I’m going to let you in on a little secret of mine.
I don’t care what the price of gold is right now. Even as I’m writing about this, I’m not going to check.
Sure, I see spot prices fairly often, but most of the time it is from a couple words in a website’s headline or links I never open.
It isn’t burnout, dismay, apathy, or resignation. I don’t tune it out because I’ve given up on common sense prevailing over the influence of Fed policies or market manipulation by big banks and institutional investors.
The thing is, I’m very bullish on gold, and I often research and write about gold and precious metal miners.
I’m perfectly content sitting in the office reading through preliminary mine reports and drilling results, and scanning for information on production, demand, and recent developments in the sector.
So why the discrepancy? I’m confident that I have taken a rational and disciplined view of the state of the gold sector and that my investment research will pay off.
Here are the three reasons why, along with what gold investors should really be paying attention to right now.
Business 101
Forget about the increasingly questionable fiat currencies and Fed policies for now. All that we need is a basic understanding of how businesses work to get a good understanding of what is to come.
It doesn’t matter how much gold can be mined. It only matters if supply and demand, plus cost and revenue, line up.
Many gold miners, including most of the biggest names in the game, can’t seem to balance out these factors.
As gold prices soared for a solid 10 years, many miners started snapping up properties with sizable reserves.
Unfortunately for them, not all mines are the same. Average ore grades have steadily declined, making the cost of moving and processing the ore far more expensive.
Then the price drop over the last two years put all these mines in jeopardy. This brings us to my first reason: Many miners cannot make a profit.
Citigroup recently published data on miners producing about half of the world’s gold. The all-in cost averaged out to $1,331/oz, marking a 23% drop.
Miners have driven down costs mostly by slashing capital costs, cutting staff, writing down the worst of their assets, and halting exploration.
This shores up the books in the short-term, but is devastating in the long-term, which brings us to reason number two.
Supply and Demand
Over the past 24 years mining companies have discovered some 1.66 billion ounces of gold in 217 major discoveries and produced 1.84 billion ounces of gold.
So there was already a mismatch between supply and demand before projects were scaled back or shut down in the last two years, and it is about to get much worse.
Significant discoveries are diminishing and the trend is accelerating. In the 1990s, 124 deposits containing 1.1 billion ounces of gold were discovered. Since 2000, only 605 million ounces in 93 such discovered deposits.
With nearly nonexistent exploration, there is no capacity to change this trend. Supply is going to continue to drop while demand, especially from China and India, continues to soar.
When gold prices rebound from the inevitable price increases and miners regain the cash flow to jump-start projects, it’ll take a long time for them to actually replenish production.
That leads to my third reason.
Long Delays
Mines aren’t just capital intensive. Permitting and building operations take years before any significant amount of gold starts coming out of the ground and into the market.
The amount of time it takes between finding gold and selling it has dramatically widened over the years too.
Between 1985 and 1995, the average was about eight years. The time increased to 11 years between 1996 and 2005, then 18 years between 2006 to 2013.
Estimates from SNL Metals & Mining suggest that the 63 projects scheduled to begin production between 2014 and 2019 will take a weighted-average of 19.5 years from the date of discovery to first production.
For 2018 and 2019, the average is estimated to be as high as thirty years.
In short, there is no industry-wide capacity to ramp up production, replenish reserves, and find new sources of revenue in a way that can address the coming supply and demand mismatch.
What Really Matters
So most mines cost more than they can make, supply and demand is off-kilter and getting worse, and many companies can’t scale their operations to capitalize on price increases.
If investors are looking in the right places, that creates a massive opportunity, and we’re already starting to see how it pays off for investors that use this approach.
Earlier this year Osisko Mining Corp. fought off a hostile bid by Goldcorp, then sold itself to Yamana Gold and Agnico Eagle Mines for $3.6 billion.
The company was highlighted in our newsletter back in late November 2013, and the stock price rose over 100% leading up to the sale.
The sole reason for the rapid stock price rise was Osisko’s Malartic mine. It had just started producing gold, and it was doing it at a mere $645/oz.
Yamana and Agnico are driving down their overall cost per ounce averages with this cheap gold, and the other majors are looking to do the same.
The war over Osisko, and the triple-digit profits for early investors, are not going to be isolated events. We’ll see a whole lot of fighting over the handful of promising projects and mines that are available.
Nor is this going to be limited to gold. With commodity prices depressed across the board, we’re going to see high stakes bids for ultra-low cost mineral extraction around the globe.
If you are interested in commodity investments, you need to track down companies with very low all-in costs that are within a couple years of production, just like the major miners.
When you find a hidden gem in the largely ignored junior miner sector that can produce ore at a fraction of what it costs for them to sell it at depressed prices, you simply don’t have to care much about the day-to-day, or even month-to-month price fluctuations.
Godspeed.
