The last few days of meaningful trading for the present calendar year are upon us and we would like to take this opportunity to tackle a mis-conception that has been touted repeatedly throughout the past year. The line of thought summarizing this mis-conception goes like this:
- Gold prices are falling and mining costs are rising.
- Therefore gold production is becoming increasingly un-profitable.
- Therefore mines will be closed.
- As a result supply is becoming scarce and the gold price will appreciate again.
Proponents of this logic have argued that the cost of mining gold is putting a floor under the price of gold (GLD), (PHYS). The same proponents have been urging "savvy" investors to buy the falling knife throughout 2013. We have argued against this logic on several occasions and continue to believe that this line of thought is flawed (at least) threefold:
- Gold prices are falling, but so are costs.
- Gold mine output is actually rising despite the falling gold price.
- The gold price does not give a rat's neck about mine supply.
After 12 years of rising gold price 2013 will be the first year with a gold price lower at the end than it was at the start. The yearly loss will be around 25%, providing a data set that can be used to (in)validate some of the touted opinions.
Cutting costs has been the single most talked about topic in earning calls of gold mining companies (GDX) this year. It took some time for cost cutting measures to be implemented and become effective, but Q3 finally delivered the data that had been promised by management. All-In Sustaining Costs among a large sample of mining companies which we reviewed here dropped from $1,187/oz in Q2 to $1,006/oz in Q3. That's a cost reduction of $181/oz or 15%. Consequently margins have actually increased across the board in the second half of 2013 despite falling realized gold prices.
To be fair, the quoted cost reductions included a number of one-time effects, but we are expecting further cost reductions to eventuate in coming quarters despite the absence of these one-time effects in the future.
2013 is forecast to become another record year in terms of gold production; and despite calls to the contrary 2014 is set to surpass this year's output yet again. While only a few mines have actually been put on care and maintenance in 2013, output has actually increased at many other mines due to high-grading and other practices designed to reduce costs per ounce. In fact, the three largest gold miners by output, Barrick Gold (ABX), Newmont Mining (NEM) and AngloGold Ashanti (AU) have reported higher production numbers in Q3 compared to previous quarters. And so have numerous others.
Furthermore, several large projects are currently under construction or in the process of commissioning or ramping up. Randgold's (GOLD) and AngloGold Ashanti's Kibali mine comes to mind, or AngloGold Ashanti's Tropicana mine to name just two. Output from these new mines plus some major mine expansions will outweigh deferred output from some projects that have been shelved for the moment, such as the infamous Pascua Lama mine owned by Barrick Gold.
The floor that never was
If production costs were actually providing a floor under the gold price, then this floor has just dropped considering Q3 numbers.
However, this floor never existed in the first place.
As we have argued in the past gold does not vanish from the surface of the earth once it is mined. It may be stored in vaults, worn around necks or minted into coins but it is rarely "consumed" like most other commodities are. Almost all of this gold can be considered for sale under the right set of circumstances or for the right price. Any newly mined gold merely adds to the overall above ground stock. And this addition is a mere drop in the ocean.
Gold price and gold mining are only interacting in one direction: the gold price has an immense influence on the financial well-being of miners; but not vice versa. Gold miners are presented with a price for their goods by the powers that be, and need to make do as best as they can.
Gold miners have been dealt a number of fat years, and need to tighten their belts now for the not-so-fat times that are upon them. Whether some of them fall by the wayside or not, it won't bother the price of gold.