Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Electricity Not a Shock To Gold Miners


South African energy not a major cost component.

South Africa's electricity provider, Eskom, was given permission to raise prices another 13.3 percent (starting in July) after already being given permission to raise prices 14.2 percent, for a total of 27.5 percent. Prices are also expected to rise 20 to 25 percent annually over the next three years too.

At first glance this might appear to be more horrible news for the South African gold miners, and the stocks (even AngloGold Ashanti (AU), which only has about 40 percent of its production in South Africa anyway) are being pounded back to their recent lows on the news this morning.

But here's the thing: Electricity is not a big cost component for the South African miners. According to the Chamber of Mines, electricity is only about 10 percent of cash production costs for the large scale deep level gold and platinum mines. According to the Chamber of Mines' chief economist, Roger Baxter, the projected 27.5 percent increase in power costs "will entail a two percent increase in cash production costs because of the increase." This isn't that big of a deal in my view. The first increase of 14.2 percent in December was obviously seen in miners' 1Q earnings, and if you will recall, all the South African miners' saw a drop in cash costs due to the weaker rand.

In fact, if gold remains merely unchanged in dollars, and the rand falls another mere two percent from today's levels, the drop in rand will completely offset the electricity price increase for a miner like Gold Fields (GFI). Thus any increase in the price of gold from here drops straight to the bottom line. And if I'm right, the rand is going to fall a lot more than 2 percent vs. the dollar going forward, which will expand South African miners' margins even more.

Click to enlarge

I'm not the only one that holds this opinion either. In fact, the Baker Steel fund said today that it has doubled its exposure to South African gold miners.

Trevor Steel, managing partner of Baker Steel Capital Managers, said:

"We recently increased our exposure to South African gold producers as their share prices were lackluster at a time when gold prices in the rand were making new highs… That was leading to a dramatic margin expansion for those producers and that was not showing up in the share prices. On a price-earnings basis, we have got companies like Gold Fields and Harmony (HMY), which we particularly like."

At the end of the day, obviously all the gold miners need a rise in the price of gold that outpaces their costs, and they haven't had that positive environment since roughly March. But we're seeing increasing signs that this environment is now changing, and that better environment is what will finally break the downtrend in the GDX/GLD ratio that we've seen since October.

Along those same lines, today is the fourth day in a row that the gold/oil ratio has moved higher (see the chart below), so that's a step in the right direction. The fact that gold is higher today even as the dollar index is getting a bump up and oil is lower is extremely impressive I might add.

Click to enlarge

What are the pro traders saying about your stocks?
Minyanville's Buzz and Banter- 14 day FREE Trial

< Previous
  • 1
Next >
Position in GLD, gold miners. GFI

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos