Evgeny Nekrasov
Doctor of geology & mineralogy

M

ajor factors that determine conditions in the market of gold are its price, prime cost of gold production in the world as well as at enterprises of major gold-miming companies, world level of production and customer demand for this metal. The difference (it is also called “fork” and “profitability corridor”) between price for gold and prime cost of its mining, which includes payments of the largest portion of taxes, is the only source of profit.
In the long term (for several years) these factors, mainly in the aggregate, cause either an increase of gold price or its reduction. Price for this metal is subject to rhythmic waves: it periodically rises, then, goes down to a minimum and, later, climbs up to a new maximum. All other reasons, including political situation in the world and in individual nations as well as speculative transactions with gold, only lead to complications in waves of price changes resulting in insignificant and short-term fluctuations that distort the regular picture.
If the "fork"/"profitability corridor" for some leading ore-mining company amounts to only $1 to $1.5 a gram of extracted metal, then, due to the necessity to pay profit and national taxes this company has to make a lot of efforts to ensure a profitable production. As the situation in the late 1990s proved, for 20% to 25% of smaller companies, which own one or two enterprises and which do not have room for maneuvering, the insignificant difference between world price and prime cost of gold extraction is fraught with unprofitable production, forced temporary or even permanent shutdown of gold mines.
Between 1998 and 2001 there was a small "fork" for gold-mining companies, which lasted quite a while. The matter was that in 2001 the world price for gold fell to the minimum and the reduction of its production prime cost slowed down. The price dynamics during the pre-crisis period (till between April and May 2001) showed that since February 1996 the downfall from the maximum price of $13.01 a gram was steadily going on during the next five years. The price reached the minimum level in February to March 2001 ($8.42 to $8.46 a gram), thus, decreasing by $4.5 a gram, i.e. annually by $0.9 a gram on average.
During those five years there were also insignificant short-term price rises: between February and March 1997 (from $10.65 to $11.29 a gram), between February and May 1998 (from $9.3 to $9.92 a gram), etc. All these price increases were short-lived fluctuations that only made the main trend more complicated.
As it turned out, this 5-year period of price reduction was the longest as starting from 1968, when gold price became open, such periods did not exceed four years (Table 1). Up till now there have been five such periods. The shortest one lasted about two years with the gold price increase of $1.3 a gram.
The protracted (from 1996 to 2001) price reduction was extremely troubling not only for companies but also for Central banks of industrially developed countries, which still act as chief holders of treasurer’s gold reserves: if this trend had continued, the real gold and foreign currency reserves could have been depreciated by many billions of dollars. It was only natural that Central banks were seeking to keep the price within a reasonable limit and between 1999 and 2000 they reached an agreement to restrict sales of large gold consignments. Such a restriction in countries of Europe annually affected 400 tons in the aggregate.
As a result of positive factors that appeared all at the same time, by mid-2001 the world market of gold became stabilized. In 2002 there was a steady price increase: the average annual price for gold rose by almost $1 a gram. By December 2003 the "profitability corridor" for gold-mining companies increased as much as over three times: up to $4 a gram as compared with about $1 a gram at the beginning of 2001. This allowed them to start mining and processing poor ores, which just recently were rejected as unprofitable.
The gold price is indirectly linked to the price for oil. Quite often the growth of the latter prompted the growth of price for the yellow metal. For example, the overthrow of Saddam Hussein’s regime in 2003 led to the increase of the gold average annual price from $10.55 a gram in April to $11.47 a gram in May. Later though the growth paused and between June and August the market was stabilized again. Apparently, this was connected with the failure to restore Iraq’s oil industry as was expected. Besides, the increase of the U.S. budget deficit for 2004 contributed to weakening positions of the dollar. All these caused a new, although not sharp, price rise: in September 2003 the gold average monthly price exceeded $12 a gram.
The lack of political stability in other oil-producing countries, including those in the Middle East as well as Nigeria and Venezuela, the persisting absence of the extra Iraqi oil and some other factors will keep up the investment demand for gold in the near term and, most likely, the price for it as well. In 2004 conditions are favorable for developing moderately expensive quarries and starting to process low-grade ores at enterprises, which were earlier balancing on the edge of profitability. The situation is also favorable for more active geological prospecting operations.
In the previous period of gold price downfall between 1996 and 2001, many gold-mining companies came close to the dangerous zone of unprofitable production and some of them were forced out of existence. Between 1999 and 2002 up to 3 to 5 unprofitable quarries were either temporarily or permanently closed down by every leading gold-mining countries each year. As a rule, quarries were small but sometimes they were medium-sized. World gold-mining enterprises with the total capacity of 30 and more tons were being put out of operation annually. Nevertheless, the gold production was maintained at the previous level. This was possible thanks to commissioning of new large enterprises, usually with open pits and, thus, a lower prime cost of extracting the metal. In other words, along with modernizing some ‘old’ quarries it was as if a great many unprofitable small-scale enterprises were being replaced by a few major quarries.
This process had its different peculiarities in different regions. A number of quarries went down mostly in developed countries while the ones were commissioned, mainly, in states of Africa and South America that were reasonably explored from the geological point of view. Those, for example, were the Sadiola, Yatela, Morila and other quarries in Mali, Geita, Bulyanhulu, Mara and others in Tanzania, Yanacocha and Pierina in Peru, Alumbrera in Argentina, etc. In 2002 with operating costs amounting to $5.5 a gram 14.9 tons of gold were produced from ores at the Sadiola quarry (Mali, Canada’s Lamgold Corp.), the production volume at the Pierina quarry (Peru, Canada’s Barrick Gold Corp.) equaled 27.9 tons of gold with the prime cost reaching $8.7 a gram.
As a result of restructuring, in five years the number of gold-mining enterprises in the world was reduced by a quarter; gold-mining companies got down to actively introducing the latest technologies and production methods. It allowed by the end of 2001 to reduce the world average prime cost of gold mining down to $7.35 a gram against $7.7 a gram in 2000 and against $8.2 a gram in 1999. However, only some countries managed to ensure a significant reduction of prime cost. Among them were South Africa, Australia, Canada. In the U.S. the prime cost increased 3% in 2000 and in 2001 it jumped by another 5% returning to initial $8.25 a gram. By our estimates, the prime cost in South Africa amounted to between $7 and $7.3 a gram. However, the true reason for its decrease was the rand devaluation. The devaluation of the local dollar was, mainly, the cause of the prime cost decrease in Australia as well. In terms of the U.S. dollars the prime cost of extracting gold in these two countries did not go down; on the contrary, it even became somewhat higher.
In 2002 to 2003 the world prime cost of gold mining kept on decreasing, though just to $7.25 a gram, i.e. annually by $0.1 a gram; it was happening chiefly because of commissioning large low-expense ore mining and processing enterprises or making them reach design capacity. Some of not so strong but profitable enterprises were expanded and they started producing ‘cheap’ gold. However, the prime cost index exceeded the world average level at the majority of existing enterprises and even at some recently built medium-sized and small quarries.
The similar situation took place at many large and relatively ‘old’ quarries.
Most of major enterprises in the U.S. (Goldstrike, Gold Quarry, Cortez, Pipeline, Meikle and others), Canada (quarries in the Hemlo province), Australia (Kalgoorlie, Gwalia, St. Ives and others), Indonesia (Grasberg, Kelian), Papua New Guinea (Porgera, Ok-Tedi, Lihir), certain large quarries in some other countries made their choice of the best ores. So, operations went deep down and that is why in 1999 to 2002, when the restructuring of the gold-mining industry was completed, the level of mining at them was decreasing while the prime cost of extracting the metal was up. Take, for example, Goldstrike, the U.S. largest quarry. In 2001 48 tons of gold were mined there with the prime cost of $8.6 a gram, it was 43.8 tons in 2002 with the prime cost of $9.2 a gram and, by our estimates, in 2003 the figures were 35.6 tons and $10.48 a gram respectively.
So, the restructuring of the gold-mining industry aimed at raising the profitability almost completely exhausted its potential already by the end of 2002. In the opinion of experts, in 2003 the prime cost of extracting gold in a number of gold-mining countries did not go down but it even was up by $0.3 to $0.5 a gram.
During the period of gold price reduction there appeared a real threat that numerous medium-sized and small quarries as well as fields might be left behind the profitability quest. That would have led to a significant reduction of gold mining or, in other words, to the need for borrowing gold from treasuries and funds so as to make jewelry and for other purposes. Thus, there would have been a conditional deficit of the primary metal.
Since a number of quarries, where a profitable gold mining could be set, is limited, it should be expected that at a certain moment commissioning of new large quarries will not be able to make up for the shutdown of numerous small quarries. In this case the level of gold mining can start going down again.
Today, the world level of gold production and consumption may be defined as steady. According to the data provided by the Mineral Information and Analytical Center (Moscow), in 1999 the world volume of gold production amounted to 2,514 tons, it was 2,541 tons in 2000, 2,545 tons in 2001 and 2,484 in 2002. While waiting for results of final calculations, some experts are predicting that the level of gold mining in 2003 will also be lower than the previous one going down by another 3% or 4%, i.e. it will amount to about 2,400 tons. Sharing this opinion I would like to note that the trend of gold mining reduction, in my view, will not last long.
There is still another trend that is something to worry about. This is a continuous downfall of consumer demand for gold jewelry. It takes place despite the growth of peoples’ income in countries of Western Europe, North America and Australia. The demand for gold is also decreasing in the world jewel industry, its chief consumer (Table 2). It is worth reminding that approximately 80% of gold in world market go to make jewelry.
Recently two groups of gold-consuming countries became obvious. One of them consisting of industrially developed countries is characterized by the fact that this noble metal is widely used there not only for the jewelry production but also for technical purposes. This consumption sector happens to be even more capacious. For example, in Japan the share of gold being used for technical purposes has reached 72.1% of 134.3 tons (2001), in Germany it has been 61.6% of 68.5 tons, 50.6% of 24.5 tons in Singapore, 35.1% of 41 tons in France. At the same time this share in the U.S. accounted for only 31.8% of 231.7 tons, it has reached 17.6% of 57.5 tons in Great Britain and 2.4% of 490.5 tons in Italy.
The second group, consisting mostly of oil-producing countries with a considerable amount of free currency available, is purchasing and using gold only to make jewelry. These are, above all, Saudi Arabia that in 2002 consumed 121 tons of gold, Egypt (76 tons), UAE (47.6 tons), Iran (37.2 tons), Kuwait (16.1tons), Oman, Qatar, Libya and others. Up to 14.1% of gold was used for technical purposes in Iran, only 4.6% in UAE and 3% in oil-producing Venezuela.
The constancy of the volume of gold, which is annually used for making jewelry as well as for technical purposes, is, at least, a stabilizing factor in maintaining world prices for this metal. At the same time, countries, where gold is, mainly, used by the jewel industry, experience a regular, though insignificant, reduction of the used gold volume. It causes either reduction of its production or prompt price decrease.
In my opinion, if there are no force majoure circumstances, by the end of the four-year rise, i.e. on the eve of 2005, an average monthly price may reach its peak of $13.5 a gram or more. After that it will start steadily falling down again. It seems to me that in 2004, at least, till the autumn, prices for gold may stay on the level of $12.5 to $13 a gram.
In the future the decreasing world gold mining with comparatively high gold prices will be quickly made up for by re-activation of temporarily closed middle-sized and small quarries, where gold extraction will again become profitable, as well as by accelerated commissioning of new quarries, including the large ones.
The decreasing demand for jewelry will also have its impact: probably in the summer or autumn of 2004 gold price will stop rising; after that it will start going down gradually and this downfall will last approximately 4 years, i.e. till the beginning of 2009.
The favorable situation with world prices for gold is very important for Russia, which remains one of the largest producers and exporters of this metal. The country has three gold fields with the biggest reserves of gold: Sukhoy Log in the Irkutsk region, Natalkinskoye and Nezhdaninskoye in the Magadan region. If the first two have comparatively poor ores with gold content amounting to between 2.5 and 3 grams per ton, the sulfide-containing ores at the Nezhdaninskoye field are richer with 5 to 5.5 grams of gold per ton. Mining gold at each of the last two is still carried out at the lowest possible level of 1 to 2 tons of the metal annually. Taking into account the volume of reserves it would make sense to bring the annual mining up to between 10 and 15 tons at each field. As the world experience shows, the largest fields of gold get now depleted in 15 to 20 years.
Probably even more attractive are the two recently explored fields Bakyrchik and Bolshevik that are located close to each other in Kazakhstan. The quarry that is processing sulfide-containing impregnation ores from the Bakyrchik field (with an average content of gold amounting to over 8 grams per ton) is also extracting a small amount of this metal: about 0.6 to 0.7 ton a year. At the same time, the cumulative reserves of gold of higher grades at both fields exceed 450 tons. Ores from these fields, like the ones from Nezhdaninskoye, contain arsenic minerals with increased concentration (in particular, arsenopyrite). However, there are comparatively cheap and ecologically safe methods to process them, which are successfully applied, for example, at the Olympiadinskoye field in the Krasnoyarsk Territory: at present, over 25 tons of gold are extracted there annually.
Thus, taking into account sufficiently high contents of gold in ores at the Nezhdaninskoye and Bakyrchik fields it is possible in a comparatively short time (in 2 to 3 years) to build and put in operation two large-scale and inexpensive ore mining and processing enterprises in Russia and Kazakhstan. If ores are mined by the low-cost quarry method with the use of advanced technologies of their processing, these projects will succeed despite the fact that their implementation will coincide with a less favorable period: during those years gold price will start going down and it may fall to the average annual level of $9 a gram or even lower.




Table 1

Periods of gold price growth

Increase of average annual price from minimum to maximum, dollar/gram Price growth during given period, dollar/gram Duration of price growth period
1 1971–1975 from 1.31 to 5.18 by 3.8 4 years
2 1977–1980 from 4.75 to 19.7 by 15 4 years
3 1985–1987 from 10.2 to 14.37 by 4.2 2 years
4 1992–1994 from 11.05 to 12.35 by 1.3 2 years
5 March 2001 –
February 2004 – from 8.38 to 13 by 4.6 2.85 years



Table 2
Structure of gold arrivals to world market & its consumption in 1999 to 2002, tons

Arrival sources 1999 2000 2001 2002
Mining 25151) 25732) 26043) 25904)
From scrap & waste 613 611 706 837
Sales from treasurer’s reserves
of Central banks 420 471 504 559
Hedged gold 484 – – –
Sales from private &
commercial reserves – 291 54 –
Total 4032 3946 3868 3985
Consumption items
Jewel industry 3149 3175 3006 2689
Other industries 513 573 484 484
Hoarding of gold bars 230 198 232 252
Investments in gold 140 – – 137
Total 4032 3946 3868 3985

_________________________
1) Gold-2000: Market review;
2) Gold-2001: Market review;
3) Gold-2002: Market review;
4) Gold-2003.