Miners supplied 764t of gold to the market in the first quarter of the year, fractionally below the 767.8t produced in Q1 2016. There were areas of growth, largely from new mines: the US and Suriname both saw increases from projects that came on stream over recent months. The additive impact from these markets, however, was offset by weakness elsewhere.
Mining lower-grade ore at Mongolia’s Oyu Tolgio copper mine resulted in a gold output reduction of around 3t. In China, extended New Year holidays at some refineries and mining companies crimped supply, as did the imposition of strict environmental management restrictions: together, these two factors knocked around 2t off Chinese gold production y-o-y.
But by far the largest impact on Q1 mine production came from Indonesia, thanks to a more than 8t fall in production from Grasberg. Production was cut back by around 60% to match domestic smelting capacity, after Indonesia introduced new restrictions on exports of unrefined metal.1 Freeport-McMoRan – Grasberg’s operator - was granted a reprieve on 21st April in the form of a six-month temporary export licence. But this issue is far from resolved, and negotiations between the two parties continue.
Despite the wrangling, Grasberg is moving into a period of high-grading and will ramp up production over the next several quarters. This, along with a few smaller projects coming on-stream – particularly in Canada and Australia – will nudge global production higher in 2017 and 2018. But the effect will only be temporary.
Having plateaued in recent years, mine production will soon enter a period of decline. The production profile of currently operating mines shows a relatively steep drop-off over the next 5 to 10 years. Even factoring in high-probability projects (those highly likely to reach commercial production), the fall in production is still significant.
This is largely a consequence of sharp cuts in capital expenditure over recent years (total capex for companies in the HUI Index2 declined 65% between 2012 and 20163 ), as well as a lack of significant discoveries. We have seen this before: lower prices in the late 1990s and early 2000s also negatively impacted production and exploration in the years that followed. And while there are signs of renewed interest in brownfield development and extending the life of existing mines, these are not yet sufficient to offset the steep cuts in project development spending of recent years. Inevitably, the supply pipeline will be squeezed.
The speed at which production will fall is uncertain. As existing reserves are depleted, the current project pipeline will be unable to replace them fully. Over the long-term, the global production profile will depend on the trajectory of the gold price and potential exploration upside, particularly the speed with which brownfield exploration can be brought into production.4
Net producer hedging
Gold producers reduced their overall net hedge positions by 15t in Q1. This compares with positive net hedging of 47.5t in Q1 2016.
In the first half of 2016 a rising dollar gold price coupled with weakening local currencies encouraged greater levels of net hedging as gold producers sought to lock in higher prices for their output. But the increase in the Q1 2017 gold price provided little temptation, particularly as prices stayed below average 2016 levels.
Project financing and/or debt repayment are key reasons why many miners opt to hedge, despite the practice being generally opposed by many shareholders. Our view is that while higher price levels may elicit more producer hedging, it will remain tactical in nature and small by historical standards. Any hedging would likely remain in line with the annual average of 16.7t since 2011, vs the 344.8t average between 1995-1999. At the end of Q1, the global hedge book stood at 237 tonnes, an almost insignificant level when compared to the 3,000t plus hedge book of the late 1990s.
Recycling contributed 283.0 tonnes to supply in the first quarter, a drop of 21% from Q1 2016. The steep y-o-y decline is largely due to recycling having jumped in Q1 2016 in response to sharply rising gold prices at that time. At 283.0 tonnes, recycling is below its long-run average (since Q1 2000) of 296.2 tonnes.
Much of the decline in recycling activity came from Southeast Asian markets – Thailand and Indonesia in particular – where local currency weakness in Q1 2016 exaggerated the rise in the US$ price. Turkey also witnessed far lower levels of recycling during the most recent quarter. Price and currency moves played their part here too, but the constitutional referendum was also a factor: the populace was reluctant to sell its gold holdings in the face of an uncertain political outcome.
Indian recycling has been remarkably subdued since November’s shock demonetisation. Retailers remained short of cash for some time, slashing their available funds to buy back holdings of old gold. The market remains in something of a holding pattern ahead of the government’s GST decision. Once that becomes evident we could see a resurgence in recycling.
Recycling levels during the first quarter can be seen as something of a ‘normalisation’ in the absence of sharp price moves. Given that recycling supplies were elevated throughout much of last year, negative comparisons are likely over the next two quarters at least.