Senior gold companies face ‘point of no return’

The twice-yearly Senior Gold Book, produced by the global mining team at HSBC Investment Bank, is one of most thorough reviews of the gold industry available to investors. It always tells it like it is, even at the risk of offending the sensibilities of mining executives, and its comments on industry trends are as insightful as they are useful.

The latest edition, subtitled Point of No Return, begins by offering a small ray of hope for the beleaguered sector. “Gold price recovery is anticipated on weakness in the U.S. dollar, with average price of US$290 per oz. in 2001 and US$300 per oz. long term.”

As for industry trends, the authors predict companies will continue to focus on improving returns, even at the expense of growth-oriented strategies. “Few gold producers currently achieve returns exceeding the cost of their funds, and the industry remains in a capital conservation phase,” they write. “The prospective return on invested capital (ROIC) for the sector averages 6.4% — owing to the depressed gold price, but also because of acquisitions made during a period when corporate strategies favoured growth at the expense of other measures of shareholder returns.”

Most of the book is dedicated to a review of companies and their performances during 2000, divided by geographic regions. However, it also includes comments about the anticipated performance of some of these companies this year.

In the South African gold sector, HSBC expects Gold Fields (gold-q) to outperform its peers as a result of ongoing improvements in the company’s operations. “The transition to sequential grid mining at Driefontein and Kloof, now in its second year, should be gaining momentum. Tarkwa [in Ghana] continues to beat the company’s most optimistic projections. The shares should also enjoy continued support in the face of potential corporate activity.”

In Australia, the firm expects Normandy (ndy-t) to be rewarded for its restructuring efforts. In the North American sector, HSBC expects Placer Dome (pdg-t) to outperform its peers, despite disappointment at the Getchell project in Nevada. “The company has focused its business plan around mine operating returns and mine site exploration, while trimming unnecessary corporate overheads.”

Compania de Minas Buenaventura (bvn-n) was given the nod for being the only senior company in the Americas in a classic growth phase, for generating excess returns on its invested capital, and for being the prime beneficiary of both exploration success and production growth at the Yanacocha gold mine in Peru.

HSBC’s latest gold survey includes a brief analysis of what might lie ahead in the next few months, including consolidation concerns. While recognizing that critical mass is necessary to attract investor attention, the firm does not believe that consolidation for the sake of growth will be the industry’s panacea. But it does expect the following to take place:

ongoing consolidation as a means of enhancing returns by reducing overheads and exploration budgets, providing operational synergies, and combining capital with resources (even though the industry’s track record in these areas is “poor”);

acquisition of junior companies with outstanding deposits in the exploration and development phase (even though these are increasingly limited in number);

limited co-operation to enhance productivity and reduce costs at the regional level (even though the industry has been slow to exploit potential cost savings by rationalizing properties or finding ways to operate fragmented camps as a unit);

additional mine closures forced by economic necessity (even though the industry has “resisted the pressure to close down unprofitable production at every opportunity”).