Mine production
Mine production was virtually unchanged from Q2 2016, dropping by less than 3t to 791.2t – the lowest second quarter since 2014. H1 output was also virtually flat at 1,557.1t. As with most quarters, increased production at some mines was offset by reductions at others.
Mine output fell in several countries. Q2 saw a sharp 8% decline in China’s mine production as the industry continued to adapt to more stringent environmental regulations. This crackdown has forced some marginal operations to close, steepening the decline in aggregate output. In Tanzania, an ongoing dispute between the government and Acacia Mining slashed production (-20% y-o-y). In March, the government imposed a ban on the company exporting gold/copper concentrate, leading to greater stockpiles within the country. Acacia accounted for around 45% of Tanzania’s 2016 gold production, which explains the magnitude of the effect on total output in Q2. And production in Mongolia fell 30% y-o-y, as Oyu Tolgoi continues through a planned phase of low grading (the mining of higher grades is expected to resume in 2018).
Gains elsewhere offset this drop. In Indonesia, gold production got a hefty boost (30% y-o-y) from the resumption of concentrate exports from Grasberg. This allowed production to ramp back up in Q2, as well as releasing some of the blocked production from Q1. The y-o-y comparison is somewhat deceptive, however, as Q2 2016 was the weakest quarter for Grasberg last year. In Suriname, the continued ramp up of Newmont's Merian gold mine helped swell output by 80% y‑o‑y. The mine reached commercial production in October 2016 and is expected to produce around 10t annually.
In Canada, Q2 output rose by 8% y-o-y, partly due to the start-up of the Hope Bay and Brucejack mines. Once at steady-state operating levels the former should add 5t per year, while the latter is expected to add 7t per year. Tambomayo (Peru) and Fortnum (Australia) also entered production in Q2, the latter having re-opened after 10 years due to further brownfield exploration and a more favourable economic situation. Both are expected to add 2-3t per year to global production.
We expect mine production to fall from 2019 onwards. Although a small number of major projects are expected to come online by the end of 2017, the project pipeline remains weak. And while major miners have improved cashflow and reduced debt over the last few years, production development expenditure remains at multi-year lows. We expect the project pipeline to see a small pick-up in 2017 and 2018 before global mine production levels begin to decline in 2019.
Early 2017 saw costs rise again: Q1 all-in sustaining costs were 12% higher y-o-y. The stronger performance of some key producer currencies against the US dollar was the main driver, although higher mine-site costs and an increase in sustaining capital expenditure also contributed to the increase. But costs remain below their 2013 peak.
Hedging
Deliveries into existing hedge positions slightly outweighed fresh hedges, leading to overall net de-hedging of 5t in Q2. De-hedging for H1 totalled 22.5t, in stark contrast to the 72.5t of hedging in H1 2016. The global hedgebook now stands at 228t, 22% lower y-o-y.
The gold price environment in H1 2017 provided scant incentive for gold miners to add to the hedgebook. The respectable 8% increase in the US$ gold price during this half year was well below the 25% increase in H1 2016 - the best H1 performance since 1980. Even in key producer currencies, the price performance in the first half of 2017 cannot compare to the previous year. But some hedging was evident. Higher local prices in April and June triggered hedging by some Australian and Canadian mines: for example, in June Gold Fields announced it had hedged 75% of its H2 2017 Australian output to protect cashflow during construction of the Gruyere project.
Project and debt financing were again the primary motivations for gold hedging rather than any change in sentiment. As we see it, many shareholders remain scarred by memories of the large-scale hedging programmes of the late 1990s/early 2000s and the practice is generally frowned upon due to the risk of missing out on any upside in the gold price. But we believe sporadic small-scale hedging, which can be useful for managing financing needs, is likely to remain a feature of the industry.
Recycling
Q2 saw a sizable decline in recycling, dropping 18% to 279.9t from 342.5t in Q2 2016. The y-o-y comparison was again affected by the elevated levels of recycling seen in the first three quarters of 2016, when the rapidly increasing global gold price, along with a tax amnesty in Indonesia, enticed consumers to cash in. The first half of 2017 represents a continued ‘normalisation’ of recycling in most markets. And it was East Asian and Middle Eastern markets that bore the brunt of the decline.
Political tensions across the Middle East prompted caution amongst consumers, who tightened their grip on holdings. In Turkey, recycling activity was curtailed as consumers remained wary of selling back their gold holdings amid the ongoing political uncertainty that has plagued the country in recent years. Many preferred to hold onto their gold, recognising its wealth protection attributes in testing times. In Egypt, the y-o-y decline masks a situation where recycling volumes are still significantly higher than normal, as local currency weakness has kept local gold prices buoyant.
In East Asian markets, the story was one of strength last year rather than weakness this year. In Indonesia, 2016 recycling volumes were boosted by a tax amnesty, while in Thailand rumours of a government crackdown on undeclared incomes prompted a rush to sell. Collectors in Vietnam were eager to take advantage of a local discount in H1 2016, selling across the border at the higher international gold price. Against last year's volumes, H1 2017 compared unfavourably.
A notable outlier this quarter was India, where recycling bucked the general trend by increasing y-o-y. Q2 saw the highest level of recycling in the country (29.6t) since 2014, as three key factors converged. Firstly, farmers sold gold to fund their impending crop-sowing activities; a common practice ahead of the sowing season. This gold has usually been repurchased after the harvest season. Secondly, anecdotal evidence suggests volumes were boosted as some consumers who bought gold during last year’s demonetisation – to dispose of old Rs500 and Rs1,000 notes – were selling this gold back in small quantities due to the fact that stability in the currency has been restored. Thirdly, the impending GST encouraged some retailers to sell gold to avoid the burden of additional reporting required under the new tax system.
In the west, the UK saw higher volumes (+6% y-o-y) despite the depletion of near-market stocks. The higher gold price – in sterling terms – prompted some consumers to cash in. However, recycling in the UK has been on a downward trend since jumping in Q3 2016 when the pound devalued sharply in the immediate aftermath of the Brexit vote. Quarterly volumes have averaged 9t since the start of 2016.
