http://www.gold-eagle.com/editorials_05/roffey051506.html
FATAL EXTRACTION
Hedging and Political Risk
(Comparison of world’s top 15 gold miners)
Investment Indicators from Peter George
Friday, May 12, 2005
SUMMARY
S.2 THE FATAL ATTRACTION OF GOLD
The phrase ‘Fatal Attraction’ harks back to a film of that name released in ‘87. It told of how a man’s ‘one night stand’ came back to haunt him. A viewer described it as:
“A fantastic journey of lust and its consequences”
The writer constructs a play on words to mimic the ‘fatal’ parallels which exist between man’s vulnerability to the attractions of woman, and his similar age-old proclivity for gold. It is no accident that when God first created man and placed him in the Garden of Eden, he planted him in close proximity to a rich deposit of gold. That happened before he met Eve. The excitement of the search for both has continued ever since, but focus in this article is on the quest for gold. Where is it found, and what are the attendant risks? How do we choose between ‘GOOD GOLD’ and ‘BAD’? Which host countries are friendly? Which are not and pose a risk? Which producers believe in the metal’s role as money and hope for the price to rise? Which have suffered fatal wounds through the practice of ‘hedging’ and will die if gold takes off? This article endeavors to separate the sheep from the goats. In the area of ‘political risk’ it will seek to lay down some principles and illustrate foolish errors.
S.4 FROM ATTRACTION TO EXTRACTION
It is the innate, God-given value of gold, which simultaneously imbues the metal with a FATAL ATTRACTION. Men desire it. They wish to hold it, touch it, store it - give it as tokens of affection to wives and girlfriends. Since its first discovery gold’s scarcity and natural beauty ensured there was always demand. This gave opportunity to others – to beg, borrow, steal and find it– with the intention of sourcing and selling it to others. Entrepreneurs prepared to mine it, would locate it in sites all over the world. Then, where possible, they would make long term plans to EXTRACT it and sell it for a PROFIT.
This article focuses on COUNTRIES of EXTRACTION – past present and future. It highlights trends in world production, to determine from whence that gold might come. More important, it attempts to provide some rating guidelines for assessing the risks and rewards of mining in different countries. Which of them offers the best all-round environment for prospective miners? Many carry substantial political risk. It is often the case that the easiest gold to extract is fraught with the greatest dangers. To use an old ‘colonial’ expression ‘the natives in far off lands occasionally grow restless’. When it happens, the process of extraction gets interrupted. Equipment is destroyed. Camps are overrun. Workers are killed. Entire operations are subjected to expropriation. Taxes are raised. ‘Royalties’ are demanded. Outside ‘partners’ are imposed without capital and so much as a ‘by your leave’. In times such as these it’s sometimes preferable to abandon ship and seek better climes.
In the lust to discover and mine at any cost, the concept of RISK is thus frequently ignored and overlooked. The large international miner is often his own worst enemy. The increasing difficulty of replacing a ‘wasting asset’ drives him to take foolish risks. American-based gold companies are increasingly the most frequent victims. In days gone by they were able to rely on the powerful reach of ‘Pax Americana’. The strong arm of US military intervention, was always there should things go wrong. Today there is a growing coterie of despotic nations blessed with promising deposits of valuable minerals – gold, oil and gas - whose governments hate and despise American power and influence. They are ready to defy US diplomatic pressure at the drop of a hat. Names like Iran, Venezuela, Peru, Uzbekistan, Indonesia, Papua New Guinea - even Russia - all readily spring to mind. The exception might be China. She herself is voraciously on the hunt for resources of her own, most notably in Africa. She needs to behave. Others - as we will discover – are fickle and have temporary favorites.
Study a list of the world’s top country producers of gold. Once past South Africa, the US, Australia, and Canada, they consist in the main of despotic nations one and all. In recent months the intransigent actions and public posturing of Venezuela, Bolivia and Iran on the oil, gas and nuclear fronts, incite those like Peru, Uzbekistan, Indonesia and the rest, to similar unilateral behavior when it comes to licensing the mining of other resources, particularly gold. A rising tide of chaotic and illegal behavior is collectively threatening to destroy the confidence of international corporations. In due course – if they are sensible – they will eliminate the countries concerned from their respective investment radar screens. On the other hand, there are certain countries which proactively do it for you. We will consider the implications for foreign investors wishing to pick winners from a very disparate bunch.
It is the purpose of this report to highlight recent incidents in certain countries with a view to alerting investors to future trends. Many blithely assume that if a stock is listed on a major international exchange – particularly London or America – that production is secure and subject to the same oversight as the country of listing. The truth can be quite different. The financial future of major corporations often rests disproportionately in the hands of despotic rulers whose future actions are unpredictable – and for whom the ‘rule of law’ is a distant stranger.
Even favorite host countries like South Africa, the US and Australia, are capable of delivering nasty shocks when it comes to the increasing influence of environmentalists and concepts like ‘black empowerment’. None is perfect. There is however one tiny nation which stands head and shoulders above the rest. It represents a model of good behavior in its attitude towards foreign investors. That country is Singapore. One can use some of the lessons they have learned and the standards they have established to judge the rest by way of comparison. At the end one can look to pick one or two winners. Hopefully they will come from countries where the unexpected is limited, futures are bright, and prospects of rising supplies of are relatively secure.
1. GOLD: A POTTED HISTORY OF PRODUCTION
Back in 1845 world gold production was nominal. By 1880 there was a minor gold rush. Six years later George Harrison discovered the ‘Main Reef Leader’ at Langlaagte, on the border of what later became known as ‘Johannesburg’, slap bang in the centre of South Africa. He had found the Great Witwatersrand Gold Basin. Eventually it would lead to the opening of seven major goldfields and two minor ones - nine in total. To date the basin has yielded in excess of 50,000 tons – a third of all the gold produced since the beginning of time. Harrison’s friend and associate Fred Struben prophetically sketched the significance of the find in a letter to his brother’s wife.
“This new discovery means the commencement of a very large goldfield and will give work not only for a few machines but for hundreds of thousands of miners. There are, I believe, innumerable similar veins about to the south of this and extending for miles in each direction. If this should turn out as I think, I wonder if the world will ever give me credit for no little trouble and thought to discover all this or will it merely call it luck. My idea it will be the latter.”
He was wrong. Today the world does acknowledge his vision and prescience – more particularly the role he played in encouraging his friends to hope for the best.
By 1986, 100 years down the line, the number of men employed on South African mines reached an all time high of 534,255. Struben had been right. Today, twenty years later in 2006, and thanks to the gold suppression efforts of the likes of British Chancellor of the Exchequer Gordon Brown, the figure has shrunk to a miserable 130,000. Yet a recent front page headline showed Brown smiling and shaking hands with South Africa’s ex-President, Nelson Mandela, basking hypocritically in misplaced adulation – “UK to give $15billion to help educate world’s poor”. Nearly seven years ago – on May 7, 1999 to be exact - it was the same Gordon Brown who publicly announced a brazen plan to dump more than half Britain’s gold stock in a thinly disguised scheme to smash the price below $300. A month later it bottomed at $253. The purpose of his country’s destructive intervention was to protect central bank FIAT currencies by rendering monetary gold ‘unattractive’. Greenspan was undoubtedly urging him on.
Today, with Brent oil prices holding above $70 a barrel – up 75% from 1980 highs of $40 – gold should be over $1500. A year ago it was less than a THIRD of that level. With friends like Gordon Brown, the gold producers of Africa don’t need enemies. The current price of $635 is still only a pale reflection of where it ought to be. Remember this as we review the history of South Africa’s gold production from 1970 to the present. The damage caused by the actions of central banks has been considerable. By the same token, one should not underestimate the ‘bounce back’ potential as prices recover towards where they ought to be. This aspect will be discussed later.
1970 was the year South African gold production hit an all-time high of 1,000 tons. At that stage the world total was 1,484 tons. South Africa’s share was an overwhelming 67%. From then until the present the nation’s contribution has fallen significantly, both in absolute terms and as a percent of an expanding world total.
The past is reviewed in a series of five-year stages. Note the sudden appearance of major new producers as one approaches the new millennium. Some are challenging South Africa. Next year one or two may temporarily surpass her. For reasons given later, it is doubtful whether South Africa will take second place for long. A potted history brings one up to date.
NB: What is striking about the above list is the extent to which South Africa has slipped from its role of outright leadership and is in apparent danger of being overtaken. Is her demise permanent or simply a function of what happens to the world’s highest cost producer during a time of major gold price suppression?
1.9 CAN SOUTH AFRICA REGAIN TRACTION AS GOLD RECOVERS?
As the gold price lifts off into the stratosphere, and margins are restored to the high-cost deep-level mines of South Africa, can the industry experience a major revival? Most of the majors doubt it and are going elsewhere. The writer disagrees and shares the optimism expressed by the Chairman of newly-listed Wits Gold, Adam Fleming (JSE code: WGR). Chairman of Harmony from 1999 to 2003, Fleming resigned to set up an exploration company. Last week he obtained a sought after listing on the Gold Mining sector of the Johannesburg Stock Exchange. To the chagrin and surprise of skeptical financial journalists, the shares registered a new high of R70 a share on their second day of listing. With 25m shares in issue it gave the upstart newcomer a market capitalization of R1,75billion!
Three years ago Fleming set out to pick up all the deep-level down-dip ground he was able. He focused on the ‘Potchefstroom Gap’ and areas adjoining famous old timers in the Southern Free State and Klerksdorp. Wits Gold owns six prospecting licenses for exploration targets previously owned by Harmony Gold, Gold Fields, and AngloGold Ashanti. The latter all have right of first refusal to repurchase up to 40% of any prospect proved economic and previously owned.
The group claims to have a total resource of 142m ozs of gold, registered by respected consultants Snowden Mining. Although much of the ounces are at depths up to 3,500 meters and over, some 25m ozs are either shallow or of high grade – up to 14gms per ton. The total resource is equivalent to almost 4,500 tons of gold.
Fleming’s confidence is unstinting:
“I think we’re in the foothills of a major gold run....It’s inconceivable to me that the majors won’t have to come back to the Wits to find gold again....an area that has supplied one in three ounces of all gold ever mined...Between eight and nine million ounces of gold has to be found every year by Newmont Mining to keep its reserves stable.”
That’s only Newmont. What about all the rest? Fleming was also supportive of South Africa’s latest minerals legislation which effectively says: “Use it or lose it.” Fleming states:
“If it wasn’t for the Minerals Bill, our gold and uranium reserves would still be sitting in a dusty filing cabinet.”
If that’s how confident Fleming is regarding gold at depth, imagine the excitement if substantial deposits can be recovered at levels far shallower. The writer will comment on these prospects later.
2.0 ‘TOP 15’ CORPORATE GOLD PRODUCERS
The writer is again indebted here to Gold Fields Minerals Services latest report. This is the list one turns to first when endeavoring to select a ‘long-haul’ winner or two for the next five years. The writer will apply two selection criteria in an effort to eliminate those producers considered least likely to offer safe and acceptable returns. The process will begin by addressing the issue of hedging. Having first demonstrated its dangers in the case of a major, the writer will analyze the risk to each of the culprits.
