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ANALYSIS-Cost-cuts put gold miners between rock and a hard place

Sept 3 (Reuters) - Deep cost cuts have helped to restore profits at gold miners pummeled by a one-third slide in bullion prices in the past three years, but the fix may only be short term and could be setting the industry up for even more long-term pain.

The all-in cost of producing an ounce of gold dropped by 23 percent to $1,331 an ounce in the year to end-March, according to data from Citigroup. The data, published on Aug. 13, covers miners producing about half of the world's gold.

Data from five of the world's biggest gold producers, including Canada's Barrick Gold Corp, South Africa's AngloGold Ashanti Ltd and Australia's Newcrest Mining Ltd, show this trend continuing to the end of the latest quarter.

A closer look at the numbers reveal, however, that almost all of the cost reduction is due to miners pulling easy levers: slashing capital and exploration spending, cutting head office costs and shrinking mine plans to focus on extracting higher-grade gold.

"Even though this is a good short-term thing for the gold sector it is exactly the worst thing that they can do from a long-term value perspective," said Johann Steyn, an analyst with Citigroup in Johannesburg.

As the gold price tanked and miners were forced to write down billions on underperforming assets, once growth-hungry investors demanded a new era of austerity. The subsequent cuts to exploration and capital spending threaten to shrink current output and future growth.

When gold starts to rise again, miners will find it harder to benefit if they have under-invested in new projects. Lower grade ounces will again become economic, and if mined as in previous upturns, will once again raise unit costs.

STICKY COSTS

What miners have found much harder to dent are mine site operating costs such as labor, fuel and power, which soared 60 percent between 2008 and 2012 when demand for these inputs surged during a global gold mining boom. Falling gold grades, which have nearly halved to 1.5 grams per tonne since 2000 as rich deposits become scarcer, have also hiked costs.

Mine site costs, known in the industry as cash costs, fell 5 percent to $696 an ounce in the past 18 months, quarterly data from the world's seven biggest gold miners show, as miners cut jobs, implemented efficiency programs and pressured suppliers.

While that represents a sharp turnaround from the cost inflation before it also shows the difficulty of making deep cuts. And some say this might be the end of the road.

"Most of the gains come in the first year after a company has made major decisions on cutting employee numbers or benefits," said Sean Boyd, chief executive of Agnico-Eagle Mines , a mid-sized producer with mines in Canada and Mexico.

Agnico was able to slash about $40 million in costs at its Arctic operations in the second half of 2013, mostly through reducing employee benefits, Boyd said. "You can only do that once on the labor cost side," he said.

Employee salaries are "sticky" and hard to reduce, said Adam Graf, an analyst with Cowen and Co. in New York. So is the price of fuel, which makes up about a third of mining costs and is set by the market.

CUTTING MUSCLE VS FAT?

Others in the industry are optimistic that miners can squeeze out more cost cuts at mine sites from better labor productivity and eliminating lower-grade ounces.

"There is more room to cut fat than there is muscle. I don't think they are cutting into the muscle right now to demonstrate profitability. The companies have been so bloated," said Chris Beer, who co-manages the RBC Global Precious Metals and Global Resource Funds.

And lower production is not necessarily a bad thing, especially if each ounce is more profitable.

Although bullion prices are not always driven by supply and demand, a drop in production could be a boon for producers as it could help to establish a floor for the gold price, said Imaru Casanova, senior gold analyst at U.S.-based fund managers Van Eck, a major gold stock investor.

Bullion was last trading at $1,268 an ounce.

SEEN THIS MOVIE BEFORE

Today's capex and other cuts are similar to those that miners made between 1996 and 2001, the last time gold was in a bear market, Citi's Steyn said.

"That was exactly why they couldn't capitalize on the gold price rally that came after," he said. Even though capex at the world's 10 biggest gold companies increased seven-fold between 2000 and 2013 to $16.6 billion, production decreased 10 percent, he said.

What is different this time around is that lower gold grades have made it that much harder to reduce mining costs.

Not all miners are slashing capex to the same degree though. At $1,486 an ounce at end-June, Goldcorp, the world's top gold miner by market value, has the highest all-in costs of the five biggest miners who publish this data as the Vancouver-based company presses on with building two mines.

"It's very easy to simply cancel or defer capital programs at a mine site," Chuck Jeannes, Goldcorp's CEO said in an interview.

"I just know that we are being very careful not to get carried away with cost reduction and find ourselves having not made the investments we need to for the long-term health of the mine."

(Editing by Andrew Hay)