Gold-mining giants face challenge from low-cost producers as price plunges

The continuing slump in world gold prices - which last week fell to a 12-year low - could put many established deep mines out of business, according to rival low- cost producers. Clifford German reports.

The warning of a global shake-out came with growing indications that Italy could become a leading gold-producing province by the new millennium if one new entrant fulfils its early promise. It is Gold Mines of Sardinia (GMS), listed on the Alternative Investment Market in London, which opened a new mine on the Mediterranean island this summer.

Its first quarterly report on Friday showed it produced 1,893 ounces of gold in its first six weeks, including 670 ounces in the final week when the mine was operating at planned capacity. The mine's average cost of production is $222 an ounce, well below the current price of gold, which closed at $313.25 an ounce in London on Friday.

As John Morris, the chief executive of GMS, points out, at least 30 per cent of the world output is uneconomic at present prices and further falls in the price would lead to a marked reduction in the supply of new-mined gold. Some deep South African mines have production costs of up to $350 an ounce.

The price of gold fell again last week to its lowest level since July 1985, after a study by Swiss officials claimed the central bank of Switzerland could sell 1,400 tonnes of gold, more than half its reserves. Sales could not begin unless they are approved by a national referendum, which cannot be held before 1999, but the sale would be the equivalent of six months' world-wide production. Analysts predict that the gold price could fall below $300 in the near future.

Commercial demand for gold, mainly for jewellery and industrial uses, consistently exceeds the supply of newly mined gold each year by around 50 per cent. But speculative demand for bullion is now insignificant, and the market is overhung by the combined gold reserves of the International Monetary Fund and dozens of central banks, which between them hold enough gold to meet world-wide demand for 10 years.

The market has been further depressed by excessive forward sales of gold, which has not yet been mined, by mining companies anxious to speed up their cash flows.

The discovery of gold on Sardinia is a recent event. The metal is not visible to the naked eye, and it took a group of incredulous geology students to detect it and a team of Australian mining entrepreneurs to extract it. But the island has large areas of low-grade gold ore both at depth and close to the surface, where it is relatively easy to mine and refine.

The whole island is rich in minerals but few ventures have been commercially successful and the last lead-zinc mine closed down just this summer. The island is also awash with earth-moving machinery and crushing mills left over from lead, zinc and copper mines.

GMS was listed on AIM last year and has the backing of Rothschilds, Fidelity and Henderson, while brokers Williams de Broe have put UK private clients into the stock. The regional government authority, EMSA, also took a 30 per cent stake.

Output is expected to reach 40,000 ounces a year shortly, rising to 70,000 ounces a year by the end of 1998 if additional capacity is brought on stream. As output rises there will be problems separating gold from the copper content of the ore, which increases as the mine goes deeper, but these are two or three years away.

If all goes well, future development could be farmed out to joint ventures with established giants like BHP and Minorco. The shares have ranged from 12p to 33.5p since they were listed. Last week they closed at 24.25p.