Wednesday, January 5, 2011

Gold Heading To Oversupply?

The news cycle still lives: when gold is down, major media outlets publish gold bears. One of them is Pawel Rajszel of Veritas Investment Research, who thinks gold could sink to $800-900 in the next couple of years. His case hinges upon a production reversal that put the question mark on the "peak gold" theory: gold cracking four digits has called forth increase in production, reversing a trend that's been in place since 2001.
As Mr. Rajszel noted, gold production had been falling steadily since 2001, when gold traded below $300 an ounce – but it is picking up as producers take advantage of higher gold prices, low debt levels and big cash holdings. In 2009, production snapped back to its highest level since 2003, and this rise is not likely a one-off event.

“We see 2009 as an inflection point that precedes a new leg of rising global production,” Mr. Rajszel said in his note. “A long streak of record-setting prices has made once-marginal deposits economic – such as previously abandoned properties – and has spawned the development of new mines, which we expect will ramp up in the coming years.”

He looked at the growth plans of 20 gold producers, collectively representing half of the world’s current mine supply.... These 20 companies are set to increase production by 25 per cent by 2013, to an estimated 50 million troy ounces from 40 million troy ounces in 2010. Factor in output from the other half of the world’s producers and global production should rise to 100 million ounces, which sails past the previous high of 83.7 million ounces.
The reason for why is because gold's rise has finally outstripped rising costs to the point where added production makes economic sense. Estmated costs for pulling gold out of the ground are $800/oz, well below the current price of around $1365.

Rajszel estimates, given his estimate for production increases this year, that it would take an additional $29 billion' worth of buying each year 'til 2013 to keep gold at the $1,400 level. Should that buying fail to appear, gold will sink down to $900 by 2013 - or $800 if central banks reverse course and unload some of their holdings.

Of course, demand is the unknown in his argument. If the net flow of funds into gold is well above $29 billion, given Rajszel's estimate, then gold will continue to push higher. There have been lots of studies showing that gold ownership isn't much compared to others assets; many of them conclude that gold is therefore underowned. In order for Rajszel's forecast to come true, the reasons for owning gold have to sink into indifferences.

On the other hand, if the reasons acquire greater force, gold will continue to rise despite those supply increases. It's true that the cure for high prices is high prices, but changes in demand is the key unknown that'll supply the tipping point.

As an aside, I note that the continued bearishness surfacing when gold hits a rough spot is a clear sign that gold is not in the mania stage. There's still a healthy difference of opinion on gold's future, which shows that groupthink has not possessed the market. Not even close, by my reckoning. There is a lot of bullishness among gold analysts, but the forecasts tend to be moderate and the level of bullishess isn't exaggerated compared to the bullishness exhibited by analysts in general. Stock analysts are typically permabulls when it comes to stocks.

Finally, a note based on the latest column by Ellen Roseman of the Toronto Star. She pondered the question of why gold has soared but some major producers' stocks haven't. Asking two familiar names in the goldbug world, Donald Coxe and Nick Barisheff, she got these answer: new deposits are getting harder to find, costs are still rising, and speculative interest has cooled.
Donald Coxe... says there’s a fear that gold mining companies could have problems replacing their production in the future.

Nevada is almost tapped out. Not much exploration is going on in Canada. And the areas where gold may be found – such as Mexico and Colombia – carry political or operating risks....

[Also], there’s a sense that costs are out of line for gold mining companies. They have to pay more for oil used in exploration vehicles – and even for their giant tires.
Barisheff made an important point: relative underperformance of gold stocks is a sign that the investing public is less willing to speculate than they were back in '01-'07, when the HUI outperformed gold itself.

Can all three of these forecasters be right? Yes, but only if a swell in earnings hasn't been reflected in stock prices. If the languishing of some of the majors is a reflection of higher costs still to come, then Rajszel's case becomes dubious.

[As an aside, for those interested in such things, the Star has a reputation of being more liberal than the Globe and Mail. Go figure.]

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