The effects of budget cuts and a lower gold price continue to plague exploration in the gold patch, with activity expected to remain subdued through Q1, according to one analyst.
After reversing a four-month decline in July, grassroots exploration activity fell to the second lowest level in its history in August, surpassed only by the lows of the financial crisis in late 2008, according to the SNL Metals Economics Group Pipeline Activity Index.
This, says the group, comes not just as a result of unfavorable commodity outlooks, but also financing pressures on the junior exploration sector and budget cuts by major and intermediate producers, that continue to “severely affect grassroots exploration activity—including initial resources announcements and drilling activity, the project development pipeline, and M&A activity.”
While very low base metals activity was more responsible for the low August numbers than gold, explains Justin DesRochers, senior industry analyst with SNL Metals Economics Group, for the last five months, gold exploration activity has remained lower than every month in 2010, 2011, 2012, and the first quarter of 2013.
If this is not the bottom for activity in the gold sector, DesRochers says it definitely feels very close.
“Another significant drop in gold price is probably the only thing that could drop gold activity levels lower,” he says.
Indeed, the gold price, says DesRochers, is going to play the biggest role in the near-term—either positively or negatively—when it comes to drill rigs on the ground.
“Even if the gold price remains steady around where it is now, I think the markets will eventually adjust to the new reality and grassroots activity will slowly pick up again. But without that price jump, any kind of recovery is likely to remain very slow paced,” he says.
While a new significant grassroots discovery could also ignite interest in the sector, DesRochers adds that the chances of this are lower due to the drop in activity itself and budget cuts.
As a result of the majors finding ways to trim spending, fewer projects are advancing through milestones, he adds.
“Many projects are now stalling due to these budget cuts, even projects that may have once been considered relatively high quality.”
And some analysts are expecting more cuts in the medium-term. In a recent research report on the global gold sector, Citigroup says even though gold companies have continued to cut capex, exploration, and corporate costs this year to "make ends meet" in the lower gold price environment, ends are still not meeting.
“Despite these cuts, we estimate that most of the global gold cost curve is burning cash at spot levels. We think further cuts are likely over the next six to 12 months as companies try to adjust to a lower gold price environment,” say Citi analysts. The next few years, they say, will likely be characterised by high-cost asset disposals, reduced capital budgets, lower exploration spending, and balance sheet recapitalization.
Maintaining its bearish view for most gold equities, Citi says companies such as Harmony
(NYSE:HMY) and AngloGold Ashanti
(NYSE:AU) look particularly vulnerable, due to the greater difficulty in turning around or closing high-cost mines than in cutting capital budgets, while Barrick
(NYSE:AUY), and Goldcorp
(NYSE:GG) look least vulnerable, due to their position on the cash cost curve.
When it comes to exploration, DesRochers is maintaining a poor outlook for this quarter, and at least into Q1 2014, with a potential for gradual improvement toward mid-2014 if financing conditions improve by the end of the first quarter.
But, he adds: “Even when things do eventually turn around, I would expect the explorers to proceed with caution and for the turnaround to be gradual.”
No positions in stocks mentioned.