Every month the United States Geological Survey (USGS) releases reports on the production, use, imports, and exports of most important minerals to U.S. industry and security. These reports are full of important information for investors focused on minerals (in our case precious metals) and they can be found on the USGS website.
For this article we will focus on U.S. gold mine production and examine what has been happening with U.S. gold mine production. Obviously the U.S. represents only a segment of world gold mine production, but it is the third largest gold producer and many of the trends we find in U.S. gold production are also occurring in countries around the world.
First let U.S. discuss the importance of mine production to gold supply and demand because this is an issue that is misunderstood by many investors in the gold industry.
The Importance of Gold Mine Production to Gold Supply
We've covered this in-depth in a previous article, so please read that article to understand the details of why mine supply is very important. But in summary the two main reasons why newly mined gold supply is very important to the gold price are as follows:
- Newly mined gold supply makes up a large portion of annual gold supply (it provides two-thirds of annual physical demand, according to the World Gold Council).
- It is held in the weakest hands (the gold miners) who sell that gold at the prevailing market price.
Since newly mined gold makes up a large percentage of the estimated 4400 tonnes of annual world gold supply, any significant reduction in this supply would need to be met with supply from other sources. The buyers who ordinarily find the 2700 tonnes a year of mine supply to meet their demand will have to make due with 2500, 2200, or 2000, and so forth. This differential will have to be made from existing holders of gold, who care much more about prices than the miners, and as gold drops they will be less willing to sell at a loss or marginal profit. So this supply would be unavailable to the market at low spot prices (unlike newly-mined gold, which is sold regardless of spot) as these sellers wait for higher prices -- which ultimately would significantly constrict supply.
To put this into perspective, if mined gold supply drops 10% because struggling miners cut back production, that would be around 250 tonnes (8 million ounces) of gold supply that would be removed from the market. This is equivalent to 25% of the GLD gold trust or all of the gold held by COMEX -- a large amount of supply that would have to be found from existing holders of gold. If current gold owners hold back their gold from the market and do not make up for this shortage of supply, then what we will have is deficit in the gold market and the pressure will build for higher prices.
U.S. Mine Supply Has Been Falling Over the Last Decade
What is interesting is that even though the gold price has risen every year over the past decade, gold production has continued to decline.
In 2003, the United States was producing 8.9 million ounces of gold from its mines, while last year it only produced 7.5 million ounces of gold - a drop of close to 20% over the last decade. This is despite an increase in the gold price from an average of $364 per ounce in 2003 to an average of over $1650 in 2012. So as the gold price has increased 400%, U.S. mine production has actually dropped - not a very good sign for the mine supply picture for gold.
But it doesn't end there. 2013 has been another poor year for U.S. mine production with mined-ounces-to-date registering 2.86 million ounces, which is 5% lower from 2012 to-date totals and almost 10% lower than 2011 to-date totals. Additionally, every single month in 2013 has produced less mined gold than in the prior two years.
If mining does not pick up in the second half of the year (and with miners cutting back production this wouldn't be a surprise), we may have the worse gold mining year over the last decade.
The interesting thing is that this drop in gold mine supply isn't just something that is solely affecting U.S. production - we are seeing it around the world from South Africa to Australia to South America. In fact, in our first quarter report of true all-in gold costs in which we covered around 25% of total world mine supply, we saw gold production dropping on both a year-over-year and a sequential basis.
What this Means for Gold Investors
We believe this is one of the many fundamental factors that are very bullish for physical gold, and if it wasn't for the massive unloading of gold via the ETF's we may be seeing a serious gold supply crunch. Since ETF gold sales have subsided significantly, much of that new supply that was compensating for reduced mine output may no longer be available.
The buyers who ordinarily find the 2700 tonnes a year of mine supply to meet their demand will have to make due with 2500, 2200, or 2000, and so forth. This differential will have to be made from existing holders of gold, who care much more about prices than miners, and as gold drops they will be less willing to sell at a loss or marginal profit. Thus this supply would not be available to the market at any spot price like newly-mined gold and these sellers would wait for higher prices - which ultimately would significantly constrict supply.
To put this into perspective, if mined gold supply drops 10% because miners are cutting back production and struggling to survive, that would be around 250 tonnes (8 million ounces) of gold supply that would be removed from the market. This is equivalent to 25% of the GLD gold trust or all of the gold held by COMEX - this is a significant amount of supply that would have to be found from existing holders of gold.
It seems that the supply picture for gold is only getting worse and many companies are producing gold at cost or even at negative all-in costs simply to meet operating expenses. This offers investors an opportunity to buy physical gold and the gold ETFs (GLD, PHYS, and CEF) as gold production drops.
Gold mining companies such as Goldcorp (NYSE:GG), Randgold (NASDAQ:GOLD), and Newmont (NYSE:NEM) offer value too but investors should be much more careful when purchasing these because the major reason why gold supply is dropping is because mining companies simply cannot produce as much gold at current prices. Explorers may offer even better value since they can develop a gold project while the gold price is low and then go to production at much higher gold prices - which we believe is only a matter of time. We have covered Pretium Resources (NYSE:PVG) in-depth and Chesapeake Gold (OTCQX:CHPGF), but there are a few other quality explorers that investors should consider. Either way investors should carefully examine any mining companies or explorers before purchasing shares.
As gold mine supply drops investors have yet another reason to be bullish on gold. Take advantage of the trading mentality of most investors who are more concerned with negative charts rather than fundamentals, and buy an asset that has strong fundamentals yet is disliked by the investing public. One day investors will realize that all-time low COMEX gold inventories, dropping mine supply, drained ETFs, increasing money supply, growing global insecurities, higher energy prices, and rapidly increasing worldwide sovereign debt may just be a bit bullish for the metal of kings.
Disclosure: I am long GG, SGOL, GOLD, PVG, OTCQX:CHPGF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.