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- Senior Stock Analyst -
Newsletter #123 06/28/2013
“Why the Skyrocketing Cost of Gold Production Will Launch Gold’s Next $750-$1,000 Jump in Price...”
“During the next leg of gold’s bull market, inflation and fear will take a back seat to the basic supply/demand fundamentals!”
To invest successfully, investors must understand the value of an asset, and the total cost to produce or replace it.
The price of most assets is basically:
Price = total cost to produce/replace
Historically, the average premium for gold has been about 112 percent above total cost.
Ten years ago, production cost was reported to be about $164 per ounce. However, the average total cost to produce gold has soared over the last decade, as low-cost mines have been depleted (and few new ones are being discovered).
Recently gold producers have re-analyzed all their costs. Using these new total cost models, the average total cost to produce gold for 2012 was about $1,104.
Therefore, gold’s target price today is about $2,340 ($1,104 average total production cost plus 112 percent average premium above total cost.)
Recommendation: Investors without a sufficient gold position should buy a quarter of total desired position now.
If the price dips to $1,320, you should add to your position. A dip below $1,170 (50 percent of the price target) is the time to go in with the balance of any gold position.
|United Arab Emirates||2,948.47||2,947.50||3,046.45||2,794.69||2,810.28||2,500.00||2,650.00|
Source: International Energy Agency
Let’s review the table:
- OPEC production peaked at 34.5 million barrels per day in 2008.
- In 2009 OPEC reduced its production because of the global recession.
- OPEC has kept production low because of the slow global economy, and to keep prices elevated.
The following chart shows the impact of production on prices:
Let’s review the chart:
- In 2008/2009, oil prices dropped to break-even levels. OPEC and many other producers cut back on production.
- As the economy began to recover, so did oil prices.
- As the table indicated, OPEC has kept production lower to keep prices elevated.
When prices get too high, which causes the global economy to slow, OPEC has raised production to increase supply and lower prices.
The Cost to Produce Gold
The following chart is from my book, The New Bull Market in Gold, page 96.
From 1982 to 2000, gold basically traded from around $300 to $400.
On page 175 of my book, I provided the cost to produce gold for different precious metals companies. This table is shown below.
|Company Name||Market Cap (Mil. $)||Cash Cost ($/oz.)||
(millions of ounces)
|Anglo American PLC (ADR)||23271.49||203||72.30|
|Newmont Mining Corp.||11525.06||155||87.20|
|Barrick Gold Corp.||9858.98||177||86.90|
|Gold Fields Limited (ADR)||5867.43||183||79|
|Placer Dome Inc.||4893.7||195||52.90|
|Harmony Gold Mining Co.||2567.75||225||49|
|Kinross Gold Corp.||2190.31||220||13.20|
|Compania de Minas Buenaventura (ADR)||1793.03||180||1.10|
|Glamis Gold Ltd.||1489.34||170||5.70|
|Meridian Gold Inc.||1118.54||87||4.20|
|Randgold Resources Ltd. (ADR)||490.22||74||11.50|
|Hecla Mining Company||446.31||137||7.69|
|Eldorado Gold Corp.||367.80||230||5.80|
The highest cost producer was Eldorado Gold at $230, and the lowest cost producer was Randgold Resources at $74. The average production cost of these producers was about $164.
Let’s look at the price chart again, focusing on the period from 1982 to 2000:
- Prices reached $500 a few times.
- Prices briefly fell below $300, when global central banks were selling their reserves.
- Prices basically traded from $300 to $400 for close to 20 years.
Now let’s look at the above-cost premium at which gold traded. At $300, gold traded about 82% above the average production cost of $164. At $400, gold traded about 143% above the average production cost of gold. The average premium price above gold’s production cost is about 112%.
2012 Gold Production Costs
The best way to understand the price of gold is to calculate its production cost. As we saw previously, if producers can’t make a profit selling their gold, they will reduce or stop production, and supplies will drop.
Since I wrote my gold book in 2003, the precious metals industry has consolidated through mergers and acquisitions. As they get bigger, these companies expand their operations beyond gold production and include other precious metals and mining businesses.
Just as there are no pure oil exploration and production public companies, there are very few pure gold mining companies. It is difficult to determine the cost to produce gold for some diversified precious metals miners.
Another important recent development in the precious metals industry is the re-evaluation of their costs. For decades, precious metal companies were understating their costs.
Major gold producers and the World Gold Council are working on a standard for the industry that better represents the total cost of producing gold. The final standard is expected in the middle of this year. The biggest changes will include long-term costs like capital expenditures.
Below is the cost breakdown for Barrick Gold:
The total cash cost is $584 per ounce, but when they add all their other expenses, the cost climbs to $945 per ounce.
Here is another look at Barrick’s gold production cost, including a breakdown of its total cash costs:
Here are the total costs for Gold Corp, the lowest cost producer we analyzed:
Gold Corp’s total cost was $874 per ounce.
Here are the costs for Newmont Mining:
The total cost for Newmont to produce an ounce of gold is about $1,149.
I analyzed the total costs of producing gold for six precious metal companies (four large and two small). Below is the analysis:
|NEM||Newmont Mining Corp.||$1,149||US|
|ABX||Barrick Gold Corp.||$945||Canada|
|AU||Anglogold Ashanti||$1,259||S. Africa|
|RIC||Richmont Mines Inc.||$1,203||Canada|
The average cost of both small and large precious metals companies is $1,104 per ounce of gold. As expected, on average, smaller companies have a higher cost per ounce than large companies, but not by much.
Compare the total cost for gold in 2003 ($164) to the 2012 total cost ($1,104).
If we compare apple to apples and Barrick’s cash cost in 2003 of $177 to its 2012 cash cost of $584, we see an increase of about three times. This is much higher than the rate of inflation.
The Price of Gold:
Total Cost Plus Historical Premium
We’ve seen that whenever prices go below cost, producers will normally cut production until prices recover. Therefore, the breakeven point is good support for an asset’s price.
Can prices go below breakeven? Sure—but normally not for very long. Prices can also move above historical premiums.
We’ve also seen that the price of an asset is its cost to produce (or replace), plus a premium. For housing the premium can range from a small amount up to three times the cost. For silver it’s two to four times. For oil, the premium is normally about three times its cost.
If we add the historical premium, we can forecast price targets for gold:
The average total cost to produce gold is about $1,104, and this should act as price support.
If prices fell to the break-even price for gold producers, supply would decrease like we saw for houses, natural gas and oil.
Note that this is a moving target and has been moving higher (much greater than the global inflation rate) as costs have jumped.
The target price for gold (using the total production cost plus the average historical premium) is $2,340.
As for demand, it comes from:
- Global central banks: most need to diversify their assets with gold.
- Retail gold customers from India and China, who traditionally are consistent gold buyers.
- Any citizen whose country is printing money and debasing its currency, especially from the G7. Since 2007, global central banks have printed more than $11 TRILLION. Citizens around the world need to protect themselves from their declining currencies to maintain their purchasing power. Throughout time, gold has done an excellent job doing that.
In general, investors need protection from the many financial risks in the global economy:
- Europe’s financial crisis, fragile banking system, and dysfunctional political and financial system;
- In the US: massive government debt, dependence on quantitative easing/money printing, and dysfunctional politics in Washington;
- The widening civil war in Syria;
- The Chinese real estate bubble.
These and other factors should provide strong demand for gold in years to come.
Gold demand promises to remain strong. Meanwhile, gold’s cost of production provides a floor under prices, and historical premiums indicate a price target of $2,340.
Investors should use today’s lower prices to invest in gold or add to their gold positions.
James DiGeorgia, Editor
THE GOLD AND ENERGY ADVISOR
The GOLD AND ENERGY ADVISOR is a newsletter dedicated to educating investors about the investment opportunities in precious metals and energy. Unless otherwise stated, all charts, graphs, forecasts and indices published in the GOLD AND ENERGY ADVISOR are developed by the employees and independent consultants employed by Finest Known, LLC. The accuracy of the data used is deemed reliable but is not guaranteed. There’s no assurance that the past performance of these, or any other forecasts or recommendations in the newsletter, will be repeated in the future. The publisher, editor, and staff of this publication may hold positions in the securities, bullion, and rare coins discussed or recommended in this issue. The publisher, editor and staff are not registered investment advisers and do not purport to offer personalized investment related advice; the publisher, editor and staff do not determine the suitability of the advice and recommendations contained herein for any subscriber. Each person must separately determine whether such advice and recommendations are suitable and whether they fit within such person’s goals and portfolio. GOLD AND ENERGY ADVISOR is affiliated with Finest Known, LLC, a dealer in rare coins and bullion. Mining companies, oil & energy exploration and/or oil & energy service companies mentioned or recommended in GOLD AND ENERGY ADVISOR may have paid or may in the future pay the publisher a promotional fee.
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