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Analysis - Gold miners' reserve cuts may mean near-term pain, long-term gain

Jan 26, 2014 18:49 IST

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(Reuters) - Barrick Gold Corp's (ABX.TO) warning this week that its in-the-ground gold reserves will shrink is widely expected to be echoed in the coming weeks by miners around the globe, spelling more asset writedowns for an already beat-up sector.

For the first time in years, miners from Canada to Australia will tell their shareholders that reserves - the future source of production, cash flow and growth - have significantly diminished, hit by bullion's 28 percent price slide in 2013.

However painful, the reserve cuts and associated writedowns are seen helping nurse the sector back to longer-term health by discouraging miners from seeking low-margin growth at the expense of profits. It is a shift most mining executives have promised over the last year and one that investors are keen to see them deliver.

"To some extent, what has hurt the stocks in the past couple of years is this perceived notion of a long mine life with many ounces. It doesn't necessarily equate to more profitability," said Chris Beer, senior portfolio manager with RBC Global Asset Management in Toronto.

"You want the best rock, not all of the rock," he said.

Reserves are estimates of the amount of metal that it is financially and technically feasible to mine. When gold prices fall, reserves tend to drop, but how much depends on the deposit, price forecasts and other subjective assumptions.

Miners revalue their reserves annually, usually at the beginning of the year, and release the revisions along with fourth-quarter results.

Barrick, the world's biggest gold producer, said on Thursday it plans to update its reserves based on a long-term average gold price of $1,100 an ounce, down from $1,500 an ounce a year earlier. Its rivals are also expected to cut price forecasts.

Spot gold rose to a two-month high of $1,272.70 on Friday. Gold is up 1 percent for the week, on track to record a fifth straight weekly gain for the first time since September 2012.

The more conservative assumptions could mark a strategic shift away from marginal deposits, a concrete move to win back investors alienated by the miners' boom time push for growth at all costs.

Gold stocks, as measured by the S&P/TSX Global Gold Index .SPTTGD, are down nearly 40 percent in the past year.

ESTIMATING RESERVES

After 12 years of rising gold prices, 2014 will be the first year for many in which investors really see the impact of lower prices on mine lives and tangible book values, said Deutsche Bank analyst Jorge Beristain.

"These are not your traditional, garden-variety M&A-related or project capex-related writedowns," he said.

To be sure, reserve writedowns will likely be smaller than the tens of billions in charges taken by miners on assets bought at peak metal prices or on development projects where costs spiraled. But they come after several consecutive quarters of bad news from the sector.

Barrick's price assumption was more conservative than the $1,200 an ounce analysts were expecting most miners to use.

"The fundamental thing is, they're trying to draw a line under the past," said Adrian Day, chief executive of Adrian Day Asset Management, referring to the billions of dollars Barrick wrote down over the past year on an ill-timed acquisition, weak metal prices and a cost blow-out at a major project.

Valuing reserves conservatively is part of that process, said Day, who recently sold down a small position in Barrick's shares, but still owns some call options.

There is a risk that Australia's biggest miner Newcrest Mining Ltd (NCM.AX) could write down as much as A$3 billion if it chooses to recalculate reserves and asset carrying values at a gold price $100 an ounce below what it used a year ago, RBC Capital Markets analyst Steuart McIntyre said in a client note.

Included in that total is a A$300 million to A$400 million reduction in the carrying value of its Telfer mine due to reserve cuts ahead of the mine's expected shutdown in 2018.

Newcrest, whose results are expected on February 14, previously used a gold price of $1,250 an ounce to estimate reserves.

'HIGH-GRADING'

But not all miners face reserve writedowns this year.

Most small- and mid-tier Australian gold miners are not expected to trim reserves this time around as they already use a gold price around $1,200 to measure reserves.

"Only if we see the gold price under $1,200 for an extended period will we see them cut reserves," said Scott Williamson, an analyst at broker Hartleys Limited in Perth.

Some miners, like London-listed Randgold Resources Ltd (RRS.L), have for years used conservative gold prices - $1,000 an ounce in Randgold's case - to estimate their reserves.

Randgold Chief Executive Mark Bristow is concerned that miners may be cutting lower-grade reserves and rejigging mine plans only as a quick fix to survive currently lower gold prices as they wait until better times return.

"The question is, are the companies going to re-cut their business long-term at a lower gold price, or are they going to re-cut their short-term business hoping they'll be rescued in the long term by the gold price?" he said. "That second one is called high-grading and it's a disaster."

High-grading is the practice of mining higher, more profitable grade - a strategy that risks reducing the overall grade of the resource and making it uneconomical to mine in the future.

(Additional reporting by Sonali Paul in Melbourne, Allison Martell in Toronto and Stephen Eisenhammer and Silvia Antonioli in London; editing by Jeffrey Hodgson, G Crosse)

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