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The Problem with Gold

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April 03, 2008 – Comments (12)

In the past I've looked into a number of gold stocks and I have consistently not liked them.  The grade of gold being mined is so low, the costs are out rageous.  When I was researching stocks, and many mining stocks, what I was noticing was the downward trend in grade.

When base metal prices boom, you get massive exploration and in general the world's reserves increase far, far faster then they are needed.  So, if you look at uranium, for example, a metal in its infancy for exploration a half century ago, it had its boom over the first nuclear plants and the arms race, and then it had a very, very long retraction due to uranium in weapons being recycled into the open market for nuclear plants.  The price got so low, there was virtually no exploration, yet with the recent boom, enough uranium has been found to supply the world with nuclear power for the next 100 years, and that's taking into consideration the many plans for expansion of nuclear power plants.

Gold is one of the most explored metals, going back thousands of years.  Every gold rush gold is mined to the limits of technology.  Take a look at history and go visit some of the old gold mining sites and you see gold mining machinery of the era just left behind when the limits of technology no longer kept up with the declining grade of gold.  It means there are lots of places where gold was known to have been mined in the past, but the places have pretty much had the cherry pickins of the gold already mined.

I did an exercise in studying the effects on costs for declining grades because of gold and because of the ya-ya-hurray that seemed to happen to gold shares when gold reserves were added, even if the reserves were, to me, of grossly questionable quality.  I go back to Goldcorp because I have spent many, many hours looking at that one and it still comes up like a pig on my radar.  Goldcorp has seen costs absolutely skyrocket due to the declining grade of gold problem and they've replace the reserves that once had them mining in a range of 70g/ton down to perhaps 1g/ton.  There are many, many gold stocks out there that ultimately grade means then need today's gold prices to remain solvent as they were cannibalizing other assets and riding the exuberant optimism to remain solvent and to pay for the losses from mining uneconomical gold "resources/reserves."

Another practice that many did as gold prices went up was they redefined "resources/reserves" by lowering the definition of economical, so you have these amazingly low cut-offs for gold grade and yippie press releases stating "reserves/resources" have increased.  Floridabuilder did an excellent post demonstrating how the builders fudged feasibility plans, take off a few cents on costs of items, slightly under estimate the labour, etc.  Well, in the homebuilders this is a linear problem, with declining grade, it you look at the graph on the "declining grade of gold problem," it is an exponential problem and a little bit of fudging on a low grade mine has enormous cost implications.  I've seen some gold mines that have come in losing hundreds of dollars per ounce mined.

I get so off track.  What prompted me to write about gold was a piece I saw today about gold hedges.   Well, actually it is looking at the cost of hedges in a single mine, Anglogold.  I think it does a pretty good job of looking at that problem.  They have 10.4 million ounces of gold hedge which will result in a price decline of about 20% from spot for2008, should price remain at about $900/oz.  That is up from being 13% below spot in 2007.

Barrick is very sophisticated in their press releases, promoting that they have no hedged gold mines in production.  This is true, but they have hedge promises at something like $300 or $400 for properties that do not yet have mines built.  It potentially means that when this catches up to them instead of increasing profits, they will have mines that are total sinkholes at the same time other mines will be coming to the end of their mine life.  This is not apparent when you look at their financial reports.  I certainly did not see it my first look and I liked Barrick my first look.  The hedges are a disaster. 

12 Comments – Post Your Own

#1) On April 03, 2008 at 10:29 AM, EScroogeJr (< 20) wrote:

The price of gold is totally unpredictable becuase gold serves no useful function. Bread, water, land, housing, oil, uranium have a clear tangible value, whereas the price of gold has to be figured like this: "if enough people believe that gold has value, it will have have value, but then if these people decide that gold is worthless, it will become worthless". Silver is better, at least it has industrial applications.

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#2) On April 03, 2008 at 11:01 AM, podrag (< 20) wrote:

'The price of gold is totally unpredictable becuase gold serves no useful function'

It serves a function as money and a store of value numbnuts. If you don't think money serves a useful purpose then you can give all your's to me.

If you are worried about gold companies not being able to mine the stuff out of the ground, then buy the metal instead. It's tangible, liquid, a store of value, untraceable and portable. What more could you want in an era of financial meltdown?

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#3) On April 03, 2008 at 11:07 AM, XMFSinchiruna (27.47) wrote:

EScrooge.. you are almost right... you just have to substitute the words 'US Dollar' in place of gold.  "If enough people believe that the USD has value, it will have value, but then if these people decide that the USD is worthless, it will become worthless".  FYI, gold does have many industrial applications, especially in audio equipment, computers, etc.  Gold is the only form of money that has intrinsic value.  I agree that silver will do better, for a host of reasons, but gold will be no slouch.

Dwot, on mining grades, I agree that many of the larger companies are plagued by declining grades as well as declining reserves that get more and more difficult to replace in a rising cost and price environment.  However, it's all relative.  As the dollar declines, demand will remain strong, so the miners with the higher relative grades and lower relative cost structures will undoubtedly profit.  I own no shares of Newmont, Barrick, Goldcorp (though I do think GG will do well for w while longer) in real life.  And I shy away from companies with big exposure to places like S. Africa, where mines have been in production for eons and the companies have to go ever deeper into the ground for their paydirt.

That being said, there are plenty of attractive equities in the intermediate and junior spaces.  Gammon Gold will do extremely well once the shorts get squeezed out.  Gold Fields is hugely undervalued, and I own it DESPITE the fact that it has operations in S. Africa.  And after the recent smack-down, Agnico Eagle and Yamana are both back in cheap cheap cheap territory.  These are the buys of the decade.  The buys of the century are in silver:  Coeur d'Alene, Endeavor Silver, ECU Silver... and surely you can appreciate the Silver Wheaton business model, as they are unaffected by cost increases, locking in contracts at a cost of $3.50 per ounce of silver!  :)

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#4) On April 03, 2008 at 11:11 AM, abitare (35.58) wrote:

Gary North (who I follow)

"As you know by now, I turned bearish on the precious metals on Friday, March 14. I published an article on how to short gold on March 17"

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#5) On April 03, 2008 at 11:33 AM, EScroogeJr (< 20) wrote:

Yes, gold as a store of value, sell dollar buy gold and all that Robert Kiyosaki stuff. Tell that to people who bought gold for $800 an ounce in 1980. Now, merely 28 years later, they are seing their first nominal gain in three decades. Was there ever a more lousy inflation hedge than this?

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#6) On April 03, 2008 at 1:51 PM, ByrneShill (74.33) wrote:

There is very little industrial applications for gold. 99% of the world gold is either buried in a fortress or a jewel of some kind.

For once I agree with EScrooge. Gold has no value whatsoever. It has a price, yes, but no value. It has no utility either. Try warming your house on a cold day with gold. Or try eating it. It won't kill you, but it won't feed you much either.

As for gold being liquid, let me laugh! Try paying for the grocery with gold if you think it is liquid. The best you can do with gold if you need money NOW is sell it to the pawn shop for 1/3 of what you paid for it. It's only very slightly more liquid than stamps or paintings.

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#7) On April 03, 2008 at 3:32 PM, DemonDoug (73.55) wrote:

Ask the folks in zimbabwe and argentina if gold has "no value whatsoever."

Here is a relatively short list of countries where gold was a store of value for those who held it while the fiat currency (along with the country) went down the drain:

Roman Empire

Weimar Germany (1920s)

Greece 1941

Hungary 1945

Chile 1970s

China late 1940s

Israel 1970s

Peru in the 1980s

Mexico in the 1980s

Yugoslavia early 1990s

Argentina late 1990s

Zimbabwe - now

Russia 1990s

Turkey 1990s

Confederate States of the US -1860s

Please note, that while some of these examples occurred in times of significant stress (ie war), many of them were simply economic blunders and most, if not all, ended up with the rich stealing from the poor.

Byrne - you are wrong about the industrial applications.  Something like 15% of the demand for gold is industrial.  About 60-70% is for jewelry.  According to this chart, 13% of the demand for gold was industrial in 2007:

Also, please note I am not a gold bug.  The best way to play inflation and commodities bulls, as well as increases in PM's, is to invest in oil.  I have written ad nauseum about this in the past.

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#8) On April 03, 2008 at 4:22 PM, EScroogeJr (< 20) wrote:

Very few people in Russia were buying gold in the 90s to rescue their savings from inflation. One reason was the illiquidity of gold, the other reason was the absence of  a civilized gold/commodities market at the time. The US dollar was the primary store of value. Apartments were the second most popular inflation hedge, and where the first two hedges were deemed insufficient, cars, refrigerators, wood-cutting machines, furnuture and electronics would pick the slack. Anything could be used as a store of value as long as it was easy to understand, easy to buy or sell, and had an indentifiable consumer application.

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#9) On April 03, 2008 at 7:03 PM, dwot (47.53) wrote:

This is an article I noticed today on gold stocks.  This author does a great job of showing problems with gold stocks.  It has silly comments.

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#10) On April 03, 2008 at 7:13 PM, DemonDoug (73.55) wrote:

Escrooge: Did you live there?  I would love to see someone trying to trade a car for some wodka.

Either give a source for your info or STFU.

Want to know how to give a source for your info?  Oh, look, in post #7, there's a nice table there showing that in 2007, 13% of all demand was industrial in nature.  That would be a source showing data proving a point.  Then again, who are we to let facts get int he way of our point.  Maybe you should take a 4th grade class and learn to do a bibliography.

Also, the time to buy gold is never in the midst of a hyperinflation, but before it happens.

Incidentally, gold is the worst place to be in in a deflation.  But, as you so lovingly like to point out, banks and the federal reserve and government will continue to try to bailout this mess by printing more and more money, so that the chance of deflation is zero.

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#11) On April 03, 2008 at 8:20 PM, EScroogeJr (< 20) wrote:

Demon,

Yes, I lived there until 1992. Trading cars for vodca was a normal practice at the time. Most of the economy then was barter. People working at a sugar factory would be paid in sugar, farm workers would be paid in potatoes,  and so on. People working in schools and hospitals were paid the ruble equivalent of $30. People working in research institutes were not paid. Roubles were worthless, and foreign currency was the king. Gold never became a popular instrument becuase in terms of liquidity it was so much inferior to the dollar and in terms of consumer value it was uncertain how many kilos of bread grandma's wedding ring would buy if things became even more rough. It was all about liquidity and utility. No one wanted to bet that a year from today he would find a greater fool with wads of cash who would be willing to buy a piece of useless yellow metal. Buying a 0.1 acre of land where one could grow potatoes seemed by far more practical.

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#12) On April 03, 2008 at 8:38 PM, EScroogeJr (< 20) wrote:

As to the second part of your question. The chance of deflation is zero. My issue with gold is that it's a lousy inflation hedge. It's this simple fact: gold consistently underperforms inflation over any considerably long time interval. Inflation you will have, but gold will protect you from it like a paper umbrella during a thunderstorm.

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