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Eric Hommelberg

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By Eric Hommelberg   Printer Friendly Version

April 18, 2005


Gold & Supply is chapter IV of the Gold Drivers Report and has a strong focus on a declining Gold supply coming years. This is important since many analysts are pointing towards lower Gold prices due to an expected increase in world gold production. Jeff Christian of the CPM group said on ROB TV late March :

World gold production levels are going up and will bring down the price of gold should it rise.

Well, maybe Mr. Christian is right but I simply disagree and here's why :

Gold production is approximately 2500 ton a year nowadays and projected to fall down to 2000 ton a year this decade. Alarm Bells were being raised everywhere since 2002 but it took a long time before falling Gold production got some media attention. Nevertheless it seems that the awareness regarding a decline in Gold supply is growing. Here's what Mineweg reported late 2004 :

The pressure is on for physical gold.

London (, Nov 25, 2004

"Demand is growing and production is falling. That is according to the latest gold supply and demand trends published by the World Gold Council covering the third quarter released this morning (November 25) and which show a contraction in supply against growth in demand."

"The figures, compiled for the World Gold Council by GFMS Ltd indicated that supply contracted sharply during Q3, dropping by 22.4 percent to 828t, against 1066t in the third quarter of last year." END.

The fact that a declining Gold supply could have a serious impact on the price of Gold coming years is gaining more credibility lately. Dow Jones News Service quoted Merril Lynch Gold fund manager Evy Hambro on falling mine output and its impact on the Gold price.

Dow Jones News Service
Falling mine output over the coming years

Wednesday, November 10, 2004

SYDNEY -- Merrill Lynch Investment Managers have a favorable outlook for gold, underpinned primarily by emerging pressures on supply, a leading member of the firm's London-based natural resources team said late Tuesday.

Amid "relatively static" demand, falling mine output over the coming years and the potential for a reduction in European central bank sales stand to prolong the rally in U.S. dollar gold prices, Merrill gold fund manager Evy Hambro explained during a visit to Sydney. END.
Already in 2002 a study published by Beacon Group Advisors forecasted a decline of Gold production of 35% for the following 5 to 8 years. (see graph below)

The reason for this was a lack of Exploration during the 1997 - 2002 period. During this period Exploration budgets had been cut by 67% simply due to the fact that Exploration programs weren't profitable with a Gold price below $350 / ounce. No Exploration means no new Gold deposits ! It's as simple as that !

Now let's focus on the Alarm Bells being raised since 2002 :

April 2002 : AngloGold
AngloGold also sounds alarm on Gold supply !
Gold Mining companies have warned that supplies of the precious metal are poised to fall sharply. The latest producer to sound the alarm bell that the industry was running out of Gold faster than it could replace it was world number two miner AngloGold, which predicted that the big discoveries of the past 20 years would run dry.

Sept 2002 : Denver Mining Conference.
Gold Executives this week gave anecdotal and numerical evidence of trends the industry has long hoped would boost what has been an ailing industry. Those trends include steady drops in yearly global output of Gold as Miners merge or "mothball" properties that can't turn a profit at Gold's current price of $322 an ounce !

Sept 2002 : CBS Market watch.
Global Gold output is seen falling 3% this year. It's biggest drop since 1976

Sept 2002 : Reuters
Gold output on slippery slope. Production levels at Gold Mines might not be sustainable because of depleted reserves at mature North American Mine operations and a fall on new mines on steam.

October 2002: The Australian Institute of Geoscientists.
The decline in Australia's Gold Industry continues.
Declining Exploration in Australia's Gold Industry is continuing to hurt production, with Gold dropping a further 8% in the year to June 30.


Then in March 2003 the strongest warning regarding dwindling Gold reserves came from Barrick's Exploration VP Alex Davidson who said :

"Big mining companies need to spend more on exploration, or else, at current annual production rates, reserves will be depleted in 10 years, he said. It can take six to eight years between making a discovery and starting mine production, and "we're not currently funding exploration at a level required to replace reserves," Davidson said."

A declining gold production can't be reversed easily :

Newmont president Pierre Lassonde said :

"The 20-year bear market in gold has weeded out marginal gold producers and significantly curbed exploration and production.". "If gold was $1,000 an ounce, it still takes four to seven years to open a mine," END.

Barrick CEO Greg Wilkins said more or less the same, he said (Nov 2004) :

"The average lead time for a large discovery to go on-stream with production was around five to seven years but that seven to 10 years was probably more realistic. ". "The industry isn't going to be able to respond immediately to higher gold prices. It is going to take a long time." END.

Trevor Steel, partner at Baker Steel Capital Managers told delegates at a two-day Euromoney gold seminar recently :

"The way I like to think of it is that the gold industry is in overdraft. It's been relying very much on discoveries that were made many, many years ago and it is not replacing the reserves it is mining every year," END.

During 2004 it became clear that the alarm bells being raised since 2002 should have been taken seriously since the gold producers were struggling indeed in order to keep up with production, the following headlines tells it all :

Thursday February 12, 2004
AngloGold saw reserves fall by 9.2-m ounces last year
AngloGold's Geologists failed to replace all the ounces it produced last year.

Monday February 16, 2004
Ashanti Announces Gold Production Lower Than Forecast
Tuesday March 2, 2004
SA gold output 4,9% lower in 2003.

Friday March 12,
Gap in Gold Production Looming

Friday April 2, 2004
Harmony Gold cuts production by 6%

Sun May 23, 2004
Aussie gold output hits record low

Friday June 18 2004
South African gold production tumbles 8.3% in first quarter

Thursday July 8, 2004
Gold supply down in Peru by 6.3%:

Wednesday July 7, 2004
Barrick Gold production declined to 1.28 million ounces in the second quarter from 1.47 million ounces a year earlier

Tuesday August 24, 2004
Australian gold output falls 16% in June qtr compared to June qtr 2003

Monday September 13, 2004
Gold miner Cambior Inc. (CBJ.TO: Quote, Profile, Research) on Monday said it expects gold production will decrease over the next four years

Thursday December 09, 2004SA's gold production down
Johannesburg - South Africa produced 85.7 tons of gold in the third quarter of 2004, the Chamber of Mines said on Thursday.

Ah you'll say ,that was 2004 so the worst about declining gold supply should be over right ? The experts are pointing towards lower Gold prices due to an expected increase of Gold production. At least that's what they want us to believe. So let's see if that's the case indeed and what good news we saw so far regarding gold supply this year :

Straight from the start of 2005 a bleak picture was painted for world's biggest Gold producer South Africa :

Production decline 33% over decade
January 19, 2005

Johannesburg: Gold output in South Africa is expected to fall slightly this year, but a bigger slide is threatened if the rand extends its bull run, a government expert said yesterday.

SA gold production could nearly stabilize this year with a buoyant dollar gold price and a stable rand, Alex Conradie, chief mineral economist with the Department of Minerals and Energy, told Reuters.

The country has seen production tumble by over a third in the past decade as high-grade mines run out of ore and firms have to dig deeper to find new deposits. END.

The message is loud and clear :

High Grade Mines are running out of Ore !

But wait, higher Gold prices will bring some mothballed facilities on steam right ? Well, higher Gold prices in US$ yes, higher Gold prices in ZAR no ! Over the last three years, the price in rand of a kilogram of gold has dropped 22% to reach 84,990 rand ($1=ZAR6.228) a kilo. Rand strength has outpaced the rise in the U.S. dollar gold price, explains Williams de Broe Mining analyst Alex Wood. So while South African miners have been paid more for their gold, their costs have grown proportionately faster -- erasing gains.

So what consequences could that have for the South African Mining industry when the high grade mines are running out of ore ? Sure it pushes the SA Gold companies into survival mode :

S Africa Gold Companies Pushed Into Survival Mode
By Jackie Range
Dow Jones Newswires
Monday, March 28, 2005

LONDON -- Drilling deep underground in dark, hot, and wet conditions, South Africa's gold miners may have little idea their industry is facing its biggest challenge yet miles above their heads.

While rival companies with dollar-based costs bask in a high gold price -- in December it reached a 16-year peak -- South Africa's gold miners have been hit by the rand's strength against the dollar and rising costs. Taking into account all their costs, half of South Africa's gold mines are currently unprofitable.
As a result, gold industry executives are taking some drastic steps to give their business a future. Consolidation, diversification, cost-cutting, mining higher grades, and closures are all on the menu.

"We're all playing a sort of game of last man standing," said Mark Wellesley-Wood, chairman of DRDGold Ltd. (DROOY), a Johannesburg-based junior gold miner with assets in South Africa, Papua New Guinea, and Fiji.

The South African gold industry is in terminal decline. In 1970 it produced 70% of the world's gold, but by 2003 it accounted for just 14.5% of global output. END.

No please digest this carefully, gold industry executives are taking some drastic steps to give their business a future. They're openly talking about cost-cutting, mining higher grades and closures. Again, mining higher grades will be a difficult endeavor since the high grade mines are running out of ore. Please don't think that these alarm bell aren't serious. Durban Deep proves that point, they're just doing what they said they would do if necessary :

S.Africa's DRDGOLD shuts North West mines

Tue Mar 22, 2005 11:20 AM ET

JOHANNESBURG, March 22 (Reuters) - Struggling South African mining group DRDGOLD (DRDJ.J: Quote, Profile, Research) has shut its loss-making North West mines, slashing production by a third and putting 6,500 people out of work. END.

Now when the high grade mines are running out of ore and closures are the tune of the day, what would you think will happen with SA future Gold production ? As Dow Jones Newswires reported :

The South African Gold Industry is in terminal decline. END

The end of the decline is nowhere in sight. Mineweb reported on April 11 :

South African gold production fell to 342.7 tonnes last year, the lowest in 73 years.

"JOHANNESBURG ( -- Uncontrollable costs are adding inordinate pressures on South Africa's gold industry, which has accelerated the demise of older shafts, says the South African Chamber of Mines. "

"There are no signs that the rate of decrease in production may be levelling out as the biggest tonnage fall came in the second half of 2004, where 20.2 tonnes less gold was produced compared to the last six months of 2003. "

"The Chamber says that because of the cost pressures and the lower rand gold price, half of South African gold production is either marginal or mined at a loss. "Some 10 mines, employing 90,000 people and accounting for about 50% of production, are marginal or loss-making at the current price (excluding capital expenditure)," says the statement. " END.

To make things even worse is that gold mines typically do not mine all out their 'ore reserves'. Here's an important comment which I received from a former Senior Exploration Geologist of Barrick Gold

Hi Eric:

I'm a geologist friend of Bill Murphy, working in northern Nevada.

Good article. One other point that people in general are unaware of, and most analysts, is that gold mines typically do not mine out all of their "ore reserves". Late in the life of mines, the typical case is that for a variety of reasons ("high-grading", gold price and labor cost fluctuations, etc.) the mine shuts down early, with a large amount of "reserves" still showing on the "books". A good recent case in point was the Homestake Mine in South Dakota, which was shut down with a large base of ore "reserves" (millions of ounces) still on the books. Many mines start up very slowly but come to an end falling off a cliff and hitting the ground with a resounding thud! Watch out for South Africa, in this regard.

Regards, Rick Redfern

Ok you'll say but what about higher Gold prices ? Wouldn't that solve SA's production worries ? the answer is NO !. As Pierre Lassonde said :

"If gold was $1,000 an ounce, it still takes four to seven years to open a mine," END.
echoed by his colleague Greg Wilkins :

"The industry isn't going to be able to respond immediately to higher gold prices. It is going to take a long time." END.

That the industry isn't able to respond immediately to higher Gold prices seems to be logical when you consider the following :

We just saw that in order to survive the Gold producers (especially the SA ones) are mining the high grade ore bodies since the low grade ore bodies aren't profitable to mine at current Gold prices and therefore qualified as being 'waste'. Now what happens if the Gold price starts to rise ? Of course the Mine's Manager's first priority is to extract the extra ore which was 'waste' just a short time ago. What does it tell you ? It tells you that the mine's mill recovery rate will drop. OK, but what does that mean ? It simply means that mine output will drop since the rated mill capacity doesn't change overnight. This mechanism is described in detail in the comments below which I received from a geology dr who is president of a junior exploration company.


I am the president of a junior exploration company. I have been in the business for over 30 years. I have a Bachelor degree in engineering, a Master's degree and a Doctorate in geology. I have worked in government, large and small companies.

I would like to bring to your attention one point that I feel is critical to the upcoming decline in gold production.

All mines are designed for a specific rate of production in tonnes mined and milled, not in ounces of gold produced. All mine's costs are measured per tonne of production, not in ounces of gold output. These mines optimize for longevity, not profit. What this means is as follows:

1. A mine is not homogeneous. It has reserve blocks that range from low-grade (for example 1 gpt), up to high-grade (for example 30 gpt). Unfortunately, there are generally many more low-grade blocks than there are high-grade blocks.

2. A mine's operating structure is generally set at initial design, in that it has a rated mill capacity of 100, 1,000, or 10,000 tonnes per day. Its cost structure is likewise set by design in that a tonne of ore costs $x to mine, $y to process with $z for G and A. Therefore, for example, a 1,000 tpd mine with $x+y+z equal to $100 per tonne must process ore of that minimum value to break even. No operator will survive for long processing sub $100 ore. At US$330 per ounce and assuming a 90% recovery from the mill, the minimum profitable grade is close to 13 gpt (or near 1/3 of an ounce per tonne). As such, the operator will optimize by mining from various orebodies and stopes to mine as much as possible above the 13 gpt cut-off. Rock with grades of 8 gpt are waste. Daily production might be economic down to as low as 300 ounces per day (1,000 tpd at 1/3 per ounce x recovery).

As the gold price moves to say $420 per ounce, few of the mine's costs change, but now the revenue is 30% greater. Consequently, the Mine Manager's first priority is to extract the extra ore that was a short time ago, waste. The cut-off or minimum grade mined goes from 13 gpt down to 9 or 10 gpt, so the mine's 1,000 tpd output now drops from 300 ounces per day to 280 ounces per day.

All gold mines operate this way! So as the price of gold goes up, primary mine production drops. The higher the price of gold, the grater the drop in primary mine production. There will be some mothballed facilities brought on stream, but the start-up capital these require generally makes these slow to get started.

The same is true in a falling gold market. Primary gold production initially increases during declining gold prices as operators "high-grade" to remain profitable.

Just some comments that are relevant. END.

Conclusion : as the price of gold goes up, primary mine production drops
(Of course Gold production will pick up steam later on with consistently higher Gold prices but as explained before, this process will take many years.)

Industry consultant Ralph Bullis is worried about a drastic decline in Gold production as well. Bullis fears that the very large Gold producers won't even survive at current extraction rates over the ... next five to 10 years. His calculation is straight forward, he says that the top 5 Gold producers are each pulling between 3.5 million and 7 million ounces out of the ground every year. In order to keep up with the current production rate the miners need to replace their mined-out reserves through Exploration . But that's exactly the problem. In order to replace 3.5 - 7 million ounces of Gold each year you'll have to find a major world class gold deposit ( > 5 million ounce) each year which is highly unlikely. Bullis refers to the U.S. Geological Survey's database of global gold deposits and notice that of the 792 discoveries listed of greater than 100,000 ounces, only 6 percent contained 5 million ounces of gold or more. This is in line with earlier comments from Barrick Gold Vice President Exploration Alex Davidson who said that since 1999 only a very few world class gold discoveries have been made.

Bullis goes on and says that even if a big discovery is made, it can take anything between three and 10 years to permit a mine in Canada and the United States, prospective areas where the major miners are looking for gold. This is in line with earlier comments from Piere Lassonde and Greg Wilkins who made it clear that the Gold Industry isn't going to respond immediately to higher Gold prices.

(Ralph Bullis was Exploration Director of Echo Bay Mines for more than a decade and was a member of the Canadian Institute of Mining committee, which helped set up guidelines on how to estimate mineral resources and reserves)

Producer de-hedging

Producer de-hedging is another factor which contributes to a decline of available mine supply. Producers turned to net de-hedgers last year and will continue at the rate of 300-400 tonnes a year. Although many analysts argued that producers would be stepping up their hedging activities again because of the rise in POG, exactly the opposite happened. Gold companies only increased the speed of de-hedging and thereby reducing the net supply even further.

Hedging died when the King of Hedgers Barrick Gold gave up their favorite Hedging game. They announced last year to stop Hedging and said that they won't do it no more for the next ten years.

Barrick Gold terminates it's Hedging program

LONDON - In what had every appearance of being a damage limitation exercise, Peter Munk, chairman of Barrick Gold, made an unscheduled return to the Gold Investment Summit here to announce his company had given up hedging - and would do no more for the next ten years.END.

Would do no more for the next ten years, maybe they're bullish on Gold ?
The table shown below says it all, mine supply is going down, de-hedging is picking up steam . Mine supply 2004 compared to 2003 is down 5%. When taken into account the reduced official sector sales and producer de-hedging as well we'll see a total drop in Mine Supply of 15%

source : World Gold Council

It should be obvious that no matter what the Gold price does in short term, Gold production is going down coming years thereby adding pressure on a tight physical Gold Market.

Highlights :
Mine Supply 2004 down 5%
South African Gold Industry is in terminal decline.
High grade Mines are running out of ore.
If Gold were $1000 / oz , it still takes four to seven years to open a mine.
The Gold Industry isn't going to be able to respond to higher Gold prices. It's going to take a long time.
Rising Gold prices put an additional short term pressure on Mine Supply.
Producer Hedging is dead since Hedging King Barrick announced to do no more hedging for the next ten years.
Industry consultant R. Bullis fears that the very large Gold producers won't survive at current production rates over the next five…ten years

Eric Hommelberg
The Gold Drivers Report

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April 15, 2005

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