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Rely On Gold’s Value
Over the past several years, the price of gold has increased due to a number of factors. These factors underpin structurally higher gold prices compared with those seen over the past two decades.
Prior to recent upward gold price adjustments, gold exploration had fallen into a precipitous decline. The $280 per ounce prices seen in 2000, too low to justify capital investment necessary to maintain mine output, had resulted in a pending drop in gold supply—supply that could not readily come online.
The lead-time to bring new discoveries into production is measured in multiples of years, even decades.
This withering of world gold supply occurred at about the same time demand from Asia and India began a long-term climb as huge middle classes emerged from the darkness of poverty.
At the same time critical, forward selling and the accumulation of gold derivatives by institutions created excess demand amounting to 5000 tonnes, or two years of world production. This effective short position in gold represented a looming disaster for derivatives holders.
The massive accumulation of gold derivatives really amounted to a bet on currencies, in particular the US dollar. The expectation: gold would remain weak and the dollar would remain strong. However, once confidence came out of the currency market, the shortage of actual gold became critical, and prices began their recent climb. Sentiment, the critical factor that drives all markets, had turned 180 degrees.
Gold made international headlines as the price rose sharply.
All other things being equal, the mining replacement cost of gold appears to be in a range of $400 to $500 per ounce on a sustained basis. This effectively places a floor under gold prices for the next several years as mining capacity catches up with growing world demand.
The ongoing conflicts in the Middle East and elsewhere may drive demand higher, as will removal of restrictions by more countries on individuals who want to own gold.
While no market moves up or down in a straight line, it is possible that gold will continue to trend higher than current price levels.
Underlain by the economic realities of supply and demand, gold remains an important portfolio holding. Shares in exploration companies provide the potential of exceptional upside through discovery leverage, and through sustained profitability at the mining level under current and forecast operating realities.
Bottom line, finding and mining gold will be profitable, and highly rewarding for investors who make the right choices for the foreseeable future.
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