One year later, the gold mining sector suffers from sagging prices and oversupply
By ROD MCQUEEN
Senior Writer The Financial Post
On March 19, 1997, at 9:10 a.m., Michael de Guzman climbed aboard a French-built Alouette 3 helicopter at Balikpapan in southeast Borneo.
The geologist had been called to explain inconsistencies in drilling results he'd been overseeing at Bre-X Minerals Ltd., but he did not appear nervous about the command performance. He was tired from drinking and singing karaoke the previous evening so he dozed until the chopper landed at Samarinda.
De Guzman changed clothes inside the airport terminal, placed three bags aboard, then sat alone in the back seats for the second leg of the trip to the Bre-X mine site in Indonesia at Busang.
After 17 minutes aloft, the pilot and mechanic, who were sitting up front, thought they felt something hit the helicopter, then there was a sudden rush of air. As the pilot fought to steady the craft, the mechanic looked behind him, saw an open side door and said: "Mike is not there. He's gone."
De Guzman's 250-metre plunge into the dense rain forest resulted in more than just the mysterious demise of one sad man. It led to revelations about the Bre-X salting fraud and precipitated a catastrophic downturn in what had been a euphoric gold mining sector.
When the bizarre event was first reported by news media a year ago today, gold was fetching US$352.40 an ounce. Yesterday it closed at US$291, up only marginally from Jan. 5 when prices hit an 18-year low of US$282.70.
It's as if de Guzman's death was a sign from the gods of tumultuous events to come.
"Gold mining companies fell over themselves to court Bre-X," says Bill Belovay, senior gold analyst at CIBC Wood Gundy Securities Inc. "Greed overcame them in their search for growth in future gold production. There's a strong promotional element in the Canadian or North American gold share industry. If you have a gold price which is not going anywhere, the best way to get gold shares moving is by promises of growth.
"The Bre-X story produced all these promises. It was the solution to the problems of the whole industry. It actually showed up the weaknesses of the North American gold mining industry."
"Barrick [Gold Corp.] got everybody to buy into the growth cult," says John Ing, president of Maison Placements Canada Inc. "When Busang disappeared, it coincided with the realization that these big deposits are not only impossible but maybe the economics leave something to be desired. The gold industry woke up to the realization that they have to make money. The quest for ounces was what was popular, not making money."
Since de Guzman's death, falling gold prices caused by oversupply - some occasioned by central bank sales - have hit North American producers hard. They have written off US$2.5 billion as they recalculate their reserves and other assets.
Many junior mines have been forced to consolidate. In February, Kinross Gold Corp. and Amax Gold Inc. merged. Black Hawk Mining Inc. acquired Triton Mining Co. Even a giant like Barrick had to seek lower costs by closing half its mines last year, thereby focusing on more efficient sites, while aiming to keep production flat in both 1997 and 1998 at the three-million-ounce level of 1996.
"If gold stays under US$300 an ounce for more than a few quarters, there will be considerable hardship in the world gold sector - and a wave of consolidation," says a research report prepared by Nesbitt Burns Inc.
"Our analysis has shown us that between US$300 and US$270 an ounce, the net asset values to the common shareholders for many North American gold producers rapidly approach zero."
Ironically, it was Nesbitt analyst Egizio Bianchini who enthused about Bre-X right to the salty end, claiming: "The gold is there." Nesbitt is arguing the firm should be excluded from a $3-billion class action lawsuit arising from the fiasco because brokers have no fiduciary relationship to clients.
Bianchini, Nesbitt and other brokerage firms have been named in the suit for allegedly misleading investors about Bre-X, which claimed to have found the world's largest gold deposit.
While increased debt has plagued many companies. Barrick and Placer Dome Inc., among others, have been able to hedge their debt successfully. Other companies, such as Newmont Mining Co. and Homestake Mining Co., are said by Nesbitt to be much more sensitive to dropping gold prices.
Yet even the good times were bad. "A great many gold companies, Barrick included, were producing gold at a loss," says Ing. "Where they were making their money was hedging profits. Barrick has almost $800 million in hedging profit over the next 10 years."
What the companies have been doing is to sell tomorrow's production at today's price. Dealers then supply gold from their own vaults or borrow it from central banks. They pay it back when the gold is produced. "The industry is getting hoist by its own petard," says Ing.
Along with organizations like the International Monetary Fund, central banks hold about 35,000 tonnes of gold, about one-third of all the gold that's been mined and an amount equal to 18 years of production at present levels.
The Netherlands, Australia and Argentina last year sold substantial portions of their holdings. Since 1980, Canada has sold 85% of its reserves.
Much of the fall in gold price and share value yesterday was blamed on the announcement by the Belgian central bank that it had sold almost 300 tonnes over the past few months.
In fact, the Belgians sold to five other central banks so the gold never came into circulation. The market pyschology, however, is such that prices tumbled anyway.
Last week, the industry told central banks the sector was about to take a whole new tack. Producers were now prepared to buy any gold the banks wanted to sell them in a bid to create a cartel and drive prices up.
"It's the equivalent of the industry shooting itself in the other foot," says Ing. "They should be focusing on producing gold at a profit and not worrying about moving the inventory."
As long as the metal stays below US$300, more mines will be forced to close, either voluntarily or involuntarily. That will mean continuing low production levels that, in turn, will miraculously sow the seeds of the sector's eventual recovery.
Both Belovay and Ing predict gold will be back to US$350 an ounce in six months.
Belovay sees fundamental value in five companies with large cash positions and low costs of production: TVX Gold Inc., Normandy Mining Ltd., Euro-Nevada Mining Corp., Franco-Nevada Mining Corp. and Prime Resources Group Inc.
Among juniors, Nesbitt likes Viceroy Resource Corp., Goldcorp Inc. and Meridian Gold Inc.
And that's the other lesson that can be drawn from the sorry legacy of Michael de Guzman. The only thing that's as enduring as the commodity itself is optimism, the very fuel that produced Busang's fool's gold in the first place.
