Capital Expenditures Plummet

Already in May this year, Macquarie reported that globally, mining capex plans have been slashed by over 20% in 2013.





From a WSJ report:


“Miners' capital expenditure levels will fall well over 20% this year, amid depressed demand for minerals and metals in many markets, Macquarie Commodities' Research said Wednesday.

Mining companies are likely to spend around $100 billion in capital expenditure on projects this year, down from $140 billion in 2012, Colin Hamilton, Macquarie's global head of commodities research, said in a press briefing. The level foreseen for this year will bring spending back to its 2011 levels, the analyst said.

Capital expenditure in mining peaked in the fourth quarter 2012, and most commodities look to have adequate supply capacity for the next couple of years, according to Macquarie. Big expenditure cuts are now taking place in the metallurgical and thermal coal project area, which typically accounts for around 30% of global mining capital expenditure, and in gold projects, which account for 10% of the mining sector's expenditure, Mr. Hamilton said.

Further cuts will occur in 2014 and 2015, before a recovery in investment levels occurs in 2016 to 2017, Mr. Hamilton said. "Miners are cutting back like crazy on capex…they need refinancing," he said. Macquarie said in a report that it expects further project delays and cancellations to be announced in the coming six months, tightening future supply-demand balances.”


(emphasis added)

Even in the copper sector, where prices have held up relatively better and which has seen a huge expansion in capital expenditure in the wake of China's sheer insatiable appetite for copper over the past decade, the peak in terms of capital expenditure on already committed projects has apparently been seen as the chart below shows. Expansion capital spending is declining sharply since its 2012 peak, while maintenance spending has leveled out after declining a bit from its 2012 peak:




Copper industry capex on expansion and maintenance – click to enlarge.



It is of course well known that the struggling gold industry is cutting back sharply on expansion as well. Numerous projects that are no longer thought to  fulfill once held expectations regarding their potential returns have been shelved or abandoned altogether. Gold mining CEOs generally have a new focus: cost-cutting. Even projects that would normally have 'made the cut', such as Fruta del Norte, the high grade Kinross property in Ecuador, have been given the boot in the wake of unreasonable taxation and/or royalty demands by governments (we have discussed this event in detail in 'The Limits of Resource Nationalism').

The latest evidence pointing to the fact that change is underway comes from AEM's latest earnings report released after the market close on Wednesday. To the joy of AEM's shareholders, it included this tidbit:


“Total cash costs per ounce are expected to be approximately $690, down from the previously estimated range of $735 to $785, in spite of realizing much lower byproduct revenue. For the full year 2013, expected all-in sustaining costs are now forecast to be approximately $1,025 per ounce, down from previous guidance of $1,100 per ounce.”


(emphasis added)

The time when costs would inexorably rise quarter after quarter seems now past. In fact, we already saw the first examples of producers reporting lower costs or slashing their forecasts regarding costs last quarter.


Indirect Evidence

Indirect evidence of the decline in demand for mining-related and earth-moving equipment (which is important in mine construction) was provided by Caterpillar's earnings report:


“Shares of Caterpillar Inc. dropped 3.8% in premarket trade Wednesday after the maker of construction equipment missed third-quarter earnings and revenue expectations, cut its full-year 2013 forecast and issued a cautious outlook for 2014. The Peoria, Ill.-based company said it earned $946 million, or $1.45 a share, in the third quarter, down from $1.70 billion, or $2.54 a share, in the same period a year earlier. Total sales and revenue fell to $13.42 billion from $16.45 billion. Analysts surveyed by FactSet had produced a consensus forecast of earnings of $1.68 a share on revenue of $14.29 billion. Caterpillar said it now expects 2013 sales and revenue of $55 billion and profit of $5.50 a share, versus a previous forecast for sales and revenue of $56 billion to $58 billion and a mid-range profit estimate of $6.50 a share. For 2014, the company said it sees "better world growth" but that "significant risks and uncertainties remain."


(emphasis added)

For gold miners, the price of gold relative to major mining input costs is what is most relevant to their profit margins, in other words, gold's 'real' price is more important than its nominal price. It is worth noting that the price of gold relative to crude oil bottomed almost exactly at the same time when the HUI index made its low. Recently, gold has risen sharply to a multi-month high against oil. This is partly due to a firmer gold price, but also due to a noticeable decline in crude oil prices following signs of political moderation in Iran and an increase in Libya's production back to above 700,000 bbl./day (as of late September), after rebel factions had nearly choked off its oil exports altogether in previous months.



Gold-oil ratio

Gold is now rising relative to crude oil – click to enlarge – click to enlarge.



Another data series we like to keep an eye on is the cost of off-road truck tires, such as those used in mining trucks. After persistently rising for many years, the rate of change in prices has recently plunged in a manner reminiscent of 2008-2009:




Annualized rate of change in off-road truck tire prices – click to enlarge.



The shelving of major new projects and developments by senior producers has also the side effect of lessening pressures on labor costs in the industry. During the boom in commodities that began in 2002, the mining industry struggled with a lack of geologists and other highly specialized job categories, driving salaries in many jobs to historically extremely high levels. The long commodities bear market from 1980 to 2000 made job prospects in the industry unattractive, and the boom took everybody by surprise. Now we should increasingly see the pressures on the labor front ease, as these high salaries are bound to have attracted newcomers, while the recent cuts in expansion capex are at the same time lowering demand.

Of course it takes time for costs to decline after a major boom concludes. In the case of gold miners, the time right after the height of the boom is usually very bad, as costs are still rising, while revenues begin to fall on account of a declining gold price.

Conversely however, there is also a 'sweet spot' after costs have been brought under control and the gold price increases again, especially if weakness in the global economy brings input costs down further. Gold stocks performed extremely well immediately after the year 2000 low, because costs had been cut to the bone, a weakening economy helped drive costs even lower, and the nominal gold price began to rise slightly instead of continuing its previous downtrend. The important point here is that margins expanded far more than the relatively mild rise in the gold price seemed to indicate; moreover, the sector had reached very undervalued levels during the preceding bear market, providing it with 'catch-up' potential.

It seems possible to us that a similar period lies ahead in the coming two to three years. Note that this is not widely expected, in other words it represents a bit of a contrarian opinion at this point in time.









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One Response to “Are Mining Costs About to Fall?”

  • JE Stater:

    I am not an expert on miners, just read some ye-reports and fully agree that capex and costs will come down. It would be interesting to review how fast the miners were in previous downswings, as I believe there is still quite a way to go.

    Interestingly, I could not fully reconcile the “fully blown cost per ounce” with the EBITDA+Capex and ounces produced KPI in the reports. I assume there are still some costs not in the “fully blown” figure. So the miners might still have some way to go before reaching an acceptable margin.

    I haven’t bought any miners yet as I find it very hard to judge how flexible (in terms of proven track-record) these guys are in managing their cost/capex base. Sure they can close down all growth capex, but wouldn’t this have almost no meaningful impact on the gold price but seriously impact their volume output as older mines slowly decay? That must look awful in a DCF.

    It would just feel much better with a 20%-30% safty margin to the gold spot price. Of course, valuation would then not be as cheap as today.

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