Gold Miners Need a New Approach to Africa

Gold miners have had a rough year. Not only have unfavorable prices suppressed margins, but ballooning costs and battered confidence have contributed to an uncomfortably long bearish stretch. However, amid the despair, Africa, which has close to 40% of global gold reserves, offers some hope. Compared with the rest of the world, Africa's wage bill is still significantly low. Nevertheless, this may soon change. Is it time for a major rethink?

Runaway costs, paired with low gold pricing, have been miners' greatest nightmare over the past year. To provide a little context, Barrick Gold , the world's largest producer of the precious metal, took $8.7 billion of writedowns during its second quarter. This came amid rising costs, as reflected in the $8.56 billion loss it made during the quarter. The miner, which also slashed its dividend from 20 cents a share to 5 cents a share, said that it would mothball, sell, or close assets running above $1,000/oz. At the time, 25% of its assets were running above the $1,000/oz mark. As pointed out by fellow FoolDan Caplinger, Barrick Gold is not alone in operating above the unsustainable $1,000/oz cost mark. Newmont Mining expects all-in costs of between $1,100 and $1,200 per ounce in 2013.

In view of gold miners' plight, Africa has taken a more influential role. Its typically low wage bill acts as a great incentive.

Infrastructure costs could offset gains from cheap labor 
According to a World Bank report, only a third of Africans living in rural areas are within two kilometers of all-seasoned roads, compared with two thirds of the population in other parts of the developing world. This has prompted many mining companies to build their own distribution networks. According to the report, electricity also remains a primary challenge. As is, Sub-Saharan Africa's 48 countries, which have a cumulative population of close to 800 million, generate roughly the same amount of power as Spain, which has a population of 45 million.  

Earlier in the year, power company Eskom Holdings, which supplies close to 95% of South Africa's power, revealed that it wanted to follow through with 16% increments in average annual tariffs until 2018 to fund its continued expansion. This came at around the same time, when the South African government was seeking to collect more tax revenue from miners. To paint a darker shade of gloom, all this is happening against the backdrop of an increased push for natural resource nationalization in areas like Zimbabwe. 

Demand for African labor pushing wages up
To digress a bit for the sake of context, renowned Nomura analyst Richard Koo earlier in September published a report on China's economy. Koo said that the decline in the working age population would lead to higher wages in China, something that has been reiterated before by numerous economists. Indeed, steady increases in wages in China have seen demand for Africa's labor rise. This has in turn translated into Africans demanding higher pay. AngloGold Ashanti can bear witness to this.

Earlier in September, AngloGold Ashanti reached a landmark wage settlement with striking South African unions. It inked a two-year settlement agreement with its workers that will see pay levels rise between 7.5% and 8% for the first year starting July 1, 2013. To sweeten the pot for its workers, AngloGold's increases in the second year will reflect changes in the consumer price index.

Another trigger for increased wages is the burgeoning middle class in Africa, which is currently growing at the fastest pace in the world. A bigger middle class comes with better education and desire for higher paying jobs. 

Fool's takeaway
In the short run, Africa won't pull the rag from under gold miners. However, considering that we Fools have an inclination toward long plays, it is important that gold miners present a convincing African strategy for the long game. A PricewaterhouseCoopers report on mining indicates that 2012's return on capital employed (ROCE) in the sector was 8%, the lowest it has been for a decade. This means that the amount of capital needed to produce profits is increasing. In effect, gold miners will need more money, either through debt or equity. Considering that equity investors have turned the other way with regard to gold miners, presenting solid strategies for Africa could set the stage for renewed interest.

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