BAY STREET: Lower costs could bring shine to major gold miners

Sun Jan 6, 2013 1:19pm EST

* Diversified miners delay projects, could slow cost inflation

* Cost cuts to give boost to bruised gold seniors

* Gold miners still need to prove lower costs, higher margins

* Analysts see dividends, earning growth as key to recovery

By Julie Gordon

TORONTO, Jan 6 (Reuters) - Sagging demand for non-precious metals - a trend that's beyond the direct control of Canada's embattled gold producers - is shaping up as their best hope for recovery in 2013 after a year that battered their share prices.

The key to restoring investor faith in the gold miners is reining in runaway cost inflation, experts say. To that end, a weakening of prices for base metals, coal and iron ore comes at just the right time for big bullion producers, who can no longer use surging gold prices to justify unrestrained spending.

Barrick Gold Corp, Goldcorp Inc and their top-tier peers are scrambling to pare spending and return more cash to their shareholders even as they gingerly push ahead with major new gold developments.

"There may be a catalyst here and that is cost stabilization," said Adam Graf, a mining analyst with Dahlman Rose in New York. "Because the rest of the mining industry is going to be weaker in 2013, that should benefit the gold guys."

Spot gold prices closed 2012 with a gain of about 7 percent, extending the metal's bull run to a 12th year. But the S&P/TSX Global Gold index, reflecting the sagging share prices of the world's top gold miners, ended the year with a decline of nearly 16 percent, its biggest annual drop since 1999.

"The market has just completely lost faith in the sector," said Graf. "And what's driving the negative sentiment is the perceptions of runaway cost inflation."

Mining costs have sky-rocketed over the past few years as strong demand from China and India pushed metal prices to historic highs, prompting a global mining boom and putting pressure on an already tight labor and equipment market.

But growth is slowing in China, and that, along with economic uncertainties in the United States and Europe, has weighed on base metal, iron ore and coal prices, leading to mine shutdowns and project deferrals around the world.

In 2012, diversified miners delayed well over $65 billion in planned capital expenditures, according to global accounting firm PwC. BHP Billiton, for example, shelved its multi-billion dollar Olympic Dam copper-uranium mine expansion, citing rising costs and weaker commodity prices.

With fewer projects competing for the same resources, the cost of labor, engineering and equipment is bound to soften -- good news for gold miners, who are pushing ahead with new mines.

Indeed, with the price of gold, widely seen as a safe-haven investment, expected to remain relatively strong over the next few years, companies that can cut costs and boost profit margins will fast become very attractive, analysts say.

"In 2013, we'll be looking at things like dividend increases, growth in earnings per share," said John Ing, a gold analyst at Maison Placements in Toronto. "And I think that will restore the enthusiasm for the gold miners."

NEW RELIGION

From September 2007 to September 2011 gold nearly tripled from around $680 an ounce to an all-time high above $1,920. That drove a period of "growth at any cost," as gold miners looked to boost production to capitalize on rising prices.

But gold fell off its peak in late 2011, and has since traded in the $1,500 to $1,800 per ounce range even as miners' costs kept rising.

That has weighed on the shares of the world's largest gold miner, Barrick, which ended 2012 down 25 percent. Goldcorp and Kinross Gold Corp fell 19 percent and 17 percent respectively.

In fact, of the 10 largest companies on the S&P/TSX Global Gold Index, only Yamana Gold Inc managed to squeak out a gain in 2012, climbing 14 percent. Barrick, by contrast, is now trading at 2009 levels.

Investors, angered by pricey takeovers, huge cost overruns on new mines and narrowing profit margins, demanded change.

Boards responded. Two top chief executives, Aaron Regent of Barrick and Tye Burt of Kinross, were ousted over the summer of 2012, while Richard O'Brien is set to leave Newmont Mining Corp in March. The shake-ups herald a shift in strategy.

"These ambitions of growth have been dashed by the reality that mega-projects bring mega-problems," said Ing. "I think the gold miners now have a new religion and that is emphasizing on profit margins."

CUTTING SPENDING

Barrick's new CEO, Jamie Sokalsky, has made good on a promise of more disciplined spending, deferring some $3 billion in capital allocation over four years. Working against that restraint is the massive Pascua-Lama gold project on the border of Chile and Argentina, where development is now expected to cost more than $8 billion.

Kinross too has announced a cost-cutting plan, while Goldcorp is currently reviewing all of its capital projects.

Indeed, most major global gold producers have vowed to clamp down on spending and focus on profit margins, even as they push ahead with new mines around the world. Yet the details on how they will keep a rein on costs, beyond benefiting from a broader industry slowdown, remain unclear.

Add in worries over ever-stricter environmental rules, higher royalty and tax demands from governments and growing opposition from local communities, and for some investors the potential rewards are simply not worth the risk.

"It's just getting harder and harder to be a mining company, more environmental restrictions, more government restrictions," said David Baskin, president of Baskin Financial in Toronto.

"It's just tough," said Baskin, who does not hold any gold mining stocks and said he has no plans to buy in 2013.

Despite the nagging concerns, many analysts and industry players believe the top tier of gold miners have hit a bottom and they see an opportunity to buy high-quality gold ounces in the ground for cheap - if miners can get those reserves out without breaking the bank.

"I really think the worse of the news is behind the gold operators. I can't imagine them being hated any more than they are right now," said David Harquail, chief executive of Franco-Nevada Corp, a gold-focused royalty and stream company.

"It's the contrarian play," he added. "But I am absolutely confident that it is going to be the money-maker." (Additional reporting by Allison Martell in Toronto; Editing by Frank McGurty, Jeffrey Hodgson and Kenneth Barry)