5 Gold Stocks That Could Tank On Higher Inflation

Includes: ABX, AU, KGC, NG, TK
by: Cris Frangold

Something very interesting is happening in India, the world's largest consumer market for precious metals. Buyers seem to be purchasing almost as much platinum as gold, the Times of India reports. Large numbers of customers are expected to pour into jewelry markets for the Hindu holiday of Akshaya Tritiya on April 24-- and when they do, a lot of them will choose platinum over gold.

The main reason for this is obvious. The prices of platinum and gold are pretty much the same on the consumer market. The price of both metals on the consumer jewelry market in India is pretty much the same at the moment, according to an All India Gems and Jewelry spokesperson quoted by the Times. That means many Indians who buy precious metals as an investment are opting for platinum, expecting it to be worth more in the future. Jewelry grade gold currently costs around 22,500 rupees ($429.75) an ounce in India, while platinum fetches 26,140 rupees ($499.27) in the jewelry markets.

Many people in India use jewelry as an investment because the government has a long history of interfering in the economy. Around 15% of the purchases in the Indian jewelry center of Surat will be in platinum this year (according to above article). Many Indian jewelers report that younger buyers seem to prefer platinum over gold.

The jewelry business and the demand for gold and silver in India should be good this year. The jewelers' strike, which had shut down the markets, is over now and jewelers are back to work. Most of India's jewelry shops closed their doors in protest in March because the nation's new budget raised the import tax on gold from 2% to 4%. The vast majority of India's jewelers are small business people that could not afford the tax.

The jewelers decided to go back to work just in time for Akshaya Tritiya after the nation's Finance Minister announced that the tax hike was under review. It is not known if the tax will be tossed out or not. According to the Forbes article, some strategists expect the end of the strike and the holiday will increase the demand for physical gold and the price of the metal on the international market. It is not clear how this increased demand will affect the price of platinum.

South African Platinum Production Down by Nearly Half

The Indian jewelers strike is not the only labor action affecting the price of precious metals. Bullion Street reported that platinum production in South Africa (the world's largest producer of the metal) fell by 47.5% in February-- that means production was cut by nearly half.

Observers blame the falloff in production on a strike by workers at Impala Platinum's mine in Rustenburg. Impala Platinum (IPLA in London), or Implats, produces 25% of the world's production at mines in Zimbabwe and South Africa. The strike lasted six weeks and ended on February 29. Production was expected to start again on March 5, Business Day South Africa reported. Impala failed to dig out about 100,000 ounces of platinum because of the strike.

South Africa's gold production also fell by about 11.5% in February and 11.3% in January because of labor problems. Production at AngloGold Ashanti (NYSE:AU) was reportedly down by 76,000 ounces because of safety stoppages. How this will affect AngloGold Ashanti is hard to determine, because 63% of the company's gold production 2011 originated outside of South Africa. Interestingly enough, AngloGold has decided to issue its financial reports in U.S. dollars rather than South African Rand. That could indicate that Anglo's management thinks its future is outside of South Africa.

Gold Production Costs Rising

If the fall in gold production has any effect on the price of gold, it is not helping some gold stocks. Barrick Gold (NYSE:ABX) was trading at a 52 -week low on Friday, April 20. The Motley Fool was even speculating on how low the company's stock can go. Part of the reason for Barrick's troubles is easy to see; it is very vulnerable to inflation. The Fool reported that Barrick's cost of production had gone up by 14% in the last quarter.

One reason for this could be fuel costs-- many of us tend to forget it, but miners burn a lot of diesel fuel. The giant machines that dig the ore from the ground and the giant trucks that haul it from the processing plant run on diesel fuel. To make matters worse, many mines are located in remote areas, where they have to generate their own electricity by burning-- you guessed it-- diesel fuel. Add to this the fact that mining companies have to ship almost everything they used to remote locations. Higher fuel costs means increased shipping costs.

A big problem for mining companies is that increasing inflation effectively eats up any gains they make from rising gold prices. Any extra money that comes in from higher prices goes right out to suppliers in the form of increased prices. This already seems to be affecting Barrick Gold. Analyst Christopher Barker is predicting that inflation could raise that company's production costs by as much as 22% next year.

It's obvious that at some point companies like Barrick will have to slash production or curtail exploration efforts in order to cover costs. The situation could get worse because the cost of starting new gold mines is going up steadily.

Barker noted that the cost of one mine alone, the Galore Creek project on the Alaska / British Columbia border, increased by 373% between 2006 and 2011. Galore Creek is being developed by NovaGold (NYSEMKT:NG) and Teck Resources (NYSE:TK). It is supposed to be one of the world's largest untapped deposits of gold and copper, with 6.2 billion pounds of copper, 4 million ounces of gold, and 65.8 million ounces of silver in the ground. Yet it may no longer be economical to develop the costs of getting the mine up and running; the costs have risen to $5.2 billion, Barker reported.

It is not just costs at Galore Creek that have gone up. Barker notes that Barrick's Cerro Casale Project in Chile was supposed to cost $2 billion when work began in 2007, but costs there are now estimated at $7 billion. The cost of another Barrick project, the Pascua Lama gold mine on the Argentina/Chile border, is now around $5 billion; it was supposed to cost just $2.8 billion in 2009 (according to Barker's article).

One reason why development costs have soared is-- you guessed it, fuel. It costs a fortune to ship all of that equipment into remote places like the Yukon and the high Andes.

With costs going up, gold companies are going to have little money left over for the exploration and development of new mines. They are also going to have less incentive to develop new properties as well. This scenario is getting much more likely, as demand for metals like gold and copper in China is falling as that nation's economic development slows. China is the world's largest market for copper.

One company already paying the price here is the Canadian producer Kinross Gold (NYSE:KGC), which has projects in such far -flung places as the African nation of Mauritania and Ecuador. Kinross fell to a new low of $9.06 on April 20, which was a 52 -week low for the stock. Kinross had already announced plans to curtail development efforts in Mauritania and reconsider its exploration plans (according to DailyFinance article by Sean Williams).

Gold itself might be a good hedge against inflation, but gold producers themselves are among the companies most vulnerable to inflation. If inflation keeps rising, precious metals production could actually start falling, even if commodity prices for the metals go up. Not even increased demand for Indian jewelry may be able to stop this weird development.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.