FUNCHAL – Some interesting research from analysts at Canadian headquartered GMP Securities builds on a theme we covered here in these pages around six weeks ago. This suggested that, if anything, the cost cutting programmes entered into by most major and mid-tier gold mining companies may have largely gone as far as they can go. (See: Has gold mine cost cutting run its course?)

Indeed in its latest mid-year report the Canadian brokerage and investment bank points out that despite some seemingly effective cost cutting, profit margins have been continuing to fall regardless. It bases its analysis on All In Sustaining Costs (AISC) and that these, despite being far more encompassing, and less open to company by company variations than cash costs, are still reckoned by many bank analysts not to go far enough to account for all corporate costs in running modern day gold mines.

The mining companies have been entering into cost reductions that may perhaps be considered as window dressing to keep individual and institutional holders happy in that the easy cuts are being made regardless of the longer-term implications these may have on a company’s future. These include cutting back and deferring capital programmes (i.e. new mine developments and expansions); selling off less economic or lossmaking mines to smaller companies which may be more flexible in their approach; mining to higher grades, and thus debilitating longer term resource and reserve levels; cutting back management tiers (perhaps an area where the bigger companies can actually make sensible savings); cutting back on exploration expenditures (which like cutting capital programmes can impact on the longer term future for the companies concerned), reducing labour forces etc.

In effect these are the easy options in helping allay shareholder and institutional pressures to cut costs, but once made it becomes increasingly difficult to maintain these or extend them into the future. Most mining companies will have been hoping against hope that there will be a substantial gold price recovery sufficient to enable them to return to better profit margins and reverse some of those cuts to activities which might be beneficial long term, but so far no such rise has been forthcoming with gold trading largely flat over the past year to 18 months.

Indeed GMP subtitles its analysis ‘Cost optimizations can only go so far…’ and notes that although costs did indeed come down in 2013 and remain below 2013 levels in their forecasts for the current year, they do seem to have plateaued. For senior producers the AISC on average have declined 8% from $1,035/oz in 2013 to the 2015 forecast of $958/oz while mid-tier producers are seeing AISC down from $963/oz to $900 /oz – a fall of 7%. Meanwhile the gold price has fallen 16% from 2013 to GMP’s forecast $1225/oz for 2015. The brokerage/investment bank then comments that the question now is how much more the miners can do to cut costs further, if at all, and whether these new cost structures are sufficient to operate in the current environment.

Looking into the analysis further, something that GMP does not seem to comment on specifically is that the analysis includes a chart which, although it still shows an overall costs decline as noted above from 2013 to 2015, what must be disturbing for the miners is that it also shows AISC moving marginally higher for 2015 than they were in 2014. This suggests that although margins have been falling, costs are beginning to rise again – something we pointed out in our earlier article which looked at costs guidance figures for 2015 from all the top tier gold miners.

Another interesting point in the GMP analysis is that higher cost producers appear to have been less successful in cutting costs than the lower cost miners – contrary to expectations. In another chart they show that for the higher cost fraction, costs have only declined 4% from 2013 to 2015, while the lower cost section saw a fall of 10% over the same period. But, again in both cases there appeared to be a marginal increase in estimated costs for 2015 over and above those for 2014.

So with AISC beginning to rise again, and perhaps with the miners having little scope for implementing further reductions, naturally occurring inflation will be eating further into margins unless we see a pickup in the gold price. Some respite has been accorded to non-US producers by US dollar strength against most other currencies and by the big fall in oil prices. But both these seem to have stalled, at least for the time being, which will bring further pressures to bear on marginal gold mining operations. Much of the industry could thus be facing serious problems in the short to medium term if higher gold prices fail to materialise and come to their rescue.