For those wondering where US shale exploration and production companies will be in about 2-3 years, look no further than the gold miners, where the disconnect between undaunted physical demand and relentless paper supply (after rebounding above 0%, GOFO is once again negative through the 3 month mark), and where high production costs and low selling prices, after two years of balance sheet pain, is finally leading many over the cliff. Case in point, Canadian gold-miner San Gold, which had a capitalization of over $1 billion in 2010 just filed for bankruptcy protection. It isn't the first gold-miner to wave the white flag, and it certainly won't be the last.
As the WSJ reported earlier, the Winnipeg-based company said in a statement that it has asked Canadian courts for an initial 30 days protection from its creditors as it seeks to restructure its business.
“San Gold spent half a billion on their assets, and they haven’t had a profitable quarter in six years,” said Greg Gibson, who became CEO in June after a boardroom revolt against the previous management.
The problem, as gold miners (and their long-suffering shareholders know) and as shale companies are about to find out, is that "the sector had overstretched itself during the commodity boom, when the high gold price, and willing investors, saw miners spend heavily on acquisitions and bring new production on line. Some of the sector’s new production was lower grade gold, which is more expensive to mine and became unprofitable as the price of gold fell."
This all happened before the Swiss National Bank imposed its currency controls by way of a EURCHF 1.20 floor on September 6, 2011 as the Eurozone was tearing apart, and which, incidentally, also marked the record high in the gold price. Since then gold has tumbled by a third and many of the smaller miners have gone bankrupt while others have stopped production or exploration as they look to raise cash.
As Gibson said, “The party is over and its time fix things" and now even the big companies, those which have access to Wall Street's ZIRP capital are starting to fold.
But it's not just western gold miners that are finally starting to feel the pain of three years of declining gold prices: even more importantly, according to Bloomberg's Chart of the Day, China's "gold diggers" are also preparing to drop their shovels.
As a reminder, China surpassed South Africa as the top bullion producer in 2007 as surging prices spurred domestic companies such as Shandong Gold and Zijin Mining Group. Global production reached a record high in 2013, according to the World Gold Council. China’s output may exceed 470 metric tons this year, up from a record 428 tons last year, according to the China Gold Association.
That is about to change: monthly output growth in China almost stalled in August through October, World Bureau data show. Miners’ costs are mostly higher than spot prices, increasing the likelihood of writedowns next year, Nick Holland, chief executive officer of Gold Fields Ltd., said Nov. 20. The production cost per unit for Shandong Gold Mining Co., one of China’s four biggest gold miners, will rise to 150 yuan per gram ($749 an ounce) in 2015 from 146 yuan now, UBS’s Lin estimates. And while Shandong will still be profitable, many of its peers will not be so lucky.
As a result, Chinese gold miners, which ramped up production are poised to begin reducing output as the price slump begins to bite with a several year delay. Putting it in context, Chinese mine output rose 15% in the first 10 months of this year, outpacing a 3.4% gain in the global total, according to World Bureau of Metal Statistics data, even as gold prices declined.
“We will see output growth moderating going forward into 2015 as miners perceive a downtrend in gold prices to persist,” said Lin Haoxiang, an analyst at UBS Group AG in Shanghai. “Falling prices are cutting into some high-cost private mines in China, while some big miners chose to reduce costs by reducing jobs and capital investments.”
The bottom line: just as everyone expects oil production to decline as capital spending plunges, the reality is that for the next couple of years domestic oil production will actually surge as producers try to put their competitors out of business while collecting every dollar of demand cash that is available, a process described previously. For the gold miners, however, the buffer period is now over even with the benefit of ZIRP providing cheap funding extending the inevitable collapse, not only in the US but also in China. And as gold prices continue to slide, the marginal cost producers - who have been living onborrowed time for year - are about to fold en masse.
What happens next is that physical gold supply is about to slide, even as demand for physical gold remains solid, or even rises more now that India is once again easing import regulations. The only question is how will relentless paper gold supply impact the price of gold and can the world hit a thought experimental state where the cost of gold is so low that physical production is completely mothballed and where the price of gold is set entirely by paper contracts representing said non-existent physical. Impossible? Then read the fascinating story of how an otherwise bankrupt Radioshack is kept in a pseudo-alive zombie state thanks to $25 billion of Credit Default Swaps who just can't envision the company folding. Now reverse that and apply it to gold.