By Steve Hunt
While new buyers of gold are motivated by the desire for safety, long-time investors in the yellow metal know they have another ace up their sleeves. That fact that makes gold such a sure bet is the rapidly increasing costs of production.
When Costs Set a Floor
Gold buyers just entering the market may be somewhat concerned about the rapid rise in prices this year. There are many factors that affect the price of goldin the market over the short-term. However, over the long-term, the issue of supply and demand is one of the most critical factors that savvy traders and investors monitor.
The simple fact is that the demand for gold increasingly outstrips the supply. Moreover, the costs of bringing more of this precious metal out of the ground have risen dramatically in the past decade.
Early in 2016, Thomson Reuters GFMS predicted a year-end price for gold above $1,200. 1 This was based primarily on the fact that global gold supply was down by 4 percent in Q4 2015, the largest drop since 2008. Importantly, this drop came in the face of a continuing rise in demand in all areas of gold consumption, including investment.
Of course, the market saw the Reuters prediction come true in mid-year, and the price remains above that earlier high-side analysis. However, the dynamics of supply and demand are even more in play in Q4 2016, with the all-in costs of production now believed to be north of $1,200 an ounce for 2016. Significantly, even at this price, average profits for gold mining concerns are negative based on GFMS calculations. Others set this floor at an even higher level.
When Practical Realities Impact Markets
Gold mining companies are, of course, in the business of making a profit. With modern mining requiring massive amounts of capital and energy, the ultimate costs are artificially lowered by today’s historic low cost of capital and oil. That fact alone could support a floor all-in, sustainable cost (AISC) of more than $1,400 an ounce. 2
The simple facts here are that the demand for gold will only be met with additional mining and output. At the same time, that additional supply will only be ensured over the long-term when mining companies can operate at a profit, or a market price for gold that is higher than their AISC.
With the multiple factors impacting the future costs of production, especially energy and capital, the upward pressure on prices to match those costs is significant. In short, even if there is a dip in the current price of gold and some mines operate at a loss to generate cash, the future market will command a higher price for gold.