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Thousands of Chileans sailed for California in the 1850s to join the gold rush and a few struck it rich, but these days prospectors from North America are heading in the opposite direction. That’s because with global demand for gold on the rise and prices soaring, Chile’s large deposits high up in the Andean Cordillera are luring the world’s largest gold mining companies.

Gold peaked at nearly US$1,900 an ounce in early September as investors nervous about macroeconomic problems in the United States and Europe sought a safe haven for their cash. But the price has since dipped, along with prices for other commodities, as worsening fears of another global recession led investors to seek refuge in the dollar.

Despite the recent volatility, however, analysts and mining companies say gold is still a good investment. The dollar is likely to remain weak while other currencies, like the euro, are far from being safe alternatives, according to a recent report by US investment bank Merrill Lynch.

Historically low interest rates globally have also contributed to a strong increase in demand for gold-linked Exchange Traded Funds (ETFs). “In our view, continued structural problems in the US and Europe are bullish for gold,” said Merrill Lynch, which has maintained its US$2,000 per ounce 12-month gold price target set in August.

Gold demand in India and China – the world’s two largest consumers – has also rocketed as incomes have risen. In India, gold is used mainly for jewelry and, to a lesser extent, electronics, while in China it is increasingly seen as a good investment. In September, the Gongmei Gold Trading Company opened China’s first ATM offering gold bars and coins in a Beijing shopping mall.

With world demand outstripping supply, this is good news for mining companies. In 2009 world production reached 2,572 tons led by China, Australia, the United States, South Africa, Russia and Peru, which is South America’s largest producer, according to the Chilean government’s Copper Commission (Cochilco).

Chile is not currently among the world’s major gold producers. It produced around 41 tons in 2009 – compared to Peru’s 182 tons – making it just the 17th largest producer in the world and fifth largest in Latin America. But with several multibillion dollar projects in the pipeline that is expected to change. 

If these projects go ahead, Chile could triple its production to around 120 tons by 2017, making it the world’s eighth largest producer, says Andrés MacLean, executive vice-president of Cochilco.

A copper by-product

Gold mining in Chile dates back to the end of the 16^th Century. The Spanish exploration of Chile was largely financed by gold, but unlike Peru’s Inca jackpot they found that Chile’s gold deposits were relatively small.

Still, the Spanish managed to produce around two tons a year mainly from gold mines in the southern part of the country that had been worked by the Mapuche to pay Inca tribute. They were eventually evicted from these mines by the Mapuche, however, and gold production subsequently declined.

The establishment of a royal mint at Santiago in 1749 led to renewed interest in gold mining but it wasn’t until the United States unpegged the dollar in 1971 that it took off. This led to a surge in exploration activity and the discovery of a series of gold deposits mostly at elevations of more than 4,000 meters in the Andean Cordillera.

Chile’s first large gold mine was the El Indio mine in the Coquimbo region which began operations in 1982, reaching peak production of 16 tons a year. Canada’s Barrick Gold Corporation, the world’s largest gold producer, bought the mine in 1994 but closed it in 2002 after its reserves were depleted.

Often found together with ores like copper and silver, gold has long been produced in Chile as a by-product of copper. In 2005, nearly 40.6% of the gold

produced in the country came from copper mines, but by 2009 this had fallen to 35.8% while production in gold mines has risen.

Today, Chile’s state copper mining firm Codelco produces about 3.5 tons of gold a year, which is up from 2.8 tons in 2008, using electrolysis to separate the gold from other minerals. Despite the increase, however, Codelco’s gold output remains less than 10% of Chile’s total production, says Vicente Pérez, head of research at Cochilco.

Most Chilean gold is produced by private firms and exported in the form of doré metal, a gold-silver alloy obtained by dissolving the ore in sodium cyanide before treating the solution with zinc. Bars of the metal are then flown to refineries in Brazil, China, Canada, Italy and Belgium amongst other countries, where the gold is separated from silver.

About half of the country’s production comes from the Atacama Region where production is concentrated in two mines: Maricunga and La Coipa, both owned by Toronto-based Kinross, which is Chile’s top gold producer accounting for about 25% of total production.

Kinross plans to invest US$19 million in exploration this year, mainly in La Coipa and its new mine, Lobo-Marte, but most of the exploration activity in northern Chile is done by a handful of Canadian junior mining firms, says José Tomas Letelier, vice-president of external affairs for Kinross South America.

“If they make a sizable find, they usually sell their rights to a larger firm like ours,” he says.

But high prices have also led to strong growth in the informal sector. Thousands of pirquineros, who are freelance miners often without safety equipment or permits, have joined the gold rush in abandoned mines or hillsides in the north of the country.

Some pirquineros make a living selling their gold to the Chilean state minerals company Enami, but several have paid with their lives, trapped by collapsing mine shafts.

Canadian gold-diggers

Chile’s largest remaining gold deposits are buried in the Andes, often near glaciers, and require heavy machinery and skilled technicians to get them out. There are only a few companies in the world with this kind of expertise and most are Canadian.

With their financial muscle and experience, Canadian miners are developing Chile’s largest gold projects: Barrick and Kinross are partnering on Cerro Casale in the Atacama Region, which recently submitted its environmental impact study; Barrick is developing the Pascua-Lama project; Kinross is behind Lobo-Marte, which also submitted its environmental study this year; and Vancouver-based Goldcorp owns the El Morro gold-copper project. Combined investment in these four projects is estimated at US$12 billion.

In fact, Air Canada’s Toronto-Santiago flight is known as the “mining shuttle” due to the number of mining executives who regularly make the 11-hour journey. But Chile is not the only South American country with buried treasure, so why are Canadian companies so intent on digging here?

According to Cochilco’s MacLean, the gold price is only part of the reason. “This increase is due in large part to the high gold prices that make projects more profitable, but also to the stable legal, social and political conditions in Chile,” he says.

Given that the development of a gold mine can take 10 years or more, political and regulatory stability is very important. “In general it is a long-term business, which means investment decisions use long-term variables,” says Alvaro Merino, head of research at Chile’s Mining Society (Sonami).

Fortunately, Chile has a reputation for regulatory and legal stability. According to the Fraser Institute 2010/11 Survey of Mining Companies, Chile ranked seventh on its Policy Potential Index and is the only jurisdiction outside North America that consistently ranks in the top ten.

“Chile’s mining industry is world-class with a clear and robust legislation,” says Igor Gonzales, president of Barrick South America. In addition to Chile’s institutional strength, its modern public infrastructure has helped make the country an attractive destination, he says.

Kinross’ Letelier agrees. “Chile has many advantages and is an attractive place to invest,” he says. Other advantages include Chile’s mining tradition and its skilled workforce.

“Chile has a history of mining, which is very important,” says Letelier.

Tax reform

Despite Chile’s advantages, however, it is increasingly expensive for mining companies. One reason is the recent increase in the Specific Tax on Mining Activity, ostensibly to help foot the bill for reconstruction after the February 27 earthquake.

In 2010, the government asked mining companies to accept an increase from the fixed rate of 5% to up to 14% in return for tax stability. Kinross accepted the arrangement for its Maricunga mine but not for La Coipa. “There was no incentive because its reserves are almost depleted,” explains Letelier.

Although mining companies negotiated the new system, the changes generate uncertainty for investors. “We need clear rules to make decisions,” says Letelier.

But the government does not expect the tax increase to have an impact on gold projects in Chile. “The tax is levied on operating income so that in periods of low prices the taxable amount also decreases,” explains MacLean at Cochilco.

Even so, mining companies are concerned about income tax rates. The corporate tax rate will be temporarily increased from 17% to 20% and 18.5% for profits earned in 2011 and 2012 respectively, but the increase could become permanent in the future.

“Now [the authorities] are talking about tax reform so in a few years the rules might change again,” says Letelier. “Who knows?”

But taxes are not the only worry for mining companies with Chile’s energy and labor costs amongst the highest in the region.

Operating costs

Given current prices, nearly all projects in Chile are profitable despite higher input costs and the peso’s recent appreciation against the dollar, but if the price falls companies may rethink their investment plans, warns Letelier.

“The gold price has fallen from US$800 to US$200 in the past, so why couldn’t it happen again?” he says.

One problem is energy prices. Gold mining is energy-intensive and electricity costs in Chile are roughly twice those in neighboring countries, but for companies like Kinross installing their own generators is not worth the expense, says Letelier.

And higher costs are impacting the company’s bottom line. Kinross’ average production cost in the third quarter of 2011 was US$576 per ounce of gold, which was 17% higher than a year earlier mainly due to higher labor, fuel and power costs.

In addition to labor costs, there is a shortage of trained professionals in Chile, especially as new projects are developed, says Letelier. “There will be strong competition for skilled workers which will only get worse,” he notes.

Kinross is developing internal training programs to meet future demand but these takes time. The government could help create a larger labor pool for the mining industry by continuing to strengthen training programs like SENCE, says Letelier.

“The demand for trained personnel will be huge and the supply is not nearly enough,” he points out.

Another challenge for mining companies is access to water. Gold mines in Chile use plenty of it, around 60 liters a second in Maricunga and La Coipa, but in the arid north of Chile water is in short supply.

“In many cases there are no water rights available or there are restrictions on water use due to drought,” says Letelier.

As a result, mining companies have implemented technology to use water more efficiently. Another solution is to pump seawater from the coast as some mining companies like Escondida are doing, but this requires a lot of energy and desalination plants.

Kinross uses water from underground streams, but as the number of mining projects grows, competition for water resources is certain to intensify, warns Letelier.

This raises another issue - the environmental impact of gold mining. Chilean gold mines have been accused by environmental groups of melting glaciers and contaminating water supplies with toxic chemicals, but the mining companies deny they have done anything illegal.

Environmental impact

Barrick’s US$5 billion Pascua-Lama project will be the largest gold project in Chile. Construction is underway and the project, which straddles the border, is expected to produce nearly 39 tons of gold a year by 2015, about 75% of which corresponds to Chile and the rest to Argentina.

In approving Pascua-Lama’s environmental impact study, the Chilean government made it a condition that nearby glaciers should not be affected. But environmental groups like Greenpeace say dust from the project is melting them and that the government must intervene.

In addition, residents in the Huasco Valley have blamed Pascua-Lama for an alarming lack of water in the area, giving rise to the campaign Agua Vale más que Oro (Water is Worth More Than Gold).

But Barrick’s Gonzales says the project complies with all the requirements of the environmental authorities in Chile and Argentina.

“Barrick has always adhered strictly to the environmental norms in all the countries where it operates and Chile is no exception,” says Gonzales.

The company has also implemented a water monitoring and management plan to ensure the quality of water downstream from the mine. “Pascua-Lama puts into practice our philosophy of responsible mining,” says Gonzales.

The environmental risks of gold mining are clear, but if properly managed by mining firms in coordination with the authorities – both Chilean and Argentine in the case of Pascua-Lama – this activity should not affect living conditions in local communities.

As it has for centuries, much of Chile’s wealth lies under its soil. With most gold mines in the hands of private companies, however, strict regulation must be balanced with regulatory stability to ensure the benefits of Chile’s buried treasure are shared by all.

Julian Dowling is Editor of bUSiness CHILE