A bull market inevitably builds excess, and nowhere is this more evident than in the evolving marginal cost curve of gold miners. At the bottom in 2002, the marginal cost of extraction was approximately $300 a troy ounce. Despite technology improvements, the marginal cost of extraction steadily rose to nearly $1,000 an ounce by 2011 as gold miners exploited lower-grade mines and as mine workers enjoyed higher wages. Since the peak in 2011, the marginal cost of extraction has come back down to $850 an ounce (see Figure 2 below, courtesy Goldman Sachs). Deflation has set in within the gold mining industry–and given that it is a commodity industry, it is a race to the bottom. Ironically, some gold miners are producing even more gold in an attempt to stem cash flow problems–thus increasing supply and depressing gold prices even as demand remains anemic. So far, there have been no major mine closures; nor major bankruptcies in the industry. We believe that neither the price of gold nor gold mining stocks will bottom until the industry experiences a couple of major mine closures and/or bankruptcies. The gold mining ETFs, GDX ($24.26) and GDXJ ($36.66), could easily decline another 25-30% from current levels.
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Wednesday, 23 April 2014
Gold Prices vs Cash and All in Mine Costs (Real Terms 1980-2014)
Putting an all too convincing medium term bearish gold case at CB Capital Research including this long run gold price vs costs chart. You have to say there is something in the DNA of miners to extract low grades and extend mine life when gold prices are good and high grade, shortening mine lives, when gold prices fall. There are very few periods in this 35 year chart where a profit has been delivered by the industry.