Will the gold rush ever end?
Monday, May 22, 2017
In response to the financial crisis in 2007, gold prices more than doubled rising from an average of $600 per ounce in 2006 to a record high of $1,700 per ounce in 2012. Since then, markets stabilized slightly, and gold prices have decreased to an average of $1,200 to $1,300 per ounce through 2015 and 2016.
While it is impossible to predict commodity price developments, gold will probably never be out of vogue. Despite the end of the gold standard, governments still keep gold as a backbone to economic instabilities. For instance, the German government, moved its gold reserves from the U.S. to France following the election of Donald Trump.
According to the World Gold Council, gold is mined on every continent except Antarctica. The world's biggest gold mine in terms of contained gold is currently located in Indonesia. The Grasberg gold mine contains an estimated gold reserve of 71 million ounces, as of December 2012. This is followed by the South Deep gold mine in South Africa, with estimated reserves of 39 million ounces.
Africa currently makes up 30 percent of global gold production. While the continent is not the mainstay of global production, it hosts a number of upcoming large-scale gold mining projects. Next to long-staying producers like Ghana, countries like Tanzania, Mali and Ivory Coast are ramping up gold production.
How profitable is the gold mining industry?
Many might imagine that gold mining is a business in which one can make easy money by sapping gold from large veins under the earth's crust. However, quite the contrary is true.
On an industrial scale, gold mining is expensive and can be damaging to the environment. The profitability of a gold mining project can vary dramatically from one site to another. For a few grams of gold, a mining company has to extract and process tonnes of ore. For instance, Acacia Mining in Tanzania extracts on average 8 to 9 grams of gold for each tonne of ore mined.
Generally, operating costs for gold mines can also vary considerably from project to project. For instance, South Africa's gold mining industry is one of the most costly in the world — while operating expenditures have fallen from over $300 per ounce down to $246 per ounce. The cost of production in the U.S. $189 per ounce and in Canada $169 per ounce.
The case of the Bulyanhulu mine in Tanzania
An excellent case in point is the Bulyanhulu mine in Tanzania. Gold prices and other factors have influenced the profitability of the project considerably.
As one of the biggest gold mining projects in Tanzania, the mine had not been particularly profitable until 2014, despite $3.6 billion in gross revenues. According to a financial analysis by OpenOil, net cashflows were negative until 2009, and after a couple of positive years turned negative again in 2013-14 with the fall of global gold prices.
Overview of the financial analysis of the Bulyanulu project in Tanzania. (Image: Open Oil)
Similar to average operating expenditures in South Africa, the Bulyanhulu project seems to face high unit costs, despite the relatively high grade of its ore.
On a pretax basis, the Internal Rate of Return (IRR) is 13.1 percent. The analysis states that this is "pretty marginal" and that mining companies would likely aim to make at least 10 percent on an after-tax basis for relatively high-risk developing country investments. Net cashflows are $282 million discounted at 10 percent, which is also very low given the economic environment and the risk taken by the investor.
The example demonstrates well the difficulties and the financial risks of the sector — not even taking into account the environmental risks and costs of the gold-mining sector. One thing is certain: When taking all risks and costs into account, gold mining might not be as profitable as one might think at first sight.
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