Will this be a Golden Year?

On an annual basis, PwC surveys gold mining companies from around the world. We contacted 51 executives from a cross-section of senior and junior gold mining companies asking them questions varying from how high do you expect gold to climb in 2012 to what gold price are you applying to your reserves? The companies surveyed represented 25.5 million ounces of gold mined in 2011, and 37.25 million ounces to be mined in 2012.

While gold mining companies enjoyed a high gold price in 2011, what is to be expected for gold’s performance in 2012? Eighty percent expect the price of gold to continue to increase, with only 6% anticipating gold to decline in 2012.

The forecast for revenues and cash flows are also expected to be higher this year. Mining executives were asked how they planned on using their increase of cash. With the ability to select more than one response, 27% of executives selected to pay dividends in 2011, a remarkable increase from the 2010’s 9% response. Acquisitions also experienced a notable increase from 2010’s results. In 2010, 5% of companies said they would use their cash to pursue acquisitions, in 2011 the response was 19% and then jumps to 29% in 2012. In terms of project development, the results have been consistently high at around 75% of mining executives looking to invest in project development.

High gold prices vs. stock price

While revenues and cash flows will be higher this year, mining companies are struggling to reap the ultimate benefits of a high gold price. More than half of our survey respondents (62%) said the price of gold was positively impacting their stock price, but the impact is less than what they expected. A reason for this modest impact is because production costs are increasing. This includes costs related to operations in remote locations, high fuel costs and a low United States dollar. As well, gold companies have numerous risks that are not inherent in an exchange-traded fund investment. For instance, there is always the risk of delays as mining properties take longer and long to reach production.

Dividends – The golden link

To avoid the risk of an exodus of investors from the gold equities market, many gold mining companies have started or plan to increase their dividends. Dividend payments for 2011 were up approximately 75% year-over-year, compared with a 26% increase in 2010. PwC expects this trend to intensify throughout 2012. In fact, 10 of the world’s largest gold producers paid nearly $2 billion in dividends in 2011.

The decision to link dividends to gold’s performance benefits both investors and mining executive teams. The benefit to investors is a clearer understanding of how their dividends will change. The benefit to a management team is that they can be more aggressive with dividend rates without concerns of maintaining levels in the long-term if gold sharply declines.

Another way gold mining companies can provide value to investors is to reduce their leverage. Lower leverage means lower earnings available for shareholders, assuming the company can earn a return higher than borrowing costs. The world’s largest mining companies have been reducing their leverage. With cash being generated and capital expenditures being delayed, repaying debt has been one of the few uses for excess cash.

2012 outlook on Mergers
& Acquisitions (M&A)

A report released in June 2011 by Standard Chartered, indicated that there was a lot of cash available for gold companies to engage in M&A activity for the purposes of securing new supplies and replacing reserves.

2011 was an exceptional year for gold acquisition with well over 400 acquisitions with an approximate worth of $12.5 billion. With 29% of respondents expecting to spend their cash on acquisitions in 2012 and 40% of companies planning to replace reserves through acquisitions, it is safe to say acquisitions remain on the minds of gold mining executives. PwC expects to see an increase in hostile bids for miners reluctant to sell at current “depressed” prices.

Digging for gold on the stock market is an important part of a company’s growth strategy; it unfortunately does little to increase the world’s total gold reserves. In fact, M&As may even negatively impact exploration activity. Since 2000, gold companies’ exploration budgets post-mergers have shrunk by 20% when compared to the companyies’ total exploration spent 12 months previous.

Falling reserve replacement impacts gold supply long-term. The less gold is available, the more valuable gold becomes, the higher the price goes – simple supply and demand basics.

For more information, please visit PwC’s mining site at: www.pwc.com/ca/mining.