Today’s bounce back in gold prices is fading into the close and as Barclays’ Suki Cooper notes, despite some physical demand response to lower prices, it has not been sufficient to combat the overall decline. In the absence of support from physical buying, where does fundamental support materialize? Should gold just put on its commodity hat, instead of its increasingly more popular currency one, its cost of production should provide some guidance.
Via Barclays’ Suki Cooper,
Last year, the average cost of production was $673/oz, and the marginal cost of production (90th percentile) was $1104/oz (Gold cash costs drive higher, 22 March 2013).
Assuming sustaining capex at around $200/oz, this indicates cost support at around $1300/oz, based on last year’s data; our global database encompasses 35% of global production.
Should prices dip below marginal cost, around 10% of production under our cost curve becomes cash-negative, representing an estimated 262 tonnes of cash-negative gold production globally. The bulk of this at-risk production is from South Africa, according to our database. Also putting pressure on gold prices is the acceleration of ETP outflows, which have already reached 66.5 tonnes for the month-to-date (until 12 April 2013). Nearly 320 tonnes of gold ETP holdings are cash negative below $1400/oz (assuming only those shares created above $1400/oz have been redeemed above $1400/oz, thus, this estimate is likely to be greater).
Although a reduction in mine supply would need to counter the supply from ETP outflows, this has raised the question whether producer hedging could gain traction. Hedging activity over the past couple of years has predominantly been related to project financing.
Looking at the 20-year price low in 1999, when prices dipped to $252/oz, prices traded a third above the annual average cash cost. The average cost of production was quite stable in the 1990s but has risen by an average 16% y/y over the past five years. The marginal cost of production has risen by 69% over the past five years, rising by 15.2% last year.
Our cycle average forecast is $1125/oz (which denotes the cost-driven estimate of the minimum sustainable price over a business cycle) before taking into consideration sustaining capex, therefore, given that cost pressures are rising and labor disruptions persist, from a fundamental perspective, support comes into play initially at around $1300/oz before a substantial quantity of mine production is put at risk.
And of course, should the central banks of the world succeed in driving the price of gold to or below its costs of production (repressing yet another asset class into stocks) then we fear the repercussions will backfire from a combination of bankruptcies, unemployment, and as we have already seen in Africa – severe social unrest.