60c : its time to run, page-30

sbm in tommorows bulletin Gold hard facts
06/06/2006



No gold comfort
The Innovators: Australian Temporary Fencing
The Speculator


Finance>Shares
Industry>Mining and metals


With gold at record prices, you would expect miners to be ecstatic. Not so. getting it out of the ground is still hugely expensive. Alan Deans reports.

The nation was still on a high. A week after Todd Russell and Brant Webb cheated death in the shaky depths of the Beaconsfield gold mine, the celebrations were in full flight.In cold contrast, the workings were closed, and a coroner’s inquest and independent inquiry were in the offing. The two miners vowed they would never descend the shaft again and the future for the small town seemed anything but golden. In fact, greater forces were at work.

Overlooked by many, world gold prices were hitting levels never seen before. Three days after Russell and Webb emerged into a chill Tasmanian dawn, bullion touched $US714.80 ($943.80) an ounce, nearly $US50 above its previous closing peak of $US666 recorded in 1980. That was an unlikely $US200 more than it fetched when 2006 started.

Such euphoria makes it very hard for any mining company simply to walk away from a rich seam of ore such as the one that lies beneath Beaconsfield. Certainly, that’s the case for the junior partner in the troubled venture, Beaconsfield Gold.

Eight days after the mine torment ended, the company issued a brief and largely unnoticed announcement vowing to bat on. Its determination was steeled even more because of the years of promise and grinding disappointment endured even before the latest calamity. Gold grades had been uncertain, the treatment plant started out as a clunker and financial calamity seemed inevitable.

Now, Bill Colvin, the company’s chief executive, is confident that – despite public doubt about the mine re-opening – he can lay his hands on a cool $20.4m to get it humming. He figures that’s more than enough to fix it up, once and for all. He wants to buy out Allstate, the joint-venture partner that owns 51.5% of the mine. Allstate runs the operations, albeit managed by a firm of Perth accountants who administer its daily activities.

Despite being handicapped by the suspension from trading of Beaconsfield’s shares, Colvin reckons he can sell shares to raise the cash. “We’ve had lots of people express support and interest,” he told The Bulletin. “We can issue the shares even if we are still suspended. The price is irrelevant if you are talking about a company that will own 100% of the mine. The price would reflect that value.

“My opinion is that there will be a safe way to reopen the mine. We believe that it would benefit from a mining company approach [as opposed to an administrator’s one]. We want to go out and explore and have a confident view of the mine and its future.”

Right around Australia, confidence is brimming in the gold-mining sector. Despite a shake-out in prices in recent days that have knocked bullion prices back some 10% from their mid-May levels, the current crop of mining company bosses have never seen it so good.

In Aussie dollar terms spot gold was selling late last week at $857/oz, about $US650 in globally quoted prices. Local miners have been brought up to believe that they were making hay whenever $600 was breached: that’s happened four times in the past 20 years.

While the recent volatility in prices is threatening to create a high-wire act for executives who want to commit to long-term mine developments, considerable leeway remains. In fact, projects that even late last year remained frustratingly stalled because of questionable economics are now getting off the blocks.

None is larger than the $2bn Boddington mine, 130km south-east of Perth in the Darling Ranges. Since shallow workings were closed in 2001, several of the world’s largest gold miners have struggled to find a profitable way to extract what remains. Newmont and AngloGold believe they can now do it, but they have an agonising wait until late 2008 before they can pour the first ingots. In today’s environment, anything could happen before then.What makes Boddington a dicey operation is its low grade. While the mine will produce a handsome 11 million ounces over its 15-year life span, the average grade is less than one gram per tonne. To the layman, that is one part per million and is invisible to the naked eye. Not many mines can survive at that grade.

Also adding to the cost is that Boddington’s gold is encased in hard rock. The soft, overlaying material has already been dug out, and the ore that remains can be removed only after extensive blasting. What’s more, it is mostly sulphide ore that requires more expensive treatment than do oxide ores.

Many mining companies contemplating such a project would look for ways to offset the financial risks. A common method is to lock in revenues by selling forward large amounts of production. Indeed, many banks require such hedging protection before they will bankroll mining projects.

Newmont, however, has a policy of never hedging. “We have retained that policy with Boddington,” explains spokesman Mike Duggan. “We would have used a range of prices in our models for the project. We believe that our production costs will be around $290 an ounce after credits for some copper that will also be produced.”

While there is a considerable buffer now for Boddington, the scale of the project adds risk that smaller companies could not handle. Other projects, however, don’t enjoy the same margin.

Robin Widdup, managing director of listed gold investor Lion Selection, says that operating costs used to commonly range between $300 and $350 an ounce. That was before a huge rise in the costs of labour, equipment and materials experienced during the past two years.

“$400 is now regarded as being low cost,” says Widdup. “The fortunate thing is that revenues have risen by even more to cover these outlays. Mines that produce at, say, $500 may seem like they are high cost, but when you look at $900 received on forward sales contracts then it is not so expensive. People have not adjusted to that yet.”

They sure haven’t. The recent sharemarket shake-out precipitated by the correction in commodity prices has dumped some miners on rocky ground. Many mid-tier producers have slumped dramatically in value – few more so than Ballarat Goldfields, which lost nearly 40% of its market capitalisation.

Widdup, and many others, don’t believe that this shake-out marks the end of the bull run. “It might be that this cycle goes on for longer than people expect. Gold remains a buy for the time being. Exploration is not replacing reserves anywhere around the world. There are not enough new mines.” Recently Lion bought more shares in Westonia Mines to help finance plans to develop its Westonia mine east of Perth, which until now has been regarded as marginal.

It’s not simply a matter of working up a business case that eager bankers will finance. Despite the apparent commonsense of forward selling production to secure project funding, hedging remains a significant risk. Many companies are loath to raise the issue in case investors take flight, just because many miners have previously got their timing wrong.

Far East Capital’s gold expert, Warwick Grigor, estimates that leading junior gold producers are sitting on $630m in unrealised losses on contracts signed at much lower prices. They got in too early, and revenues are now suffering. He believes that investors might be better off backing companies with new projects and no hedging.

“At the very least, the numbers are sobering,” Grigor says, in reference to established mining companies. “In the extreme cases, they are scary.”

He estimates that during the six weeks between late March and early May alone, Resolute Mining doubled its unrealised hedging losses to $145m. Oceana Gold’s problems jumped from $45m to $94m, prompting it to restructure its exposure and book an as yet unquantified write-off to gain future upside and provide leeway to advance new projects.

Others listed by Grigor as holding sizeable hedging losses are Equigold ($72m), Perseverance ($55m), Kingsgate ($43m), Croesus ($39m), Emperor ($39m), Agincourt ($31m) and Dragon Mining ($31m).

Chris Cairns, the managing director of budding gold producer Integra Mining, is taking a cautious approach to the development of his Aldiss-Randalls mine in Western Australia. “There are risks with a company like ours – that have no current cash flow – trying to bring on a project with a cost of $45m. People would want to be assured we could do it on time and within budget.”

Aldiss-Randalls contains 1.2 million ounces – a sizeable resource, and it is near the surface. But it also has comparatively high operating costs of $548/oz and, until now, would not easily have got off the ground.

Integra is taking a savvy approach, however, and recently paid just $3m to buy an existing processing plant from the New Celebration mine in Kalgoorlie.

While that is shifted to a new site, Cairns has plans to build a small mine at Integra’s Maxwell deposit and have the ore toll-treated by a third party. That will provide cash to help fund Aldiss-Randalls, which should be in production by the end of next year.

Cairns is considering how best to cover development costs, including hedging. He says that he could sign a three-year forward sales contract that would lock-in $1025/oz prices, but even that enticement may not be good enough. “If you are facing 20%–30% annual cost increases, as the industry has been lately, then at the end of the sales contract the margins would be looking pretty skinny. We are facing a much more dynamic market at the moment, and we have to ensure that we get it right.”

He says it is likely Integra will agree to some hedging, some straight bank financing and put in place options that establish a floor price for gold sales while also allowing upside. “If we get it wrong first up, we run the risk of blowing the company up.”

One company acting with a degree of confidence towards becoming a major producer, however, is St Barbara. It has recently trebled reserves to 1.1 million ounces after paying just $2.3m a year ago, when gold was much cheaper, to buy choice assets from the failed Sons of Gwalia. It has sold some smaller mines and investments, also raising nearly $60m in a share issue to partly finance an underground mine called Gwalia Deeps.

“Our feasibility study on the Lenora project – Gwalia Deeps plus the Tarmoola open cut – is due for completion in the September quarter,” says chief executive Edward Eshuys. “If that is favourable, we could be back into production at Tarmoola next March quarter and at Gwalia a year later.”

The Gwalia workings were first mined in 1897, and when they closed in 1963 they had reached 1.1km in depth. Latest drilling shows that high grade mineralisation extends to at least 2km.

There seems little doubt that the project will go ahead, with just $40m required to fund the balance of the cost. Eshuys says that this would come from mining cash flows. It is expected to cost $450/oz at Leonora, the same as St Barbara’s current outlays.

A curious counterpoint to the tight-rope act being performed by local gold-mining hopefuls is the comparative advantages being gained by those eyeing offshore developments.

Mines in Papua New Guinea, Africa, Indonesia, Laos, the Philippines and Thailand used to be regarded as carrying considerably more risk because of political uncertainties. But, increasingly, Australian companies are opening mines in such locations with greater confidence.

Widdup says that many of the cost increases plaguing local projects have not occurred elsewhere. Labor remains cheap, and in many countries experienced people are readily available. “It is quite an unusual situation. Investors haven’t digested all of the factors.”

Lion is backing this judgement by holding substantial holdings in groups including Lafayette Mining, Indophil Resources, Austindo Resources and Iamgold