Gold Mining Costs "Led by Prices", Not the Reverse

Gold mining doesn't put floor under prices, says study. Vice versa in fact...

 

GOLD MINING costs respond to changes in market price, according to a new study, rather than acting to support or push prices higher as commonly assumed.

 

"The gold price should and does cause changes in the cost of extraction," says a summary published today in the London Bullion Market Association's quarterly magazine, The Alchemist.

 

Writing jointly with Fergal O'Connor – senior lecturer at York's St.John Business School in England – and data consultancy Thomson Reuters GFMS's director of precious metals mining research William Tankard, "The theoretical and empirical evidence points to the fact that gold prices are a determinant of producers' cash costs," says Professor Brian Lucey of Trinity College Dublin.

 

Firstly any rise in market prices will encourage output from otherwise loss-making projects, note the authors, which will raise the industry's average output cost per ounce. Secondly, annual mine supply (around 3,100 tonnes in 2014) is only a fraction of the amount already above ground (estimated at 180,000 tonnes). So the mining industry lacks the pricing power needed to impose higher costs to buyers, as scrap supplies from existing holders can easily reach market.

 

This claim challenges the widely-held view that gold mining costs should act as a floor for the gold price in the medium to long term – a view argued by fellow academics Eric Levin and Robert Wright, then respectively at the universities of Glasgow and Strathclyde in Scotland, in a 2006 paper for market-development organization the World Gold Council.

 

"The long-run price of gold is related to the marginal cost of extraction," wrote Levin and Wright, whose broader claim – that gold has a close relationship with the rate of inflation in the wider economy – was based in part on the idea that inflation is transmitted to gold prices through rising production costs.

 

More recently, commodities analysts at investment bank Goldman Sachs said this summer that a likely drop to $1050 in world gold prices by end-2014 will prove "generally short-lived". Because 90% of the world's current mine output would be unprofitable on an all-in costs basis at that price, Goldman's team peg $1200 per ounce as "a good estimate of the floor for gold".

 

But looking at direct mining costs – known as "cash costs" in the mining industry – the new claim from Lucey, O'Connor and Tankard is that global averages track market prices, rather than the other way round. The same finding was "confirmed in the vast majority" of national-level gold mining data too, and "also using total production costs." 

 

The accounting methodology behind "all in sustaining costs" – agreed and applied by the World Gold Council's gold-mining members in mid-2013 – includes new exploration, capital expenditure and corporate running costs, as well as the direct production cost of each ounce.

 

Debate over the variability and comparability of such figures continues, but it's the cost of developing economically sustainable mines, analysts argue, which explain why the last decade's surging gold price failed to deliver stronger profits for the major gold miners.

 

All due to report third-quarter earnings at the end of October, the world's top three gold miners – Barrick (NYSE:ABX), Newmont (NYSE:NEM) and Goldcorp (NYSE:GG) – last reported all-in sustaining costs of $865 per ounce (down 5% from mid-2013), $1063 (down 17%) and $1060 (down 19%) respectively.