Gold’s investor relevance remains as strong as ever Part 1

GAVIN WENDT: Gold has performed an enormously valuable role as a store of value for thousands of years, throughout most of the world’s civilisations.

Unlike currencies, which can wax and wane dramatically in value – and collapse altogether – gold’s value remains intrinsic and remarkably consistent over time.

Hence, it has provided an enduring role as an insurance policy in investors’ portfolios.

Gold has however had its relevance questioned over the past half-century, commencing with US President Richard Nixon’s move in 1971 away from the previous Bretton Woods system of having the US currency backed by gold.

Nixon implemented a regime based on a freely-floating fiat currency that remains in place today.

As financial systems have evolved over recent decades, gold has increasingly been perceived as somewhat of an ancient relic – not only by investors but also by governments.

If we cast our minds back to 1997 some of us will recall the actions of the Australian government via the RBA, which sold two-thirds of Australia’s gold reserves at prices around $300/oz or lower – in the midst of the Asian economic crisis.

The official version of events went that since gold was no longer important to the international monetary system, the central bank no longer needed to hold it as an asset against its liabilities.

What a mistake that was.

I love the chart above because it demonstrates that despite perceptions of gold being an arcane relic, it has performed exceptionally well over the last 15-year period, particularly against the high-flying Dow Jones and NASDAQ Indices.

Even today gold continues to defy the skeptics, demonstrating robust price support as we’ve previously predicted around the $1,200/oz mark.

There a couple of really interesting observations worth making with respect to the gold sector.

The first aspect that we’ll address relates to an analyst report from Canadian brokerage GMP that points to declining profit margins among the world’s heavyweight and mid-tier gold miners.

In its latest mid-year report, GMP outlines the fact that despite some seemingly effective cost-cutting by the world’s major gold producers, profit margins have nevertheless continued to decline.

Their analysis is based on All-In-Sustaining Costs (AISC) and that these costs are still too high.

There is a belief that gold miners have entered into cost reductions that could potentially be regarded more as ‘window dressing’ to keep individual and institutional holders happy, rather than meaningful sustainable initiatives.

These include cutting back and deferring capital program (such as new mine developments and expansions); selling off less economic or loss-making mines to smaller companies that might be more flexible in their approach; mining to higher grades (and thus debilitating longer-term resource and reserve levels); and cutting back on exploration expenditures (which like cutting capital programs can impact on the longer term future for the companies concerned).

Many of these are ‘soft’ options that are not so easy to maintain over the longer-term – hence gold producers are hoping for an improvement in gold prices that will allow for these measures to be reversed over time.

GMP has subtitled its analysis ‘Cost optimizations can only go so far…’ and notes that although costs did indeed come down during 2013 and remain below 2013 levels in their forecasts for the current year, they seem to have levelled out.

For senior producers the AISC on average have declined 8% from $1,035/oz in 2013 to the 2015 fore-cast of $958/oz, while mid-tier producers are seeing AISC down from $963/oz to $900 /oz – a fall of 7%.

Meanwhile the gold price has fallen 16% from 2013 to GMP’s forecast $1225/oz for 2015.

The big question therefore is how much more the miners can do to further cut costs, if at all – and whether these new cost structures are sufficient to operate in the current environment.

GMP’s analysis also shows estimates of AISC moving marginally higher for 2015 compared to 2014 – which suggests that although margins have been falling, costs are beginning to rise again.

Another interesting point with respect to GMP’s analysis is that higher-cost producers appear to have been less successful in cutting costs than lower-cost miners, with higher-cost miners seeing coast reductions of around 4% from 2013 to 2015, whilst the lower-cost sector has managed cost reductions of 10% over the same period.

Some respite has been accorded to non-US producers by US dollar strength against most other currencies (especially the A$) and significant falls in crude oil prices.

However for much of the industry margins remain under pressure, which again casts a shadow over the industry’s supply-side.

Gavin Wendt is the founder of MineLife, publisher of the MineLife Weekly Resource Report

 

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