Miners dig deeper - but will gold still go up?

The easy gold may have gone, but new technology means South African miners can now dig as deep as 4km down. How much will it cost them? And will they be able to meet demand?

Digging yourself into the deepest man-made hole in the world is pretty radical. Not even a land-short South African gold miner would shovel out his Rand unless he had confidence that what is down there is going to go up!

Getting into the Guinness Book of Records on this basis is too expensive unless the results are going pay off. So it's a pretty strong positive signal for gold that Gold Fields, the world's fourth biggest producer, and Anglo Gold Ashanti, the world's third, are both putting their money into going 4km underground.

The sad fact, and not just for South Africa, is that the easy bits of gold have long been mined out. The same applies to all metals all the way around the world. It's not surprising in South Africa, which has apparently been mined since at least a few years into AD.

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Now it is a struggle gold grades from existing mines have been declining, wages are rising as are social costs, equipment prices are soaring, skilled professionals are in short supply, but production and revenues have been falling. Those South African mine companies have to work really hard for their (and shareholders') profits.

Why costs are rising for South African gold miners

They have special problems, ones that don't normally make it to the front pages of the mining news! South Africa's mining costs are already the highest in the world and it seems unlikely that this will be waved away with a magic wand any time soon. The gold industry may have grown rich on the country's cheap labour but those chickens are now coming home to roost. Only a few weeks ago the National Union of Mineworkers was demanding a 15 per cent wage increase for its members. Going deeper means higher medical insurance costs too.

Another labour factor, which seldom gets a mention in any mining company PR, is the challenge of HIV/AIDS. This has become endemic among South African and migrant workers alike. So, medical insurance premiums and disability cover are higher than elsewhere.

Then there are the technical challenges of going 4 km down, including how to keep things cool enough for workers to operate effectively, not to mention the design of haulage systems.

At 4km below, the rock temperature nears a sweltering 56C. If talk of going to 5km ever materialises the temperature rises a further 14 degrees! That is pretty damn hot. Mining companies will have to look very closely at improved cooling technologies. They are certainly going to burn some electricity! Driefontein's current annual electricity bill is already ZAR250m ($35m) and makes up 12% of costs.

Another issue will be the time lost travelling. (Makes the London tube seem a doddle in comparison!) To get to the bottom of Tautona mine currently takes around an hour and a half. This is set to increase to two hours as the mine goes deeper, which means only 4.5 to 5 hours out of a nine hour shift will be spent working, says AngloGold Ashanti. So that is another indirect labour cost.

The mines are considering new technologies, like using linear motor systems. These are streamlined systems which don't need the use of a rope. But they are still in R&D.

Housekeeping for South African gold is tight just because of all of this and its mining is becoming difficult. According to South African gold research group GFMS, local currency cash profit margins for the 'Big Four'

producing regions are "South Africa, 58% of cash costs; Australia, 85%; Canada, 87%; and in the United States, 69%. The increases in cash margins by comparison with those registered in 2005 were 190%, 73%, 41% and 49% respectively." It latest figure (2005) overall for mine cost of producing an ounce of gold is an average of US$317. Now it will be more. Plus, deep mines cost...

Faced with top-of-the-league expenses, the gold price was for a long time too low for the South Africans to bother to dig on their home turf. The grass was definitely greener, or at least cheaper, elsewhere. But, US$640 or so an ounce puts a different complexion on it. Plus, other countries have wised up on the value of their resources. These days, be they dictator or president, there is a tough bargain in profit sharing, road building, or generally improving the country.

And digging deep into South Africa's vast unexplored reserves does not look as daunting, with technology improving all the time. Summing it up, as Gold Fields CEO Ian Cockerill said recently. "This means we should be trying to acquire additional ounces." So it is back to the backyard.

First a bit of geography: the mines were we are talking about lie near Carltonville on the Witwatersrand, South West of Johannesburg. The Witwatersrand is home to the richest deposits of gold anywhere on earth and is where gold was struck by the Englishman George Harrison in 1886, starting the long-term European gold rush.

Gold Fields is forking out ZAR4.7 billion (US$663m) to deepen its Kloof and Driefontein mine. This takes a bit of time but it anticipates getting a further 10.8 million ounces of gold out of this mine. Gold Fields believes that this could extend the life of Driefontein, a granddaddy of a mine which has delivered more gold than any other in history, to around 2035.

Meanwhile AngloGold Ashanti is spending $160 million to drill down at its Tautona mine to 3900 metres. This mine is expected to yield a further 2.6 million ounces. The deepening of Mponeng, another of AngloGold's mines, to 3600m has been made possible by a ZAR2bn ($282m) injection.

Even Harmony, the fifth largest gold producer in the world, is at it - although its projects are not quite as ambitious. It is deepening its Elandsrand mine to 3300m, expected to yield an additional 6.22million ounces.

Aside from the capital costs to dig deeper at Driefontein, running such a deep mine will cost ZAR1886/oz ($269m/oz) over the life of the mine. At recent gold spot prices which are hovering around the $640/oz mark that is not bad going you might say. But even at that level of operating expense, for investors it depends on whether companies will be able to keep costs on a tight rein.

Gold price will stay high despite new mines

So, why the optimism on gold when there is the prospect of all these refurbished mines opening up for business!

Mines are worse than vines. It takes years before they produce. Even the South African Chamber of Mines is not very confident that the trend of declining supplies will be reversed in the very near future. Lead times are very long. At Driefontein, they are only expecting to get the gold out the ground sometime after 2011, while at Tautona it could be any time between next year and 2017.

Plus, those mining companies are not going to rush the gold out. More than anyone they know the effect overproduction will have on the price. You only have to look at how clever the South Africans have always been at managing precious prices like diamonds.

By Isabelle Turner and Erin Hamilton for The Daily Reckoning. You can read more from Isabelle, Erin and many others at www.dailyreckoning.co.uk