A new report issued by McKinsey & Company is worth your attention. It gives an in-depth review on the state of the mining industry. At a time when you may be considering (re)investing in mining shares, this is a valuable piece of background information.
The gold industry today finds itself at an inflection point between the recent era of cost-out initiatives and balance sheet deleveraging, and an increasing need to focus on growth and the replenishment of depleting gold reserves.
However, after a period of impairments, write-downs, and value destruction following the M&A frenzy of the last gold price boom, shareholders in search of improved returns and greater management accountability are unlikely to support significant M&A programs which have been the traditional mainstay of production growth and gold reserve expansion for major gold companies. The future strategic options to drive growth will differ across industry players, but all will need to consider a mix of organic and inorganic approaches if they want to return to growth in an economic and sustainable way.
What goes up must come down
Since the turn of the century, the gold industry has experienced a roller coaster ride, with prices rising from $255 an ounce in 2001 to highs of $1,906 a decade later, before falling to $1,056 by December 2015. This reversal of fortune led debt-heavy gold companies, which had engaged in aggressive M&A programs before the peak, to initiate dramatic cost-out programs, resulting in all-in sustaining costs (AISC) declining 20 percent to $879 an ounce between 2012 and 2017, and significant impairments totaling $129 billion since 2011 (Exhibit 1).
The impact of these initiatives, coupled with current higher gold prices, has restored the health of large gold companies, evidenced by stronger cash flows, leaner cost structures, and de-levered balance sheets.
The replacement imperative
However, this recovery has come at a cost as gold reserves have declined by approximately 26 percent to 713 million ounces (Exhibit 2), due in part to a reduction of about 70 percent in exploration expenditure as companies sought to preserve cash. This raises the uncomfortable prospect of a looming reserve crisis.
During the last boom, gold companies sought to bolster reserves by launching acquisitions, with annual acquisitions peaking at $38 billion in 2011, while the average price paid per ounce reserve in this peak period was often more than 300 percent higher than deals executed a decade earlier. In recent years, shareholders and activist investors have become increasingly vocal about value destruction resulting from aggressive M&A strategies. This challenge is being exacerbated as greenfield exploration programs have failed to deliver but a handful of significant gold discoveries above 6 million ounces since 2006.