Recently Goldman Sachs advised clients to short gold. A few days later gold hit a Niagara plunge, falling below $1400/oz. To us, this meant that hedge funds were bailing. They have little or no restrictions on speculative trading and they do it all the time. So where does that leave us on gold? It leaves us with fundamentals.
The cost from "mine to refine" has been estimated to be, industry wide, about $1,200/oz (J. Brumley, InvestorPlace, April 8, 2013), depending on where the gold is: littoral, open pit or deep shaft. Gold mining's most environmentally dangerous aspect is that it uses cyanide leaching. This requires special safeguards, but most of the other costs have been growing steadily, too.
So, at its current price level, there is a priority on cutting costs because margins get squeezed: the cost/oz is only just below the price. The last resort way to cut cost is to lower production. The analogy in the oil business is when a low price for oil causes companies to shut in wells.
Clearly less global production, were it to happen, would support gold's price in the face of continuing increases in demand. The World Gold Council says demand is still growing, although net demand was slightly down in 2012 (gold peaked late in the year). But 2012 saw record demand in the fourth quarter (1,196 tonnes - a tonne is 1,000 kg), 15% higher compared to the previous five years. The WGC writes, "An increase in central bank net purchases was concentrated among...emerging markets. Demand...was the highest for almost 50 years."
India is the strongest consumer market. Demand there is strong primarily due to cultural values. Demand in China has been growing with the rise of its middle class. Consumers in both of these countries buy gold jewelry far more commonly than coins and bars, typical of consumers worldwide.
Some investors object to gold because it has no DCF (discounted cash flow), revenues, earnings, etc. They say gold is only worth what the market thinks it's worth, but there's no product or service to evaluate. Well, we've seen stocks go to zero and close to it in the 2001 dot com bubble bust, whereas the closest gold ever came to something similar was in 1981 when it spiked to $880/oz, then settled to $255/oz. So sure, gold doesn't pay a dividend, but it also doesn't go Chapter 11. As long as people adorn themselves with gold jewelry - and we know who they are, right guys? - gold will always have a relatively expensive bottom price. It's just that we'll never know what that price is ahead of time.
On the supply side, the WGC writes that net supply declined in 2012 by 1.4% year-over-year, typical of recent years.
The conclusion from all this: gold has a lot of deep pockets and steady global demand. Supply struggles to keep up and costs keep rising. Superimposed on this, we have speculative trading that creates volatility in the gold price and blurs gold fundamentals.
With the usual uncertainties about future inflation and the extent to which our greenback could suffer eventual devaluation, yet with bullish gold supply/demand stats, how can we overcome the issue that gold pays no dividends?
One answer is Newmont Mining (NYSE:NEM), now paying a very nice 5% due to the low stock price. That dividend could come under some pressure, but it's a sensible play on gold.
Newmont has gold mines in Peru, Ghana, Indonesia, Mexico, New Zealand, Australia and the U.S. (Nevada). It is the only gold miner in the S&P 500. Its gold reserves are 99 million ounces. Newmont has 40,000 employees worldwide. Newmont's cost: $1,295/oz in 2012.
The cost of the DJIA per oz of gold has recently spiked (after a long decline, see cxoadvisory.com or goldnews.bullionvault.com), but long-term, inflation and interest rates will increase. If you're patient, it makes sense to buy Newmont and get paid while you wait for a recovery in the gold price.
Gold could weaken further, of course. Lots of boomers will continue to seek income and they won't have the risk tolerance for mining stocks, so they might sell their gold. But despite the many concerns, we think the odds favor Newmont being a good long-term bet and the fundamentals favor gold itself.