GOLD IN SOUTH AFRICA MINING REFINING FABRICATION TRADE

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2 GOLD IN SOUTH AFRICA MINING REFINING FABRICATION TRADE

3 Photograph courtesy: Rand Refinery Limited

4 CONTENTS CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW 1 MINING REFINING FABRICATION TRADE GOLD IN SOUTH AFRICA CHAPTER 2 RESERVES TO DORÉ: THE GOLD MINING INDUSTRY CHAPTER 3 DORÉ TO SEMI-FINISHED PRODUCT: REFINING AND RECYCLING CHAPTER 4 FINAL PRODUCT: JEWELLERY CHAPTER 5 FINAL PRODUCT: COINS, INDUSTRIAL END USES AND INVESTMENT CHAPTER 6 TRANSFORMING THE INDUSTRY: LEGISLATIVE, FISCAL AND FINANCIAL CONTEXT CHAPTER 7 TRADE APPENDICES APPENDIX 1: APPENDIX 2: INTERVIEW LIST THE SOUTH AFRICAN ECONOMY IN AN INTERNATIONAL CONTEXT APPENDIX 3: TRAINING AND SKILLS TRANSFER APPENDIX 4: THE INTERNATIONAL GOLD MARKET RESEARCH DIRECTORY: FACT SHEETS ON MAJOR INDUSTRY PARTICIPANTS 8 GLOSSARY OF TERMS AND ACRONYMS GOLD IN SOUTH AFRICA 1

5 Gold in South Africa was funded by AngloGold Ashanti Limited, the World Gold Council, the Department of Trade and Industry and the Industrial Development Corporation of South Africa Limited and researched by Virtual Metals Research & Consulting Limited. The publication is protected by international copyright law. All rights are reserved. No part of this publication (text, data or graphic) may be reproduced, stored in a data retrieval system or transmitted, in any form whatsoever or by any means (electronic, mechanical, photocopying, recording or otherwise) without obtaining prior written consent from the funders. Unauthorised and/or unlicensed copying of any part of this publication is a violation of copyright law. Violators may be subject to legal proceedings and liable for substantial monetary damages per infringement as well as costs and legal fees. While the funders and researcher have made all reasonable efforts to ensure that information in this review is accurate at the time of publication, there may be inadvertent errors and omissions and a lack of accuracy or correctness. They make no representation or warranty, express or implied, as to the accuracy or completeness of the review. The review is not and cannot be construed as an offer to sell, buy or trade any securities, equities, commodities or related derivative products, and the review in no way offers investment advice. The funders and researcher and their employees and office bearers therefore accept no liability for any direct, special, indirect or consequential losses or damages, or any other losses or damages of whatever kind resulting from whatever action or cause through the use of any information obtained directly or indirectly from the separate or joint sections contained in this review. The funders and researcher also have no obligation to inform recipients or readers if, in the future, they revise their opinions or modify or correct information contained in the review. Gold in South Africa was published in January Virtual Metals Research and Consulting Limited comprises a uniquely skilled team, with a collective 60 years experience in the precious metals markets. Clients include world-class mining companies, for whom Virtual Metals specialises in proprietary research covering gold, silver and the platinum group metals, refiners, bullion banks, equity brokers, trading houses and other institutions. Virtual Metals particular strengths include macro-economic analysis, the generation of supply and demand scenarios, costs analysis, derivative research and price forecasting. Project management: Lebone Resources Design and layout: Russell and Associates

6 FOREWORD BY THE FUNDERS The objective of the funders in commissioning the research described in this document, Gold in South Africa, was to create a source of reference for the industry on the gold business in South Africa in its entirety. The scope of the research was ambitious; it aimed to cover the gold value chain from mining and refining through to the use of gold in jewellery, bars, coins and other applications, encompassing all aspects of the business of gold. This is the first time that a project of this scope and nature has been attempted in the South African context. The research relied on primary sources of information where possible, engaging with a broad spectrum of participants throughout the value chain to understand how the gold business in South Africa operates and to gather data on the individual businesses which make up this industry. Existing data sources were analysed as well as the legislative, social and economic framework in which the industry operates in South Africa. It is the hope of the funders that this review will prove a worthwhile source of reference to all those engaged in the gold industry in South Africa and that it will be a tool for both South African and overseas investors to identify and define opportunities for initiating or expanding business ventures in gold. The funders of this research would like to thank both those involved in its compilation and those who contributed to and supported the research by sharing information and insights during the course of the project. Mandisi Mpahlwa (MP) Minister of Trade and Industry Department of Trade and Industry Kelvin Williams Executive Director AngloGold Ashanti Limited Geoffrey Qhena President/Chief Executive Officer Industrial Development Corporation of South Africa Limited James Burton Chief Executive Officer World Gold Council GOLD IN SOUTH AFRICA

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8 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW CHAPTER 1 Contents: 1.1 INTRODUCTION AND METHODOLOGY OVERVIEW OF RESEARCH FINDINGS Reserves to doré: the gold mining industry (Chapter 2) Doré to semi-finished product: refining and recycling (Chapter 3) Final product: jewellery (Chapter 4) Final product: coins, industrial end uses and investment (Chapter 5) Transforming the industry: legislative, fiscal and financial context (Chapter 6) Trade (Chapter 7) OPPORTUNITIES AND CHALLENGES IN THE SOUTH AFRICAN GOLD BUSINESS Opportunities Challenges 16 1 Photographs: Courtesy of Gold Fields Limited GOLD IN SOUTH AFRICA 3

9 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Research and analysis were conducted into the production, processing and use of gold in South Africa INTRODUCTION AND METHODOLOGY In developing this review of the South African gold industry, research and analysis were conducted into the production, processing and use of gold in South Africa literally the business of gold in its entirety within the country. One-on-one interviews were conducted with sectoral market participants, and with associated governmental and commercial organisations. A list of entities interviewed appears in Appendix 1. The research directory included at the end of this review gives further details of the major industry participants and many of the companies interviewed in the course of compiling this review. Data on the smaller companies was in some cases either unavailable or uneven, and the focus of the research directory is therefore on the larger industry participants where data was more readily available. The research also entailed analysis of statistics that provide a context for this information, for example, trade data, employment equity plans, retail jewellery databases, South African Police Services data covering gold licences and jewellery permits and information relating to black economic empowerment (BEE). Wherever possible, data has been verified by cross-checking various sources. However, there are areas where data is not available or not verifiable, for example regarding gold production stolen from the mines, finished gold jewellery smuggled into the country to avoid import duties, or jewellery stolen locally. In these instances, reference is made to anecdotal evidence gleaned from industry discussions. The numbers have, however, been excluded from the statistics. There are also instances where the only statistics available are deemed to be unreliable. The report highlights these instances and explains how this data is treated. All volumes of gold are in metric tons (t) unless otherwise stated. All references to $ or Dollar relate to the US Dollar. 4 GOLD IN SOUTH AFRICA

10 1.2 OVERVIEW OF RESEARCH FINDINGS Key participants in the gold industry in South Africa are shown in the following table, along with the chapter in which they are referenced or described. Participants in the gold industry in South Africa Chapter Mining Large primary gold mining companies 2 By-product gold mining companies 2 Small-scale miners 2 Informal miners 2 Industry representatives 2 Trade unions 2 Refining Primary refiners 3 Recyclers 3 Jewellery manufacturing Large manufacturers 4 Medium sized manufacturers 4 Small manufacturers 4 Micro manufacturers 4 Jewellery retailing Retail chains 4 Discount stores 4 Dedicated local retailers 4 Dedicated tourist retailers 4 Single outlet retailers 4 Industry representatives 4 Trade publications 4 Coins, Mints 5 electronics and Component fabricators 5 dental alloys Dental laboratories 5 Government Department of Trade and Industry 6 and officials Department of Minerals and Energy 2 South African Revenue Services 6 South African Reserve Bank 6 Mintek 2 Industrial Development Corporation 6 Mining Qualifications Authority Appendix 3 Other JSE Limited 5 Banks 5 Training and Universities of technology Appendix 3 skills transfer Universities Appendix 3 Private and government initiatives Appendix 3 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW GOLD IN SOUTH AFRICA 5

11 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW In 2004, South Africa produced 342t of fine gold, contributing 14% to global primary output... The following table summarises the main statistical findings pertaining to the gold value chain: The South African gold value chain in fine gold and metric tons 2004 Sector/Topic & chapter Description t % Gold production South African gold production from: Chapter 2 Primary gold producers By-product producers Small-scale gold producers Total Refining Gold to refining from: and recycling South African mine output Chapter 3 Other mine output (Non-RSA) Dump retreatment (RSA) Recycling Total Gold fabrication Gold from refining to: Chapters 4 and 5 Bars Jewellery manufacture Coins Dental alloys Electronics Total Gold jewellery Jewellery imports 1.3 Chapter 4 Jewellery exports 5.1 Domestic sales (includes imports) 5.9 Domestic sales (locally manufactured) 4.6 Gold coin fabrication Krugerrand bullion Chapter 5 Krugerrand proofs Proteas Naturas R R Medallions Total Trade flows of gold Exports from South Africa 3 Chapter 7 Bars Coins 0.7 Jewellery 5.1 Total Imports to South Africa 3 Bars 0.0 Coins 0.3 Jewellery 1.3 Total 1.6 All figures are rounded to one decimal. 1 Gold bars are made up as follows: 46% - 400oz bars, 51% - kilobars, 3% - other small bars including 100g bars and tola bars (small bars primarily sold in the Indian market). 2 Actual sales of coins were 3.4t, the difference being drawn from inventory. 3 As calculated from official import/export data. Difficulties associated with the interpertation of this data are discussed more fully in Chapter 7. 6 GOLD IN SOUTH AFRICA

12 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Numbers employed in the South African gold value chain 2004 Sector Number of individuals employed % Gold production 187, Refining and recycling Jewellery manufacturing 2, Jewellery retailing 2, Coin fabrication Other Total employed in the South African gold business 193, Close on 200,000 people employed in the gold business in South Africa... 4 The category other represents estimates of total employees in various gold-related spheres of activity, including for example dental laboratories, electronic hardware manufacturing, the Gold of Africa Museum and those directly involved with the ABSA s Exchange Traded Fund. Key data and findings from the research are outlined below, ordered according to the chapters in which they appear Reserves to doré: the gold mining industry (Chapter 2) The discovery of the Witwatersrand Goldfields in 1886 led to the development of South Africa s world-class gold mining industry which has dominated the world s gold mining scene for 120 years. In fact, the Witwatersrand Goldfields will probably remain the greatest goldfield ever discovered, surpassing all others by several orders of magnitude. Since records of production were first collected in 1884 until 2004 the South African gold mining sector has produced 50,055t of gold which accounts for some 33% of all the gold estimated above surface. The total remaining South African gold ore resources are estimated to be some 40,000t, of which about 8,000 to 10,000t are economically recoverable depending on the Rand gold price and cost scenarios applied. The Witwatersrand Basin South Africa Scale Central Rand Group West Rand Group Granite Basement Gold Fields GOLD IN SOUTH AFRICA 7

13 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW South Africa dominated the global gold mining industry for much of the past 120 years, rising to peak production of 1,000t (67% of global mine supply) in Today, the industry is in a mature, declining phase with production having declined to 342t in While South Africa is still the largest gold producer in the world, the closure of older mines and shafts could see the country lose this position over the next five years. Global gold production 2004 Country t South Africa 342 USA 260 Australia 253 China 220 Peru 173 Russia 159 Canada 129 Indonesia 100 Uzbekistan 90 Papua New Guinea 71 Ghana 60 Tanzania 48 Mali 40 Chile 39 Brazil 34 Colombia 30 Argentina 27 Mexico 24 Kazakhstan 22 Kyrgyzstan 22 Data source: Raw Materials Group, March 2005 Three of the six largest international gold mining companies in the world are South African. The South African gold mining industry can be divided into four sub-sectors: large, publicly-listed gold mining companies; companies producing gold as a by-product of other metal mining (mainly Platinum Group Metals (PGM) producers); tailings retreatment operations (operated either by large listed companies or by small-scale miners); and junior or small-scale miners There is also very limited, informal gold mining undertaken. The five large publicly listed companies AngloGold Ashanti, Gold Fields, Harmony, DRDGOLD and Western Areas dominate South African gold production, and were responsible for 312.1t (91%) of the country s production in Historically, the gold mining sector in South Africa has been a large employer, although employment has declined substantially in recent years. As at June 2004, the gold mining sector employed 187,039 people, and was the mining industry s largest employer, accounting for 41% of all employment in mining. By comparison, the USA and Australian gold mining sectors employ approximately 14,300 and 6,300 people respectively, a function particularly of the type of mining in those countries in comparison with South Africa. (In both of these countries, mining tends to employ high levels of mechanisation.) Consequently, productivity levels for South Africa are significantly lower than those in the USA and Australia; it is calculated that South Africa produces 55oz fine gold per employee, in comparison with 1,220oz per employee in the USA and 1,342oz per employee in Australia. 8 GOLD IN SOUTH AFRICA

14 1.2.2 Doré to semi-finished product: refining and recycling (Chapter 3) In terms of both value and volume, gold refining in South Africa is concentrated in the hands of its two primary refiners; Rand Refinery and Musuku Beneficiation Systems. In 2004, the primary refiners and the recyclers treated 445t of gold, of which all but approximately 2t was treated by the two primary refiners. Primary refiners: Until very recently, Rand Refinery was the only South African operation to be accredited by the London Bullion Market Association (LBMA). Rand Refinery is also one of only five refineries in the world to have been appointed by the LBMA as a Good Delivery Referee, responsible for the testing of samples from Good Delivery refiners in support of the LBMA s Good Delivery system. Established in 1921, Rand Refinery has a long history. As well as processing feed from the South African operations of its shareholders, which it receives mainly in the form of doré, Rand Refinery treats mine output from non-south African mines in Ghana, Mali, Tanzania, Namibia and Argentina. Musuku Beneficiation Systems was established in 1997 by Harmony Gold Mining, Mintek and BAE Systems, and is currently wholly-owned by Harmony. Musuku processes feed from all of Harmony s South African gold operations. 98% of this feed is in the form of cathode slime. Musuku secured LBMA accreditation in September Recyclers: In addition to the primary refiners, there are at least another seven known but very small recyclers operating in South Africa. CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Global gold refining capacity utilisation in 2004 was estimated at 55%, indicative of an industry in a state of over-capacity. Africa s gold refining capacity utilisation (of which South Africa represents 98%) was 61%. Global refinery utilisation was estimated at 55% in In 2004, 432.7t, or 97.2% of refining output, was in the form of bars for export. Kilobars of 99.5% and 99.99% purity accounted for 221.6t, or 51.2% of these sales and 99.5% London Good Delivery Bars accounted for a further 193.7t, or 44.8%. The balance of bar production was sold in the form of small bars, mainly of 100g. Analysis of South African gold bar sales 2004 t % 400oz bars: London Good Delivery London Good Delivery Sub-total Kilobars: Sub-total g bars g bars Tola bars Sub-total Total Data Source: Rand Refinery Limited and Musuku Beneficiation Systems Another 9.6t, or 2.2% of refining output was sold to the local gold jewellery manufacturing sector, mainly in the form of semi-fabricated product such as granules, plate and wire. The balance went into coins, electronics and dental alloys. In 2004, the gold refining sector employed 532 people, or 0.3% of total employees in the South African gold value chain. The gold refining sector employed 532 people in GOLD IN SOUTH AFRICA 9

15 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW South African jewellery manufacturers used 9.64t of fine gold in Jewellery manufacturers are classified into four categories of business: micro, small, medium and large. Only three of the manufacturers can be classified as large manufacturers (annual gold usage in excess of 750kg) and these account for 66.8% of gold usage Final product: jewellery (Chapter 4) Jewellery manufacturing is the largest category of gold fabrication in South Africa, as it is worldwide. South African jewellery manufacturers used an identifiable 9.64t of fine gold in 2004, and exported 5.07t of fine gold in finished jewellery, primarily to the USA and Europe. Official jewellery imports amounted to 1.28t. Local jewellery sales are therefore estimated at 5.85t, of which 4.57t is manufactured locally. Jewellery manufacturers were classified into four categories of business, based on size of manufacturing throughput. Data on a sample of 34 businesses, including manufacturers from all four categories, was analysed. These businesses accounted for 8.4t of fine gold consumption in 2004, or 88% of the total. Classification of manufacturers Micro Manufacturers using 20kg or less per annum Small Manufacturers using more than 20kg but less than 50kg per annum Medium Manufacturers using more than 50kg but less than 750kg per annum Large Manufacturers using in excess of 750kg per annum While there are a large number of jewellery manufacturing businesses in operation, only three of these businesses can be classified as large manufacturers (annual gold usage in excess of 750kg) and these three manufacturers account for 6.5t or 66.8% of the gold usage in the South African manufacturing industry. The top 10 manufacturers account for 7.9t or 82% of total fine gold usage. Jewellery manufacturing in South Africa is heavily concentrated in Johannesburg and Cape Town. Businesses are privately-owned, in 90% of cases family-owned. 80% of fine gold used in jewellery is used to manufacture mass-produced products, the remainder being used in cast or hand-made products. The bulk of jewellery purchases in South Africa are of 9 carat gold... The bulk of jewellery purchases in South Africa are of 9 carat jewellery, with 95% of gold jewellery sold in this format. The balance is sold as 14 or 18 carat. Mark-ups in jewellery manufacturing vary from approximately 5% in massproduced chain to between 15 and 20% for basic mass-produced product, and up to 40% for high caratage, hand-made or gem-set items. Capacity utilisation is highly seasonal, peaking in the period September to December as retailers increase stock for Christmas sales... Capacity utilisation is highly seasonal, peaking in the period September to December as retailers increase stock for Christmas sales. Jewellery manufacturing employs an estimated 2,800 individuals, or 1.4% of those employed in the total value chain, although this number is difficult to verify on the basis of existing data. Retail sales of all jewellery (including gold, silver, platinum and gem-set jewellery and watches) totalled R2.4bn in 2003 (latest available data). In both value and volume terms, the sector is characterised by a high level of consolidation, with four companies accounting for an estimated 64% of jewellery sales at retail level. These four companies own a total of 11 jewellery chains. Retail mark-ups range from 20 to 50% for non-core products in discount stores to 250% for core products in South African jewellery retailers, and up to 350% for specialist and fast-moving items. After jewellery, coin fabrication is the second largest category of physical gold usage Final product: coins, industrial end uses and investment (Chapter 5) After jewellery manufacture, coin fabrication is the second largest category of physical gold usage, and the only other end use to show significant offtake in South Africa, accounting for 2.93t of gold consumption in Consumption of gold in dental alloys accounted for only 0.04t of consumption per annum and electronics for 0.01t. Consumption in these three categories remains small in relation to total South African gold production, accounting for less than 1% of total production. 10 GOLD IN SOUTH AFRICA

16 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW The SA Mint produces several legal tender coins. The best known and most widely sold is the 22 carat Krugerrand. It also produces 24 carat legal tender coins, including the Natura, the Protea and R1 and R2 commemorative issue coins. The best-known and most widely sold coin produced by the SA Mint is the Krugerrand... South African coin fabrication 2002 to 2004 t Krugerrand bullion Krugerrand proofs Proteas Naturas R R Total Data Source: SA Mint, Universal Mint and Gold Reef City Mint. Proof Krugerrands (limited edition, high quality coins) are sold at a high margin (42% in 2005). Bullion Krugerrands, the supply of which is not limited, sell at a margin of 3 to 9%, depending on size. Approximately 50% of Krugerrands produced in South Africa are exported, although the ratio of local sales to exports is heavily affected by the gold price and the Rand/Dollar exchange rate. Margins on 24 carat coins are approximately 30%. There is little demand for gold for use in dental alloys in South Africa; its use is not encouraged by medical insurance providers, only one of which subsidises its use. The use of gold in the electronics industry is insignificant, with only five South African companies involved in the manufacture of gold electronic components. Since the introduction of a gold Exchange Traded Fund (ETF) by Absa in November 2005, South Africans have invested in just less than 3t of fine gold via this vehicle. ETFs allow investors to trade shares representing gold, the value of which is fully backed by physical gold, on stock exchanges as easily as any other exchange-listed security. The South African ETF is the smallest of the four gold ETFs launched thus far (the others being in Australia, the UK and the USA), reflecting the small size of the potential market locally and the relatively short time for which it has traded. A Krugerrand futures contract is available, but this is very thinly traded. Proof Krugerrands (limited edition, high quality coins) are sold at a high margin... There is limited demand for gold in dental alloys... Use of gold in electronics is insignificant... Limited demand for gold Exchange Traded Fund (ETF) Transforming the industry: legislative, fiscal and financial context (Chapter 6) Chapter 6 reviews key legislation affecting the gold industry, as well as the fiscal environment in which the industry operates, the financing methods available to the mining, refining and jewellery sectors, and the role played by Government and associated entities. Policy governing mining and mineral extraction vests primarily in the Deparment of Minerals and Energy. Policy governing mining and mineral extraction vests primarily in the Deparment of Minerals and Energy... Legislation most relevant to the value chain includes: the Mining Rights Act of 1967 and its proposed amendments; the Mineral and Petroleum Resources Development Act of 2002 (MPRDA); the Broad-Based Socio-Economic Empowerment Charter for the Mining Industry (The Mining Charter); and the Mineral and Petroleum Royalty Bill. The Mining Rights Act of 1967 regulates the possession and trade of gold in businesses making use of gold as a raw material. One of the distinguishing features of the South African gold business, compared to other countries, is that South Africans are effectively prohibited from owning gold other than in bullion coins or jewellery 1. The Precious Metals Bill, currently in the process of parliamentary approval, will reduce these restrictions to some extent, although it stops short of total deregulation of the metal. 1 Bullion coins are gold coins usually 22 or 24 carat. All bullion coins currently minted in South Africa are legal tender. GOLD IN SOUTH AFRICA 11

17 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW The MPRDA is based on the principle of state custodianship of mineral resources... The policies underpinning the MPRDA were developed in consultation with government, the formal and informal industry sector, labour and associated communities, in recognition of the fact that the country s existing mineral policies required review to overcome the historical exclusion of the majority of the population. The MPRDA is based on the principle of state custodianship of mineral resources and abolishes the previous regime of private mineral rights. Applications for prospecting, exploration and mining rights must now be made to the state. Transitional provisions in the act allow for the conversion of existing rights, referred to as old-order to new-order prospecting and mining rights. The Mining Charter is the framework for redressing the historical, social and economic inequalities inherent in South Africa s minerals industry. It provides for companies in the mining idustry to set specific targets regarding human resource development, employment equity, housing and community development, procurement and ownership. The Mineral and Petroleum Royalty Bill, scheduled to become effective in 2009, will introduce a royalty payable to the state by mineral producers. The structure of the proposed royalties (based on revenues rather than profits, with rates varying according to sector) is the subject of continuing debate. In the section of this chapter dealing with taxation, the impact of two categories of taxation (corporate tax and Value-Added Tax or VAT) is analysed. Mining income derived from gold is taxed on the basis of a formula... Billions South Africa exports 2004, top five countries, Rand Data source: Department of Trade and Industry Mining income derived from gold is taxed on the basis of a formula, with more profitable mines paying tax at a higher rate. The effect of this is that each gold mine s tax rate is calculated separately and (with certain exceptions, discussed more fully in the relevant section), ring-fenced to that mine. VAT was introduced in 1991 and amended in VAT is levied on all goods and services at a standard rate of 14% (except for specified exclusions). VAT payments and refunds operate on a two-month cycle a factor cited by jewellery manufacturers, especially the smaller ones, as adding to cash-flow problems for their businesses. The chapter concludes by analysing the various financing methods in place, and the role of the Department of Trade and Industry, the Industrial Development Corporation and the South African Reserve Bank (SARB). Insofar as project finance is concerned, mining and refining are capital-intensive processes that require long lead times and substantial financing. Projects in these areas are normally funded internally or by raising capital on the equity market. The jewellery sector has historically been hampered by a lack of cost-competitive facilities for financing the use of precious metals in the fabrication line. Issues relating to loan costs, collateral requirements and insurance are explained, and the new Gold Advance Scheme developed by AngloGold Ashanti, Gold Fields, BAE Systems, Saab and Standard Bank is described. The objectives of the scheme are essentially to reduce the cost of funding inventory for South African jewellery manufacturers, to increase the volume and value of South African jewellery manufacture and export, and to attract new investors and entrants to the jewellery manufacturing sector Trade (Chapter 7) Since 1994, the value of South Africa s total exports has risen, on average, by 12% per year from approximately R85bn in 1994 to approximately R270bn in The contribution of mining to South African exports by value, however, has fallen from 50% in 1994 to 32% in USA, UK and Japan are largest markets for SA goods... The USA, UK and Japan are the largest markets for South African goods and, in value terms, represented 33% of the country s total exports in Europe and Asia account for 60% of the value of all South African exports. 12 GOLD IN SOUTH AFRICA

18 Exports of fine gold in bars, as calculated from official import/export data, decreased from 452t in 1999 to 421t in 2004, a decrease of almost 7%. Exports of fine gold coins and medallions also decreased, from 1.07t in 1999 to 0.72t in 2004, a decrease of about 33%. In contrast, fine gold exports in the form of jewellery have risen since 1999 at an average of 23% per annum, from a base of 1.81t in 1999 to 5.07t in During this period, the value of these exports rose from approximately R110m in 1999 to R495m in In 2004, some 62% of jewellery in exports was destined for the USA, and 11% for the UK market. This increase in exports of gold jewellery has occurred despite a volatile Rand and the recent strength of the local currency against the Dollar. Since 1994, the value of total manufacturing and industrial sector imports by South Africa has risen by an average of 15% per year from approximately R75bn in 1994 to approximately R300bn in Germany, the USA and China are the top three exporters of goods to South Africa. Germany is the largest exporter to South Africa accounting for 14.6% of the value of imports into the country in Asia and Europe together account for 80% of the value of South African imports. Imports of non-south African doré for refining at Rand Refinery are not recorded in South African trade data. This is because ownership of the gold in the refining pipeline does not pass to Rand Refinery, but remains with the mine from which the doré originated. Imports of fine gold jewellery into South Africa increased by 50% from 0.85t in 1999 to 1.28t in In value terms, this equates to R65m in 1999, increasing to R150m in Together, Hong Kong and China accounted for one-third of these imports, as this region capitalised on increased general trade with South Africa, more competitive jewellery manufacturing charges and Rand strength. Imports of fine gold coins decreased significantly from 2.68t in 1999 to 0.32t in CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW There is anecdotal evidence that the strength of the Rand has encouraged a high level of smuggling of finished jewellery into South Africa, to avoid both the 20% import tax and the 14% VAT. Since undeclared imports are not reflected in the official trade statistics, official figures may understate the true levels of gold jewellery entering the country, possibly by a significant margin. It appears that the Rand strength has encouraged a high level of smuggling of finished jewellery into South Africa... South Africa enjoys favoured nation status with the USA in terms of the African Growth and Opportunity Act of 2000 (AGOA), which allows South African gold jewellery fabricators to export their finished product to the USA free of import duties. This provides South African jewellery manufacturers with a cost advantage over their European and Far Eastern competitors, on whom a 6% duty is levied for jewellery product exported to the USA. Under the South African/European Trade Development and Co-operation Agreement (TDCS), a free trade area between South Africa and the European Union is being developed through the abolition of import and export tariffs between the two trading partners. Import and export duties will be reduced from their maximum of 20% in 2003 to zero by The country will then be able to export local gold jewellery duty-free into Europe. Thus over the next six years, the European market will progressively be opened up to South African jewellery manufacturers at an increasingly attractive fiscal rate. Tourist arrivals in 2003 (latest available data) totalled 6.5 million, 69% of whom were from Africa, and 20% from Europe. Many long-haul visitors (those from Europe, North America and Asia in particular) arrive with the intention of buying a piece of jewellery. The gold caratage associated with tourist purchases is higher than that in the South African domestic jewellery market, with 18 carat predominating especially in gem-set items. GOLD IN SOUTH AFRICA 13

19 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW 1.3 OPPORTUNITIES AND CHALLENGES IN THE SOUTH AFRICAN GOLD BUSINESS Gold mining industry in South Africa is essentially mature... The gold mining industry in South Africa is essentially mature and production tonnage is showing a declining profile. There is increasing debate on how growth of the downstream gold industry can be achieved, to add value to gold mined in South Africa. The research identified a number of challenges and opportunities in respect of the downstream gold industry in South Africa. Opportunities Challenges AGOA Inbound tourism: interest in jewellery Refining capacity and refining track record South African/European Trade Development and Co-operation Agreement (exporters) Emerging middle class among Historically Disadvantaged South Africans (HDSAs) Gold financing schemes Closer co-operation between industry and government Laws forbidding ownership of gold other than jewellery and bullion coins Current lack of access to cost-effective finance and insurance for jewellery manufacturers Start-up costs and cost of working capital associated with gold jewellery manufacturing Performance of the local currency Quality imports at competitive prices based on cheaper offshore labour and the strong Rand Technical limitations and ageing equipment Shortage of skills and concerns about training Low productivity Adverse effect of crime on jewellery sales Lack of co-operation in the gold business, especially in jewellery manufacturing Local jewellery retail sales are a small and declining proportion of all consumer goods purchased External perceptions of local jewellery/quality issues Lack of data South Africa/European Trade Development and Co-operation Agreement (local industry) Opportunities AGOA - The African Growth and Opportunity Act of 2000 AGOA provides South African exporters to the USA with a 6% advantage over countries paying full duty as import duties are waived... Affected sector: Jewellery manufacturing targeting the export market AGOA was ratified on 18 May 2000 and amended in 2002 and It provides South African exporters to the USA with a 6% advantage over countries paying full duty since import duties into the USA for South African exporters are waived. The Act offers incentives for African countries to open their economies and build free markets. These incentives are to encourage trade between African countries and the USA by eliminating duties and introducing quotas in specified products. In 2004, 62% of South African jewellery exports were destined for the United States, partly as a consequence of AGOA. 14 GOLD IN SOUTH AFRICA

20 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Inbound tourist interest in jewellery Affected Sector: Jewellery manufacturing and retailing Inbound tourists frequently visit the country with the intention of buying a piece of quality jewellery, especially gem-set with diamonds or tanzanite. Gold jewellery sales benefit indirectly as a result. Inbound tourists intend buying jewellery... Since 1994, inbound tourist arrivals have increased substantially. Refining capacity and refining track record Affected sector: Jewellery manufacturing and gold mining companies The two primary refiners offer localised refining services and capacity to refine gold competitively. Rand Refinery also offers secure warehousing. Both Rand Refinery and Musuku Beneficiation Systems have London Bullion Market Association accreditation and Rand Refinery serves as a referee in international quality control for the LBMA. In September 2004, Rand Refinery became the world s first refinery to receive Dubai Good Delivery accreditation. The South African/European Trade Development and Co-operation Agreement Affected sector: Jewellery manufacturing targeting the export market The South African/European Trade Development and Co-operation Fund (TDCS) provides for the creation of a free trade agreement between the European Union and South Africa by no later than 31 December By this date, 90% of all trade between the two partners will be free of customs duties. The phase-down of import duties, from current levels of 20%, allowed for by TDCS has important implications for the local jewellery industry as the European Union will gradually be rendered a free trade zone in the way that the USA is under AGOA. The reduction of tariffs applies to jewellery fabricated from gold, silver and PGM. This means that locally produced precious metals jewellery will eventually enjoy access to this market free of import duties. This represents a major opportunity for exporters of South African-manufactured gold jewellery. However, it also presents a threat for local manufacturers reliant on domestic sales. (See below.) The emerging middle class among HDSAs Affected sector: Jewellery manufacturing and retailing In South Africa, a new middle class among the formerly disadvantaged is developing. Jewellery manufacturers have noted this trend, reflected in the increasing numbers of new accounts being opened with those jewellery retailers offering credit facilities. In response to this trend, jewellery manufacturers are adapting their product range to suit this new market segment. A new middle class is developing in South Africa... Closer co-operation between gold manufacturing industry and government Affected sectors: Jewellery manufacturing and government Continued and expanded government assistance by means of financial incentives could improve the outlook for jewellery manufacturers. Continued and expanded government assistance... Government and the private sector could also work together on joint marketing efforts targeting both local consumers and tourists. GOLD IN SOUTH AFRICA 15

21 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Gold financing schemes Affordable loans would make the industry more competitive... Quotable quotes: The current focus on beneficiation is not right. We are trying to force people into beneficiation in the belief that this can be achieved by yet more legislation. But by creating a decriminalised environment of ownership of gold we will obtain greater organic growth. We were born and bred in an environment that criminalises ownership of unwrought gold. Getting rid of that law will solve the problem immediately. Office bearer, industry body Affected sectors: Jewellery manufacturing and mining industry Access to affordable gold loans and other financing incentives would render the local jewellery manufacturers more competitive internationally and would facilitate growth in the jewellery manufacturing sector in South Africa Challenges Laws forbidding ownership of gold other than jewellery and bullion coins Affected sectors: Jewellery manufacturing and investment The Mining Rights Act of 1967 (and its subsequent amendments) restricts gold ownership by South African citizens to finished jewellery and bullion coins 2. The regulatory system of recovery works licences and jewellery permits dictates the way jewellery manufacturers run their businesses. The fact that citizens are limited regarding ownership of physical gold products also restricts the local investment market in gold. Current proposed amendments to the Mining Rights Act, which would result in the deregulation of ownership of minted bars 3, would go some way towards liberalising the South African gold market. However, proposed amendments still fall far short of entirely liberalising the ownership of gold. Lack of access to cost-effective finance and insurance for jewellery manufacturers Lack of access to affordable finance is a predominant reason for business failure, failure to grow and a disincentive to invest... Affected sector: Jewellery manufacturing especially small businesses Interviews with the manufacturing sector (especially the medium and small businesses, 4 ) highlight the lack of access to affordable finance as the predominant reason for business failure, failure to grow an existing business, or as a primary disincentive to entering the sector in the first place 5. Demonstrating the extent to which local manufacturers are disadvantaged, the table overleaf indicates a comparison of the different jewellery financing mechanisms currently in place in Dubai, Italy and South Africa. These figures are estimates as loan agreements are invariably confidential and can vary between different parties. Quotable quotes: Of course I don t have a balance sheet I am a one-man band trying to run a tiny business. Micro manufacturer Small jewellery manufacturers have little or no credit standing, insubstantial balance sheets, insufficient personal loan guarantees... The major difference between jewellery fabricators in Dubai (and in some cases in Italy) and those in South Africa is that the former are able to borrow metal at a cost close to the international gold lease rate against a letter of credit issued by a local bank. South African jewellery manufacturers are required to post collateral as local banks will not accept letters of credit. Furthermore, since they borrow Rands and not metal, they are obliged to borrow the currency at prime money market interest rates. Problems relating to cash flow were also noted in the research, with the manufacturers having to borrow funds at several percentage points above prime rates to finance short-term cash requirements. In most financial respects, these businesses are no different to those operating in other sectors, save for one that sets the gold jewellery manufacturer apart and that is the high cost and volatile nature of the jewellery manufacturer s primary raw material. With the exception of the large manufacturers, South African gold fabricators do not yet have access to the metal financing structures enjoyed by their overseas competitors. Currently, they buy their raw material outright using working capital or they finance it at the local prime lending rate plus a risk premium. Again, collateral is required as loan security, usually 120% of the value of the gold borrowed. The disadvantage suffered by local manufacturers is the value of the raw material, compounded by the fact that small jewellery manufacturers have little or no credit 2 See Chapter 6 for details of this Act and its billed amendments. 3 See Glossary of Terms for full definition of minted bars. 4 See Chapter 4 for the definition of the gold jewellery manufacturing categories used in this review. 5 See Chapter 6 for details on finance. 16 GOLD IN SOUTH AFRICA

22 standing, insubstantial balance sheets, insufficient personal loan guarantees and represent high credit risks to commercial banks. Gold jewellery finance Cost of loans as of mid 2005 Dubai Italy South Africa Loan Type gold gold Rand Gold lease Gold lease Prime Interest 2% 3% 10.5% Risk premium 0.70% 0.70% 2%-3% LOC (Note 1) Local Bank Local Bank None Cost of LOC 1% 1% NA Collateral (other than LOC) None None 120% Total cost of loan 3.70% 4.75% 12.5%-13.5% Insurance needed over metal on loan Yes Yes Yes Data source: Vitual Metals Note 1: Letter of Credit. Not all Italian manufacturers make use of letters of credit. Those most affected by this situation are the small manufacturers. The larger companies potentially qualify for gold financing schemes. In addition, large retailers interviewed reported that, on placing an order with larger jewellery manufacturers, they settle immediately for the cost of purchasing the associated fine gold. This relieves the manufacturer of the related cash flow and financing issues. The small jewellery manufacturers tend not to supply the large retailers, since they cannot deliver finished product in the volumes required. CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Manufacturers of all sizes face an additional cost. Those interviewed noted that while they had insurance cover for third party liability and stock in transit, the premiums associated with insuring jewellery inventories and metal in the manufacturing pipeline are prohibitively expensive. Absence of insurance will automatically disqualify a jewellery fabricator from participating in gold financing schemes as sufficient insurance coverage is a pre-requisite. Premiums associated with insuring jewellery, inventories and metal in the manufacturing pipeline are prohibitively expensive... Start-up costs and the cost of working capital associated with gold jewellery manufacturing Affected sector: Jewellery manufacturing especially small businesses Without access to metal-based funding (as described above), local jewellery manufacturers have two options: they may either fund their businesses using their own capital or borrow from commercial banks. The former is usually not an option a problem not unique to the gold jewellery industry but experienced by small businesses in general. But the South African jewellery manufacturer is further disadvantaged on a number of levels. 1. Interest rates in South Africa have remained high relative to other countries. The chart on the right compares monetary interest rates in South Africa to the gold lease rate, which forms the basis of the borrowing cost to many overseas competitors of the South African jewellery manufacturers. 2. The high cost of start-up. Discussions with small manufacturers revealed that even a small workshop, for example, with two jewellery benches, a small furnace and equipped with basic tools and equipment, such as facilities for plating, can cost up to R250,000. Chain-making machines, imported from Italy, cost R150,000 each. Additionally, all spares and additional chain-making dies have to be imported. 3. The nature of gold as a raw material. The very high value of the basic raw material and the often volatile behaviour of the price of gold disadvantage the jewellery fabricator more than other manufacturing sectors. GOLD IN SOUTH AFRICA 17

23 CHAPTER 1 GOLD IN SOUTH AFRICA: INTRODUCTION AND OVERVIEW Performance of the local currency Affected sectors: Mining, jewellery manufacturing (especially small businesses) The strength of the Rand during much of 2003 and 2004 against the Dollar, British Pound and Euro, was cited not only as a barrier to market entry but also a threat to the survival of the mining industry and to jewellery manufacturers in South Africa. The performance of the Rand since 2000 is shown on the left. With the Rand/Dollar exchange rate at R6/$, jewellery manufacturers in South Africa reported that finished jewellery can be imported at a cost less than the manufacturing cost incurred by local manufacturers for the same or very similar product. This is so even after taking into account the 20% import duty into the country and a clearance fee of 2% - 3%. Manufacturers also note that an unknown volume of foreign-manufactured gold jewellery is being smuggled into the country to avoid import duties and this has served to further disadvantage the local manufacturers. The stronger the Rand against other currencies, the greater the incentive to import finished jewellery legitimately, and, even more so, to bring these goods into the country illegally. The effect of the strong local currency has been increasing pressure on the mark-ups earned by local manufacturers... In 2001, when the Rand weakened sharply against the Dollar to average R10.52/$ for the year, exports of gold jewellery from South Africa were robust 6. Countries of destination were the USA, the UK and other parts of Europe, Australia, Israel and Panama. As the currency strengthened, reaching highs of R5.60 to the Dollar in 2004, these same manufacturers reported that their levels of exports were under pressure and they were restructuring their business models in an attempt to recapture local market share. The effect has been increasing pressure on the markups earned by local manufacturers given the added competition for local business. Throughout 2004, there is also evidence of: manufacturers importing finished gold jewellery from countries in the Far East, Israel and Turkey, rather than fabricating similar gold jewellery themselves; and larger retailers importing finished gold jewellery rather than placing orders with the local jewellery manufacturers. Quality imports at competive prices based on cheaper offshore labour and the strong Rand South African manufacturers are unable to compete with low labour costs associated with jewellery manufacturing in China, Thailand and Turkey... Affected sector: Jewellery manufacturing South African manufacturers are unable to compete with low labour costs in jewellery manufacturing in, for example, China, Thailand and Turkey. This is an area of concern and a threat to local manufacturing capacity. Italian jewellery still leads the field in terms of quality and finish. However, imports from Turkey have gained ground and compete with quality products from other countries. It was felt that goods from Far Eastern countries such as China were not yet on a par with respect to finish. However, in the mass market, especially where lightweight jewellery items were concerned, the decisive factor was price rather than quality. In environments such as China where there are no minimum wages or labour unionisation the cost of labour is lower than in South Africa. It is, therefore, difficult for local jewellery manufacturers to compete internationally. 6 See Chapter 7 for details on the growth of jewellery exports from South Africa. 18 GOLD IN SOUTH AFRICA