The Problems With Gold Miners Could Have Been Avoided

The Problems With Gold Miners Could Have Been Avoided

The gold mining industry has not had it easy over the past 12 or so months. After gold prices hit record highs in 2011 and new capital surged into mining projects many gold mining companies and their management teams believed that they could do no wrong.

However, nearly two years on and the industry is in trouble. The price of gold has collapsed, from a high of nearly $1,900 per ounce back in 2011, to within inches of $1,200 per ounce back in July. Unfortunately, according to data compiled by Bloomberg earlier this year, if the price of gold trades below $1,300, around 30%-40% of global mine production is unprofitable. What's more, many mining companies used the high price of gold to value their mines (gold mines, like other assets, are valued according to the value of their contents).

Newcrest Mining currently holds the crown for the gold sector's biggest writedown in history. The total: $6 billion. Nonetheless, Barrick Gold's (NYSE: ABX)writedown on its Pascua-Lama mine in the Andes, which cost the company $5.1 billion, is potentially one of the biggest single-mine writedowns in history.

Newcrest's writedowns highlight the issue of overspending in the boom times, which many miners are now suffering for. Indeed, some analysts have stated that Newcrest's acquisition of the Hidden Valley mine, was a "bad investment" caused by "high priced paper purchasing high priced paper" (overpriced Newcrest stock was offered in lieu of cash for the acquisition of a competitor, which was also overpriced).

The scale of Newcrest's mistake is brought to light by recent figures that suggest the cash cost of gold production at the Hidden Valley has at points reached $1,900. Bear in mind that this is the cash cost per ounce and does not include items such as capital spending and exploration costs, unlike the all-in-sustaining-cash cost, which is usually much higher. Indicating that at some points since production commenced, Newcrest could have been operating its Hidden Value mine at a considerable loss.

Bigger problems
In addition to the falling price of gold and writedowns, companies are facing rising wage costs. South African miner AngloGold Ashanti has been embroiled in arguments with workers over pay for the majority of this year. Inflation within South Africa is running at around 5.6% per year, and companies operating within the country are under pressure to increase wages at a rate greater than this. So, while the gold price continues to head downwards, South African mining companies are having to stump up for wage increases above 6% for their workforces. Still, back in June workers' unions were calling for a minimum wage hike of around 61%, but mining companies only wanted to offer a hike of 4%: in real terms, a cut in pay.

However, after several spates of industrial action, AngloGold has been forced to offer a wage hike of between 7.5% and 8% for 2013, followed by an inflation-linked wage rise during 2014. Workers' "living out" allowance is also set to rise around 10% a year for the next two years.

As the gold price continues to slide, these wage hikes do not bode well for AngloGold's already loss-making operations.

Fat cats
Harmony Gold Mining
is also facing wage-inflation pressures, although in this case it is management and not workers that is pressuring profits. From 2008 through 2012, total pay for executive management at Harmony, including gains from share options rose 72%, from 12.7 million rand to 21.8 million rand. Over the same period Harmony's gold production fell 18%.

Harmony's workers on the other hand have only seen wage increases of around 40% during the same period. With Harmony's gold output declining, the final dividend being cut, and capex being slashed by 650 million rand for fiscal 2014, it would appear that the company is struggling for cash, but not when it comes to management pay packets.

Foolish summary
In my experience a management team like Harmony's that increases their own pay-packets even when the company is struggling to turn a profit is a bad sign. Moreover, a company with rapidly rising wage costs but falling revenues looks similarly troubling. In addition, Newcrest's and Barrick's record-breaking writedowns do not say much for their management teams as they should have avoided overpaying in the first place.

All in all, the gold mining industry is facing more problems than just the falling price of gold, and it would appear that most of these problems, especially where management is concerned, could be avoidable.

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Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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