We have often said that fundamentals are not necessarily the key influence in the path of the gold price – sentiment and fear are perhaps the main influences on the yellow metal’s price movements. And at the moment neither seem to be playing a significant role in where gold’s path is trending. Indeed some technical analysts, who make their predictions based virtually solely on chart performance, see gold falling yet further with possible significant support levels at $1,200 – and then, if that is breached, as low as $1,000.
But, eventually fundamentals have to play a role, even if not the defining one. At $1200 perhaps a third or more of current newly mined gold would be being produced at a loss on an all-in costs basis. At $1000 this figure rises probably to over 50%, perhaps even higher, and there is little most miners can do to influence this, given the dominance of large ultra low grade operations these days in global gold output. Some may be able to tweak grades a little to stay afloat at the expense of turning large swathes of ore into waste and reducing mine life and NPV. However it should be noted that mining higher grades without reducing mill throughput will lead to a rise in gold output from some of these. Even so this may not be enough to counter the overall trend from the lower prices of falling output and, perhaps even more significantly in the medium to long term to a virtual total halt to new mine construction and development.
There are few new mines being brought on line which can produce gold profitably at less than $1000 an ounce despite what they may say about far lower cash costs. Once the cost of servicing the mine capital expenditure is taken into account, together with sustaining capital and ever rising royalties and taxation as countries around the world seem to be doing their best to strangle their golden geese these quoted cash costs are largely a very poor indicator of what a mine is really able to accomplish in terms of profits. How often do we see even major mining companies reporting cash costs at perhaps 50% of the current gold price, yet still failing to make overall profits of any significance? Reported low cash costs are, in many cases – perhaps most cases – largely a device to suck in new investors and keep shareholders happy. They are seldom the best indicator of what a mine will actually achieve.
What this all means in reality is that profitable miners faced with lower and lower gold prices are going to shut down uneconomic mines rather than mine at a loss. And less profitable companies, which may not have this option, will just disappear. If shareholders are lucky, their assets will be snapped up by cash rich companies which understand that mining is a cyclical industry and can afford to keep currently unprofitable operations and projects on a care and maintenance basis until the cycle reverses again – as it surely will.
Gold has been in a bull market for 12 years and a 50% retracement from its high – not unknown in such a market – would drop the price back to just under $1000. But if it does reach this level then new mined gold output will be cut back drastically – and the incentive to sell gold scrap will virtually disappear. If recent activity in the physical market is anything to go by, the demand for gold bullion will skyrocket. There will come an enormous shortage of physical gold and prices will have to turn round dramatically. In fact we are already beginning to see some of this happening at around the $1300 level. Mines are closing, projects are being deferred and demand for physical metal is surging, particularly in the East. Premiums in these areas of high gold demand are running at elevated levels.
To a minor extent Indian government moves may be putting something of a damper on gold demand there in this gold-loving nation, but we see this only as temporary as more and more physical gold will bypass official channels as old gold smuggling routes are re-opened and new ones initiated. Official statistics may thus show a sharp fall in gold imports – but how accurate will these be?
Meanwhile physical gold will continue to flow from West to East, until premiums rise in the West to match those in the East, and this in itself will mean a hike in the price of physical gold. Once the markets start to turn they could move fast. The big money is in a better position to spot this point and act on it than the small investor. Indeed the cynics will tell you that the big money has been the instigator of the crash in the gold price all along and is just waiting for this moment to jump back in as their short positions can be unwound and they can then sit back and rake in the profits as the cycle starts moving up again. And the cynics may well be correct!
The difficulty for the smaller investor is to spot the point at which this turning point will occur. It has to be getting closer and closer – it may already have arrived despite what the technical analysts may tell you. Watch for gold mine shutdowns and significant sized operations to be put on care and maintenance. That will signify the beginning of the end. For the adventurous seek out junior gold miners which really can produce gold at less than $1,000 after all costs are taken into account – there aren’t many – and which have the financial strength to ride out the storm. They should generate great returns when the market picks up.
The gold majors do have the financial strength to ride things out and they are beginning to be far less profligate with their development capital and general costs. Virtually all are running at multi-year lows in terms of stock prices. They are mostly all beginning, as Mineweb repeatedly called for a few years back, to report all-in costs so their true profitability is easier to assess now than it has ever been. There thus may be some bargains here too.
But, one has to recognise, gold prices could yet drift down a little more before they turn. If the general stock markets start to plunge in fear of central bank stimulus being withdrawn, the gold price could fall with them as some hedge funds need to liquidate anything they can – as happened in 2008. If this starts to occur again gold will almost certainly be the first to recover as it did in early 2009. We have to be at least nearing the cusp – the point at which a sharp trend reversal occurs. At these gold price levels downsides become more and more limited – but can still occur nonetheless.