Will the pursuit of scale pan out for big gold miners?

A steep and structural increase in the gold sector's cost base has raised debate about whether big miners like Barrick and Newmont should continue to push for scale or instead focus on shareholder returns.

The on-again, off-again merger discussions between Canada’s Barrick Gold and Newmont Mining of the US underscores what a mess the pursuit of size has made of the gold-mining sector.

Barrick and Newmont have recently reopened discussions they have had several times over the past decade, which could lead to the merger of the world’s biggest and second-biggest gold miners and a spin-out of their Australasian gold assets in the process. Despite an apparent hiccup on the detail of the spin-out, there is an expectation in the market that the merger talks will resume.

While in this market there has been a focus on Newcrest Mining and the $5.8 billion loss it reported last year, its woes reflect bleak, broader industry experiences. Barrick announced a loss of $US10.3bn last year and Newmont a loss of $US2.5bn.

The challenges the sector is experiencing go well beyond the gold price, which has slumped again in the past fortnight to trade at around $US1287 an ounce -- about 30 per cent lower than its level two and a half years ago.

While it has traded up marginally this year, the price fell 27 per cent last year. With the US dollar firming and both the US and Europe more concerned about deflation than inflation, exchange-traded gold funds and wealthy investors dumped their holdings.

The dive in the price has exposed a steep and structural increase in the sector’s cost base and a decrease in the quality of its resources from the scramble for growth when the price was trading at record levels.

Across the sector there were write-offs of something close to $US30 billion last year as the companies reappraised the value of their resources in the context of the lower gold price. All-in costs of production for the sector that have been estimated at around $US1400 a tonne. (Newcrest, for instance, has said it needs an Australian dollar price of $1450 to be cash flow positive. The current price is $A1378 an ounce.)

The sector is shutting down the lower-grade and higher-cost production the big miners were scrambling to buy or develop during the goldrush years. Some of the companies are pushing harder into copper to try to diversify away from their reliance on gold and in response to the paucity of available new and large resources. All are trying to reduce costs.

There is an interesting discussion occurring about whether the push for scale via acquisitions (led by Barrick) needs to be unwound to refocus the big end of the sector on large, lower-cost mines and on returns to shareholders rather than managerial ambitions.

For Barrick and Newmont, the allure of a merger lies in the prospective synergies from combining their North America operations. Both have large low-cost operations in Nevada and bringing them together could create the core of the estimated $US1bn of synergies.

A merger would also enable the two North American groups to offload their less productive mines in Australasia and Africa, largely through a demerger to their existing shareholders.

Merging the two largest producers and then spinning out a significant slice of their asset bases would be quite a complicated process but could create a cleaner, more profitable and North American-focused group.

The real challenge for Barrick, Newmont and the sector more generally would be to reduce production costs against the backdrop of expectations that the gold price will continue to remain below $US1300 an ounce for some time.

A merger of Barrick and Newmont and the synergies it could generate if well-executed might help expedite the process of lowering their cost bases. But in the absence of an unexpected rebound in the gold price, they -- like the mining industry generally -- will have no option but to continue to focus on big reductions in operating costs.