Gold producers worth a mention

Most of the discussion around the gold price focuses on the demand side of the equation, with the most notable arguments that the developed world, led by China and India, are underinvested in the commodity and thus their diversification strategies will put upward pressure on pricing of physical gold, driving prices higher over the medium term. This is a very difficult conversation, one which basically tries to forecast what investors will do. If the gold price falls overnight by $200, there is no doubt the developing world will be cautious in gold investing. There are also the arguments around central bank policies and thus gold’s place as a counter currency to the US$ but this argument is again based on the expected actions of central banks which takes into account many assumptions.

One way which we seek to pick trends in the gold price is to focus on the supply side, an area that not many forecasters take into account. We don’t look at the intention of current large holders of gold, like Italy for example, but instead look at the marginal cost of producing an ounce of gold. Emerging gold producers are a great source of information, they signal the ease or difficulty in mining and processing gold for resale into the market. Most gold bullion produced by emerging gold producers, like those in Australia for example, is sold to the local mint which acts as a wholesaler. The Australian market is fortunate to contain dozens of listed, emerging gold producers, who have raised money over the past few years and are now producing around 100,000 ounces annually which is a respectable level.

The recent trend has shown a large increase in the marginal cost of production. Take Ramelius Resources for example, one of the worst performers on the ASX200 index today, which not only disappointed with its production volume numbers but the cost of its production too. Ramelius posted a A$931 per ounce cash cost for the June quarter, its neighbors and listed peers are close by at around $850-$900 per ounce. Listed leader Newcrest mining, which ranks among the top 10 global producers of gold, is also experiencing cost in Australia of around $714-$849 per ounce.

Numbers will vary depending on geography and credits from other metals during the mining process, like copper and silver, but our point here is gold production is becoming more expensive and even though the buffer between the spot gold price and cash costs is still large, the trend is more important. These costs don’t include the initial, often large capital costs. If marginal costs of producing an ounce of gold, from quality locations like Australia, continue to rise, there will be solid support for the medium term gold price, which combined with all the demand side arguments, provides a solid outlook for the yellow metal.