Can the smaller gold producers survive?

The following is the first of a 2-part overview of how junior and mid-tier gold mining companies are coping in today’s low-price environment.

Not since the gold bubble of the early 1980s has the London bullion fix been watched with so much trepidation. Each day, producers cross their fingers and hope the price doesn’t crash through another barrier, as low prices close their profit margins.

As gold prices slide further into the mire, more and more mines stand to be rendered uneconomic. Can the industry save itself?

The industry’s biggest companies have insisted the answer is in low costs. Quantity — reserves and resources — is out, and quality is in. That formula works well for large companies, not least because higher-cost operations can be closed without making a significant impact on production. But for a smaller producer in the middle and junior tier of the industry, simply jettisoning the higher-cost operations does not make sense.

There is always the hope of squeezing more costs in day-to-day operations, and cutting drastically in general corporate costs. But that ultimately means slashing exploration and development budgets, which are the lifeblood of production.

And how much further can cost-cutting go on the production side? According to a research memo circulated by Goepel McDermid Securities, gold mining is not a sustainable business at current gold prices. This is based on the assumption that industry costs have been cut to practical limits over the past few years.

“Even if companies produce at US$210 or US$215, per oz., when you include the cost of ongoing development and acquisition, you ramp right up to US$300 per oz.,” says Goepel McDermid analyst Donald Poirier, adding that it is difficult to find an undeveloped project that will have a total production cost (including depreciation, amortization and closure expenses) under US$300 per oz.

The research memo also points out that companies with higher production costs, major capital requirements or weak debt-servicing capacity, at today’s gold prices, may not be around when the gold price improves.

A caving gold price has exposed two obvious causes of trouble for the mid-tier producers: unsuccessful projects and too much debt. Many of the mid-tier companies, who lacked the big chequebooks of the major gold producers, took on marginal projects, which were easier to acquire but have turned out to be poor investments in the tougher gold market. When companies took on debt to buy or build poor-quality projects, the ingredients for failure were poured into the mixture.

Pegasus Gold was the first casualty from the falling gold price. In the third quarter of 1997, the company announced massive writedowns of US$350 million (totalling US$8.55 per share), before filing for bankruptcy in January 1998. The marginal Mt. Todd gold mine in Australia is generally conceded to have been the project that grounded Pegasus, and large environmental liabilities (notably at the Zortman mine in Montana) did nothing to help.

The company continued operating under the control of its creditors, and shareholders were left holding worthless paper when the company reorganized under the name Apollo Gold. The creditors took shares of the new company as a settlement against the old debts.

The still-private company is examining its options for the future, including a merger with a public company. Apollo’s cash costs, including taxes and royalties, remain competitive at US$222 per oz. on production of 50,000 oz. through April.

Royal Oak Mines is the poster child for uncontrolled debt. The high-cost producer pinned its hopes of recovery on the Kemess project in northern British Columbia, insisting it could make Kemess profitable despite the deposit’s low grade. In doing so, Royal Oak racked up debts of more than $500 million (much of it bearing interest at rates that would make a loan shark salivate), then went through a cycle of restructurings and “technical” defaults before succumbing in April. Kemess never lived up to its billing as Royal Oak’s savior, and the company’s carcass is now being picked by creditors, many of whom are unlikely to get a satisfying meal.

Another early casualty,Echo Bay Mines (ECO-X), laid off employees and wrote down US$360 million at the end of 1997, and yet is still not out of danger from its high debt load. The company survives on its hedging strategy, which involved selling forward its 1999 production of up to 475,000 oz. at US$349 per oz., but owes US$57.1 million in gold loans, currency loans and a revolving line of credit. It also owes US$114 million in capital securities, though it has been able to defer payment of interest, without penalty, for the past 18 months.

Total production costs at Echo Bay’s operations in Nevada and Washington sit above the current gold price. In the first quarter of 1999, cash operating costs were US$216 per oz. gold, compared with US$208 per oz. for the corresponding period last year. Total production costs were unchanged at US$316 per oz. in the first quarter of 1999.

Dayton Mining (DAY-T) earned US$410,000 (or US2 cents per share) on revenue of US$10.2 million during the first quarter, compared with a loss of US$2.2 million (US8 cents per share) on revenue of US$6.65 million a year earlier.

The average realized price of gold sold during the quarter was US$310 per oz., compared with US$403 per oz. a year ago. The company has hedged 63,000 oz. at a price of $340 per oz.

Dayton holds a 100% interest in the Andacollo gold mine in central Chile. Gold production there rang in at 32,882 oz. gold at a cash operating cost of US$196 per oz. in the first quarter, compared with 18,109 oz. gold at US$284 per oz. a year earlier.

In 1997, Dayton issued a US$69-million, 7% convertible debenture. The proceeds were used to service its bank debt, support capital expenditures at the mine and service interest on debentures to the tune of US$4.8 million per year. In an effort to reorganize its capital structure in the face of low gold prices, Dayton sought and obtained debenture-holder and shareholder approval to convert all of the US$69 million worth of debentures into 310 million common shares of the company. The transaction was approved in late March. The company’s total issued and outstanding shares now stand at 351 million.

At the end of the first quarter, Dayton reported a long-term debt of US$8.1 million. Total liabilities rang in at about US$25.2 million.

Heap leachers

Pegasus and Echo Bay are part of that early-80s generation of companies that made their fortunes in the open-pit operations of the western U.S. Many of the mines of that golden age have closed, or are nearing the end of their productive lives, and their age sometimes shows. There is still one advantage — mature operations have low capital costs; but debts can wipe out that advantage quickly.

Viceroy Resource (VOY-T) posted a first-quarter loss of $201,000 (or nil per share), compared with a loss of $1.7 million (3 cents per share) in the year-ago period. Revenue between the two quarters slipped to $11.4 million from $16.1 million.

The company realized US$401 per oz. on gold sales as a result of its hedging program, and working capital stood at $49.3 million at the end of the first quarter.

Viceroy owns and operates the Brewery Creek mine in northwestern Yukon. The mine produced 6,806 oz. gold at a cash operating cost of US$323 per oz. during the first quarter of 1999. In the corresponding period of 1998, the operation produced 10,342 oz. at US$236 per oz. The increase was attributed to lower gold production.

Reserves at the mine stand at 11.8 million tonnes grading 1.13 grams gold per tonne, equivalent to 426,000 contained ounces.

Viceroy also holds a 75% interest in the Castle Mountain mine in southern California, with the remainder held by MK Gold (MKAU-Q).

Castle Mountain produced 16,334 oz. gold during the first three months of 1999 at a cash operating cost of US$344 per oz., down from 23
,459 oz. at US$348 per oz. in the year-ago period. The discrepancy in cash costs was attributed to the deferral of waste stripping and reduced material and supply costs.

Reserves at the open-pit, heap-leach operation are pegged at 8.9 million tonnes grading 1.26 grams gold, or 358,000 contained ounces.

At the end of the first quarter, Viceroy reported a long-term debt of $13 million and total liabilities of $32.9 million.

Now fixated on the fast-track development of its Red Lake gold mine in northwestern Ontario, Goldcorp (G-T) has already proved its capabilities as an operator through its Wharf open-pit gold mine in South Dakota.

First-quarter gold production from Wharf totalled 22,224 oz. at a cash production cost of US$199 per oz. and a total operating cost of US$234 per oz. During this time, the company sold 23,000 oz. gold at an average US$287 per oz. and recorded earnings of US$88,000 on gold revenue of US$6.6 million. (Another US$5 million in revenue came from the company’s industrial minerals operations.)

Goldcorp says the mine is on target to produce 104,000 oz. gold this year at a cash production cost of US$197 per oz.

On March 31, Goldcorp US$22.2 million in working capital (including US$9.5 million in cash and short-term investments) and US$11.4 million in liabilities. In May, Goldcorp netted C$56.8 million in a bought deal, with the money being directed toward development at Red Lake.

Mergers have also helped mid-tier producers weather low gold prices. Companies with cash on hand or low debt have been able to strengthen by buying up other operations.

In March, Glamis Gold (GLG-N) took over Rayrock Resources, adding three new mines to its portfolio at a time when Glamis’s main operations were showing their age.

The company, in partnership with Barrick Gold (ABX-N), remains active with an underground development program on the Carlin trend in Nevada. Currently, Glamis is drilling the San Martin deposit in Honduras, which was acquired in its takeover of Mar-West Resources in 1998. Meanwhile, exploration continues at the Cerro Blanco project, also in Guatemala.

What puts Glamis in the driver’s seat is US$34.2 million in working capital, including US$30 million in uncommitted cash.

The company has US$4 million in current liabilities, which is due to be paid in July.

Denver-based Vista Gold (VGZ-T) hoped to take the same route, when it announced merger discussions with Metallica Resources (MR-T) in May. However, the merger proposal fell through in following month.

Nevertheless, the company has tried to remain competitive through the acquisition of the Mineral Ridge gold mine in Nevada in late 1998.

The company owes US$15 million in non-recourse debt against Mineral Ridge. Otherwise it is debt-free, with a cash position of US$5.5 million.

In Bolivia, Vista is proceeding with development plans for the Amayapampa gold project, where capital costs are estimated at US$23 million.

Narrow-vein winners

One class of operation still seems to be successful: small high-grade vein mines. One reason is that improvements in productivity save money by the tonne of ore, and when that tonne has plenty of gold, the savings per ounce produced multiply. Another reason is that capital costs in underground mines often come in small, manageable lumps that a small company can digest. By comparison, large, open-pit operations often carry big initial capital costs that force the mine to do or die early in its life.

A potent combination of high grades and low mining costs is allowing Toronto-based junior River Gold (RIV-T) to ride out low gold prices and even turn a small profit.

During the first quarter of 1999, at its Eagle River underground mine north of Wawa, Ont., River Gold mined vein gold grading 10.7 grams gold per tonne, producing 21,000 oz. gold at a cash cost of US$205 per oz. The company also maintained a broken-ore stockpile of 192,000 tonnes.

During this time, River Gold realized a price of US$286 per oz. for its production and managed to post earnings of $287,000 on revenue of $9.2 million.

Of note, the company is nearing completion a $1.2-million program that will boost the capacity of its mill by 50% to a daily 900 tonnes. As well, River Gold plans to deepen the shaft at Eagle River to an initial 740 metres, with work to get under way this summer. Production is projected at 100,000 oz. gold for 1999.

River Gold also periodically mines the nearby Edwards deposit of Vencan Gold (VCG-M) in return for half that project’s profits. Mining and development at Edwards continue, and milling was set to resume in the second quarter. On March 31, River Gold had current assets totalling $5.8 million, current liabilities of $9.1 million, and gold and bank loans totalling $2 million.

Bent on growth, Vancouver-based Aurizon Mines (ARZ-T) has boosted its attributable gold production every year since the early 1990s and even managed to turn a slight profit last year despite the industry downturn.

From its half-owned Beaufor and Sleeping Giant underground mines in Quebec, Aurizon’s share of gold production during the first quarter of 1999 was 15,865 oz., mined at a total cash cost of US$197 per oz. and a total production cost of US$230 per oz. Aurizon is operator at Beaufor, where it is partnered with Louvem Mines (LOV-M). Cambior (CBJ-T) holds 50% of Sleeping Giant and operates the mine. The production gains from both mines were better than expected, owing to an unanticipated rise in head grades.

For the first quarter, Aurizon realized US$309 per oz. for its share of production and posted healthy earnings of $1.5 million on revenue of $7.5 million. Aurizon ended the period with $8.6 million in cash and equivalents, coupled with $3.4 million in long-term debt.

This year, Aurizon expects its share of production to reach 60,000 oz. at a total cash cost of US$195 per oz.. As well, in a prescient move, the junior has sold forward all its 1999 production and will receive a minimum US$300 per oz.

Aurizon’s long-term goal is to be producing 150,000 oz. annually by 2002 from its existing mines and from its wholly owned Casa Berardi project in northwestern Quebec. At Casa Berardi, more than $7 million is being spent this year on an ongoing feasibility study that is attempting to delineate a 1-million-oz. resource.

Like River and Aurizon, Richmont Mines (RIC-T) owes its success to being a good underground operator. Its weak performance in the first quarter of 1999 — a $517,685 loss on revenue of $9.3 million — obscures a long string of profitability at its underground mines: Francoeur in northwestern Quebec and Nugget Pond in Newfoundland.

Direct production costs at Francoeur ballooned to US$286 in the first quarter of 1999, during a cash-consuming development program. First-quarter costs in 1998 were a more typical US$218 per oz. Nugget Pond still mines 0.3-oz. ore at a cash cost of US$155, among the lowest in the industry.

Another small producer, Claude Resources (CRJ-T), has been quietly forging a similar success in northern Saskatchewan. Claude earned $1.2 million on revenue of $8.3 million in the first quarter of 1999, on the strength of record production from the Seabee and Currie Rose properties northeast of La Ronge.

Claude’s cash cost in the first quarter, US$194 per oz., included some exploration expenditures at Currie Rose. Direct costs for actual production were closer to the 1998 first-quarter figure of US$173.

Exall Resources (EXL-T) made money at its 65.6%-held Glimmer gold mine in northeastern Ontario last year. By year-end, the junior posted net income of $2.5 million and had $1.5 million in its kitty. The mine produced 64,319 oz. at a cash cost of US$238 per oz. in 1998, its first year of production. It operated at a rate of 871 tonnes per day, treating ore grading 6.67 grams gold per tonne.

In the 1999 first quarter, the mine produced 12,79
5 oz. gold at a cash cost of US$259 per oz. Exall posted net income of $332,761 for the period.

Glimmer Resources (GME-V) holds a 34.4% interest in the mine. However, the company and Exall are engaged in a legal dispute over their respective interests.