An analysis of precious metals costs by Wellington Capital Markets claims, The perfect storm that precipitated higher capital costs has passed, leaving in its wake a favorable development window for precious metals project.

An unprecedented rate of cost deflation will boost the economics of gold mines and gold projects, a mining sector report by analysts Steve Parsons, Paolo Lostritto, Ryan Walker and John Miniotis suggests.

The costs of key mine inputs, such as steel and diesel, strongly influence mining construction and operating costs, and have plunged lower, according to Wellington. Explosives, mill reagents, and contract labor costs also all trended lower last year.

The analysts estimated that a 20-25% decline in construction costs and the rapid deterioration in equipment costs could mean that a number of late-stage gold mine development projects could benefit. Meanwhile, lead times on large capital items have collapsed from three years to two years.

With gold prices little changed and pointing higher, the implication is that recent feasibility studies quite likely understate the project economics. The magnitude of the differential depends on the timestamp of the feasibility study and the complexity of the project.

The situation could also create an opportunity for investors, Wellington claimed.

The analysts suggested that companies on the cusp of project construction and in the process of soliciting firm bids should benefit from input cost deflation. Bottom line, it is the development companies going out for firm bids on equipment and embarking on project construction in the deflated cost window that stand to benefit.

In fact, the analysts asserted that almost all gold companies stand to benefit from the marked downturn in input prices; however, our analysis indicates almost unequivocally that companies with large, bulk-tonnage mines and projects stand to benefit the most, particularly those that benefit from  a weak local currency vis-à-vis the U.S. dollar and have a heavy reliance on diesel and steel.

Price breaks are also in the offing for secondary equipment, infrastructure build-out materials and labor. Prices for pumps, pipes, steel vessels, structural steel, as well as cement and labour are tracking lower and typically account for 30%-50% of mine development costs, Wellington noted.

Gold producers are also posed to benefit from the slowdown in the base metals market, which improves the availability of skilled labor and generate lower contractor rates.

The analysts also found that the better availability of engineering, procurement, construction, management (EPCM) firms should help moderate financial risk, and ultimately expedite share price re-ratings as companies transition to commercial production sooner than they would have otherwise. The improved availability of EPCM firms is also likely to improve project execution and moderate project risk, they suggested.

Meanwhile, the devaluation of currencies relative to the U.S. dollar should provide scope for construction labour savings for mines built outside the United States, the analysts said.

If mine input costs return to the levels of late 2006/early 2007 during this year, Wellington suggested that gold equities will be undervalued by 35%.

Wellington expects mining analysts to be substantially quicker to embrace and respond to the more palatable concept of cost deflation. As such, we believe it is only a matter of time before lower capex and lower operating costs estimates are employed.