Volatility brings its rewards to those who adapt, but in any case the gold mining companies are diversifying
Most serious investors dislike volatility. It's why many of them have missed out on the resources boom of the past few years. But if you can hold down your breakfast on the roller coaster, the rewards have been great.
The volatility in share price movements of gold stocks has been amazing. It is driven more by the radical swings in the value of the rand against the US dollar than by the dollar gold price itself, which has generally performed as predicted (see page 46).
There seems little likelihood of this level of volatility declining soon, so investors have a choice. Either they adapt and learn to trade these shares, or they can avoid them and put their money somewhere less volatile. The "experts" have punted the US dollar, IT stocks or blue-chip corporate heavyweight counters like Enron. The choice seems easy.
At the beginning of 2001, revenues earned by the SA gold companies were under severe pressure. The gold price had fallen below US$300/oz and the rand was worth around R7,50.
Conditions were so bad that Mark Wellesley-Wood, chairman of marginal producer Durban Roodepoort Deep (DRD), threatened closure of its mines if the unions did not agree to lower salary increases than the industry norm. He got his way .
No sooner was the ink dry on the wage contracts than the dollar gold price started to run and then, from the end of 2001 to the third quarter of 2002, the rand lingered at levels well below R11. In the process it delivered huge windfall profits to the SA gold companies. The result was a rand gold price that soared from an average of R72 877/kg in 2001 to above R110 000/kg in the last few months of that year.
The top performance came from shares in the "Roodepoort Rocket" - DRD - which blasted off from a low of 470c to a high of R56,50 in this period.
That reflected the huge leap in revenues earned by the gold mines as well as the transformation of their longer-term prospects, as the higher gold price turned "unpay" areas - where the grade of ore was too low to be mined economically - to "pay".
The immediate impact of the higher gold price and higher share prices was to focus gold management's attention away from growth by acquisition to organic growth through expansion of existing assets.
There were few takeovers last year, the only major one being Canadian heavyweight Placer Dome's bid for Australian gold producer Delta. That went through unchallenged, despite Delta management trying every trick in the book to rustle up a counterbid to raise the price.
Also, SA gold executives finally had what they maintained they always needed to justify big capital expenditure programmes - confidence in a firm and rising dollar gold price.
So, in early February this year, Harmony CEO Bernard Swanepoel announced the go-ahead for expansion projects worth R1,8bn in the group and that further projects totalling nearly R5,5bn were under consideration. This represented a strategic shift. Until then Harmony management had preferred to sink its spare cash into growth by acquisition instead of organic growth.
Growth by acquisition - assuming the deal is done at sensible values - generates immediate returns. It can take up to seven years before any meaningful returns start to flow from the money ploughed into a new, deep-level shaft system.
Sadly, what goes up must come down. Swanepoel based his organic growth plans on a floor gold price of R95 000/kg. By the end of April the gold price had sunk to around R78 000/kg, thanks to a strengthening of the rand against the dollar that was as stunning as its prior collapse.
Gold share prices melted down. By end-April Harmony shares were down to R73,44, GFL had dropped to R71,40 and the "Roodepoort Rocket" was belching smoke as it spiralled down to R16.
The situation facing the SA gold mines has been made worse by the proposed imposition of a 3% royalty on gross revenues in terms of the royalty bill, which is part of the new mining legislation dispensation through which the state will own the country's mineral rights.
The gold miners have opposed the proposal because of its punitive nature. It is a turnover tax, so a company would have to pay it even if it were making an overall loss on operations.
The gold mines would prefer a royalty linked to profitability. Finance minister Trevor Manuel is not keen on that because of the way the profit and loss account can be manipulated.
DRD is the most exposed because most of its operations are marginal, so it comes as no surprise that Wellesley-Wood is the most outspoken about his strategy. He told investors in late April that DRD was rationalising operations and 1 000 jobs would go - assuming a gold price of R85 000/kg was maintained.
He described the royalty bill as "the last straw" for the gold mining industry in SA and said DRD would reduce its investment programme in this country and concentrate on growing overseas.
Swanepoel was not as outspoken as Wellesley-Wood but the same pattern is evident in Harmony's actions.
Swanepoel is highly critical of government's apparent "strong rand" policy but says he believes Harmony's mines are in "pretty good nick" and that management is not changing its assumption of a R95 000/kg floor price.
As a result, the R1,3bn Doornkop South shaft project is going ahead because it will start producing only in three to four years.
"We are as committed to SA as ever," says Swanepoel, "but, if government makes the macroeconomic environment difficult, then you are going to see diversification."
Such diversification is already well under way at Harmony, which started moving into Australia about three years ago.
The programme has picked up speed rapidly over the past year with a move into Russia and then into Papua New Guinea (PNG). In late 2002 Harmony spent US$26,4m to buy a 31% stake in Highland Gold, which produced 178 000 oz of gold from its mines in Russia that year. In February this year Harmony announced a successful bid costing US$90m for all of Australian-listed Abelle Ltd, which owns "two of the largest undeveloped gold projects in the world", located in PNG.
AngloGold is well ahead of the pack in diversification and already sources about 40% of its earnings from gold production outside SA. So it's not surprising that AngloGold CEO Bobby Godsell sounds the most sanguine of the SA gold executives on the current state of affairs.
"Cowboys don't cry," he told investors in April at the release of the group's results for the March quarter. "The exchange rate is a factor we have no control over. We benefited enormously from the plunge in the rand last year and we will live with its current strength."
Yet AngloGold has taken immediate steps to cope, trimming about R250m off its working cost and capital budgets for the balance of 2003.
The inescapable message is that the strong rand policy is damaging the gold mining industry and that damage will be compounded if government goes through with the imposition of a 3% royalty on turnover.
