EDITORIAL & OPINION — FACTS ‘N’ FIGURES — Gold industry transforms

The years 1997 and 1998 were trying times for the U.S. gold industry. Gold prices fell to an 18-year low and were clearly the driving force behind changes in the industry. This price decline spurred expected results among U.S. producers: a profit squeeze, cost cutting, corporate consolidation, and considerable concern for local economies supported by gold mining.

In addition, falling prices appear to have fundamentally changed many producers’ strategies, from the accumulation of new reserves to cost-cutting and the acquisition of low-cost reserves.

With these developments hanging over the market, 1997 and 1998 were years of contrasts. Declining prices contrasted with increased U.S. and world output from new mines and expansions completed before prices fell. However, this momentum cannot be sustained in the long run at current prices. Overall, world production in 1997 grew 4.6% while U.S. production grew 6.7%, with increases in U.S. production accounting for more than 20% of the increase in world output.

In the face of low prices, U.S. producers have focused on cutting operating costs. Based on the survey conducted for this study, total cash operating costs (which include taxes and royalties) for U.S. producers declined from US$256 per oz. in 1995 to US$234 in 1996, and to US$214 in 1997. Those costs are estimated to be US$192 for 1998.

Following the initial drop in gold prices in late 1996, little corporate restructuring or merger and acquisition activity was recorded. However, as the price continued to drop into 1998 and 1999, North American companies became more active in restructuring and acquisitions.

Another contrast in the world industry has been the profit squeeze resulting from the falling prices, which has caused significant concern in local U.S. economies supported by gold mining. Although major layoffs or shutdowns have yet to materialize, this is not to say there have been no effects. Direct employment in the U.S. precious metals mining industry has declined by more than 2,000 jobs. Indirect job losses are estimated to be 10 times that figure, primarily as a result of scaled-back exploration and development activity.

As of mid-1998, only three U.S. gold mines had announced plans to close immediately, and these were associated with the bankruptcy reorganization of Pegasus Gold. Some companies announced imminent closures unless prices improve, while others announced the shutdown of parts of their facilities as cost-cutting measures. More commonly, producers postponed exploration and development activities pending price increases.

While these job losses and reductions in investment are clearly a matter of concern for local economies supported by gold mining, the damage has been relatively minor.

However, the severity of the effects of falling gold prices on regional economies in the U.S. depend entirely on where one looks. Montana’s precious metals industry has clearly been hit hardest, with the closure of two mines owned by Pegasus Gold and the passage of a ballot initiative banning the use of cyanide. On the other hand, the opening by Amax Gold (now part of Kinross Gold) of the Fort Knox mine north of Fairbanks, Alaska, has provided significant stimulus to that local economy. In Nevada, which accounts for 70% of U.S. gold production, major impacts were felt primarily in exploration and development. There have been layoffs at some mines, and this is likely to continue as long as the gold price stays below US$300 per oz.

Also, although producers in 1997 and 1998 were successful from an operational standpoint, they reported disappointing financial statements. The 22 North American producers with U.S. operations included in the study managed only US$326 million in earnings before federal taxes and asset writedowns on sales of US$7.3 billion. After writedowns, the same companies lost US$1.7 billion. Furthermore, the total market capitalization of these firms lost, in the midst of a booming stock market, about one-third of its value from year-end 1996 to year-end 1997. It continued to lose ground in 1998.

Because the U.S. industry has several low-cost producers capable of earning profits at current prices, it would appear that the investing public has overreacted to the industry’s current situation. Nonetheless, the outlook for the industry clearly rests on the future of price of gold. If the price recovers, the industry, through its cost-cutting, is poised to achieve new levels of profitability. However, if prices fail to improve, or deteriorate further, the low costs of many U.S. miners will give them a competitive edge over producers in other countries.

— The author is director of the Natural Resource Industry Institute at the University of Nevada. The preceding originally appeared in Gold News, a publication of the Washington, D.C.-based Gold Institute.