South African Labor Unrest Brings More Downside to Gold Miners

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South African labor unions have never been easy to deal with. The country is notorious for outbreaks of violence related to negotiations between unions and mining companies. Once again, the situation is getting tense. The South African National Union of Mineworkers (NUM) announced that its members were ready to go on strike.

Workers want higher wages. The negotiations between miners and unions, however, have not lead to any consensus agreement. Miners, who have suffered from lower gold prices this year, cannot afford another wage hike. On the other side, unions do not want to lose any ground.

Who is affected?
Among miners who operate in South Africa are AngloGold Ashanti (ADR)  (NYSE: AU  ) , Harmony Gold Mining (ADR) (NYSE: HMY  ) and Gold Fields (ADR) (NYSE: GFI  ) . Harmony is the most exposed company. It gets 91.6% of its total production from operations in South Africa. AngloGold gets 32.8% of its gold production from South African mines, while Gold Fields gets 17.2%.

AngloGold has already had a strike this year
AngloGold faced an illegal strike in the second quarter. Fortunately for the company, the strike did not last long enough to create any substantial damage. AngloGold's South African unit's cash costs per ounce rose 14.2% in comparison with the second quarter of 2012. The company had to invest in safety measures to curtail fall-of-ground incidents.

Falling gold prices have made AngloGold strive to battle costs. The company has reduced its capital expenditures forecast for 2013 by 8%. In addition, it has omitted its interim dividend. The company finds it difficult to operate profitably at the current level of gold prices despite all cost-cutting measures, and a strike would only make things worse.

Harmony Gold is very exposed to South Africa
It's easy to see that Harmony gold is overwhelmingly dependent on its South African operations, which puts the company at the biggest risk in case of a massive strike. The company did not manage to make any profit in the second quarter due to falling gold prices.

However, gold prices have bounced 16% higher from their lowest levels and now Harmony has a chance to operate profitably in the third quarter. The company has managed to reduce its cash costs to $1,156 per ounce, down 9% from the results of the first quarter. If the strike spreads among unions, Harmony's operations could become paralyzed.

Gold Fields tries to improve its cost profile
Just like AngloGold, Gold Fields had to omit its interim dividend. The company reported that its all-in sustaining costs rose 8.6% to $1,416 per ounce. This means that Gold Fields would not be profitable if gold prices stay where they are right now.

In an attempt to improve its cost profile, Gold Fields announced a $300 million deal to purchase three Australian mines from Barrick Gold. These mines operated at all-in sustaining costs of $1,145 per ounce in the first half of this year. The thing that might concern investors about the purchase is the fact that Gold Fields decided to spend this money instead of saving it.

Gold Fields' South Deep project in South Africa was supposed to break even this year. However, the company has stated that it is still cash negative. A possible strike would only deepen the existing problems.

Bottom line
In addition to falling gold prices, which is a universal problem for all gold miners, these South African miners carry additional risks. All three miners were unable to operate profitably in the second quarter of this year, mostly because they had relatively high costs of production; this is why they would vigorously oppose wage increases proposed by unions.

On the other side, unions are not likely to be cooperative. The strike could last for a long time, and outbreaks of violence and physical damage to mines are also possible, as it has happened before.

In the current market, investors can find gold miners that have lower costs and operate in safer countries. I expect more downside for these three stocks.

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