nonsense. An impairment simply means an investment decision has destroyed value instead of creating it. I don’t think we should pretend it is anything different.

Protecting shareholders’ equity

There is no better way to measure a mining company’s value than its mineable reserve per share. It is probably a little simplistic to use just ounces — one should also add a grade to the ounce profile. It is really the inherent and only measure of the value of a mining stock, because it’s what you get per share.

Issuing paper at a discount or at a stage in the cycle when the traditional resource funds — the long-term funds — are stressed always destroys value.

Doing cash deals in an industry, where everything trades at a premium, does not really create value unless the gold price goes up. As we all know, the gold price goes up and down, but not necessarily in that order.

On the other hand, value can be created when premiums and stock prices are low, but again it is important that you do that at the bottom of the cycle.

At all times it is important for mine company managers to put the interest of their long-term investors above those of the speculators.

Here are a few more don’ts one should consider: Don’t cut back on essentials in a downturn. If you find yourself having to cut back on essentials in a downturn, you have the wrong project. For example, retrenching skilled workers — particularly geologists. Everyone, as the downturn comes, gets rid of exploration and geologists. The result is that we are short of this skill in our industry today.

The need for more exploration

If we looked at the broader picture, it is clear that since the turn of the century less than half of the gold mined has been replaced by new discoveries.

In our quest as an industry for short-term gratification, the major gold miners have shown a reluctance to invest in exploration, in geologists and to venture into those regions, where world-class deposits are still to be found.

There is an old saying that when you hunt elephants you have to go to elephant country. But as we’ve seen over the last five years or so, there have been few tentative ventures into Africa, as an example, by the majors. But very quickly they have drawn back into their comfort zone, into the mature goldfields where they are spending more on exploration, but with diminishing results.

It is bad enough that the world’s gold inventory is shrinking. What’s even worse is the steady deterioration of the quality of our reserves.

During the upturn in the cycle, the industry added reserves by recalculating the value of the reserves in line with the ever-rising gold price that of course results in declining grades. The decline in the ore grade continues to be exacerbated by the high grading of ores.

Our industry is constantly reducing the quality of its asset base, which has a significant impact on us and on our ability to manage future gold price cyclicality.

The only option that we have to reverse this trend is to start up our exploration programs and revisit the less explored, but premier, gold destinations, and explore for new deposits with world-class credentials.

Making major discoveries

We know that the world’s mature goldfields have been largely depleted. There are only a handful of regions that still hold a promise of world-class discoveries. As an example, three of these are in Africa, with the two most prospective being West Africa and East and Central Africa. And this is where Randgold operates and where we are hunting for our next big mine.

Our major discoveries over the past 20 years have been in these regions.

Of course, operating in remote, undeveloped parts of the world has its challenges, sometimes considerable ones. But armed with a long-term strategy, sound scenario planning, stakeholder philosophy and a hard-earned social licence, it is possible to overcome these.