Even thousand-dollar gold won't boost supply soon

By Eric Onstad
Reuters
Tuesday, March 4, 2008

http://www.reuters.com/article/hotStocksNews/idUSL0475144320080304

LONDON -- A jump in the gold price over the magical $1,000 per ounce level would not be enough to bring on a surge of new production due to uncertainty over long-term prices, logistics problems, and scarcity of projects.

Global gold production has slipped by six percent since 2001 and analysts say current record prices are not expected to reverse the eroding trend in the next several years.

A buoyant gold price -- which touched an all-time peak of $989.30 an ounce on Monday -- allows firms to exploit lower-quality ore, but a dearth of new mine discoveries will mean that any real boost to production would be years away.

"Pick a number, even at $1,200 or $2,000, even at those very high prices, the existing resource bases are getting depleted. That you can't stop," said analyst Leon Esterhuizen with RBC Capital Markets in Johannesburg.

"The high gold price will certainly encourage exploration. The question is when you find the stuff, how long will that take to get into production."

Even when new deposits emerge, they may not be developed for a variety of reasons, including shortages of skilled labor and infrastructure, high capital costs, legal restrictions in emerging-market countries, and long-term price assumptions.

Before committing to expensive projects that may be producing for decades, mining firms must be sure that the prices used to judge viability will be sustained.

Mining firms rarely make public their long-term price assumptions, but analysts say projects have been delayed as their viability is shattered due to rising capital costs and long-term price estimates of around $500-$600 per ounce.

Canada's Teck Cominco said this month several projects would remain on hold, including the Galore Creek gold and copper project, on which development was halted last November when capital cost estimates more than doubled to C$5 billion ($5.06 billion).

...Hedging no option

"At current spot prices, pretty much all the projects out there are going to be viable anyway. It's more a question of how long it stays up here rather than how high it goes," said John Reade, head of metals strategy at UBS Investment Bank in London.

"It would have to stay high long enough to persuade the companies that this is sustained."

In the past miners might lock in current high prices by hedging at least a portion of the future production, but a groundswell of opposition by many investors to hedging has forced major firms to shun the practice.

Investors, bullish on rallying gold prices, argue that firms should be exposed to spot prices and have slammed firms for previous hedging at low levels that has dampened profits.

"Effectively, that is one way that the investor pressure against hedging is preventing companies from growing," Reade said.

Even with favorable economics, projects are encountering obstacles to building mines due to a global commodities boom that has led to shortages in a range of inputs, from skilled workers to giant tires.

"I don't think that margins are the real problem in terms of supply. ... The real issue is more around logistics as opposed to the pricing," JP Morgan analyst Michael Jansen said in London.

"There are problems in terms of developing world quality, large-scale resources, so miners have instead chosen to grow through merger and acquisition rather than organically and I can't see that changing short-term.

"We're still seeing some mine projects coming through, but net-net there's not much chance really of any growth in the next two years in terms of total mine supply."

... Lower grades

In the short term, firms may adjust yield requirements downward as higher prices allow them to exploit ore containing lower percentages of gold, but this is not expected to be significant in terms of overall production.

"The biggest part of extra gold you will get with a higher gold price is essentially gold that you've left behind because it was too low grade," Esterhuizen said.

A rising gold price has already spurred junior mining firms to take a new look at previously ignored deposits

South Africa's Wits Gold built up the sixth largest gold resource in the world by buying up mining rights to deep-level deposits deemed uneconomic by major firms.

But most analysts believe that it would take at least a decade to bring those news mines into production.

New prospecting has been shifting from mature gold producers like South Africa, which lost its top ranking in terms of output last year, to countries like Russia and China, but navigating around political and legal requirements may also extend lead times to getting gold out of the ground, analysts said.

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