Roundup Takeaway 2: Peak Gold and a Better Boom
"We are very close to peak gold, by which I mean this: our industry is never again going to mine as much gold as we did this year."
So said the head of the largest gold company in the world by market cap – Chuck Jeannes, president and CEO of Goldcorp – in his keynote address at Roundup.
Granted, the guy is biased to believe in gold. But success doesn't stem from acting based on wants, it stems from acting based information.
And the data behind peak gold make a lot of sense.
The fundamental reason is simple: the cost to discover an ounce of gold keeps climbing. Since 1975 discovery costs have increased 100-fold. Then, as discovery costs have climbed, exploration spending has declined.
Higher cost + less funding = fewer ounces discovered.
Making matters worse: of the shrunken pool of exploration dollars, majors are spending a larger portion than usual. That is not a good thing because, as Jeannes himself says, "Majors are not very good at grassroots exploration. We much prefer to let juniors do that and then come in and buy the assets."
Those are the reasons. The results have been manifesting for years.
Gold discovery peaked in 1995. The sector found more ounces that year than ever before – and ever since. Aside from surge in 2007, the number of ounces discovered per year has been in decline for 20 years.
Guess what the average time to bring a new discovery into production is now? Yup: 18 to 20 years.
"It's not just coincidence that gold production is peaking today, right about 20 years after the discovery peak," said Jeannes. "Looking forward, gold supply is going to be lower. That's peak gold."
Peak supply bodes well for gold – if demand is consistent or climbing. Like me, Jeannes believes it is.
To reach that conclusion you have to add up the two sides of the gold market. One side is paper, dominated by exchange-traded funds. If you only watch gold through that lens, you saw major selling over the last two years.
But the other side of the market is physical – jewelry and bars. And demand on that side is rising.
"As investors were bailing out of ETFs, different investors were buying physical gold," Jeannes said. "The drop in ounces held by the ETFs versus the increase in ounces into China: there's been a great transfer of wealth represented by gold from New York and London to Hong Kong and Shanghai. And I don't think that's a bad thing because those are much stronger hands in terms of holding ounces than hedge funds."
Those stronger hands are part of the reason gold has significant support at US$1,200 per oz. The Shanghai premium – the added cost to buy an ounce of gold on a particular day in Shanghai – demonstrates that support clearly. When demand is high, the premium rises. And each time gold drops below $1,200, the premium rises because Chinese buyers rush in.
The summary to here: peak gold means supply is going down and consistent demand plus a well-established price floor means prices have nowhere to go but up.
That's great, but what does that mean for gold equities? Seems a silly question – if gold is rising, gold equities should rise too, right? Well yes, and no.
Between 2003 and 2013 gold gain 270%. In that time frame gold miners (as represented by XAU, the Philadelphia Gold-Silver Index) gained only 74%.
How did miners squander so much gold price gain? By letting costs climb right alongside gold.
"We can blame inflation and labour costs and all kinds of things, but really we have to accept a lot of the blame because we allowed grades to go down," said Jeannes. "We lowered our cut-off grades and we chased marginal ounces and as a result we saw higher costs. Then you combine higher costs with the fact that we have to reinvest our business and you see that, over that ten-year period, we didn't make any money – we didn't generate any cash flow."
That is why investors abandoned the mining space. As they disappeared, share prices sank. Whether you look at price to net asset value (P/NAV) or price to cash flow (P/CF), gold equities are at a 30-year low.
That is ugly – but it also means opportunity.
As I wrote about on Friday, the smart folks in the sector did not spend the bear market sulking. They spent it assessing what when wrong and how to make more of the boom next time.
Things are already improving. After running rampant during the bull market, gold producers have successfully reined in costs. The industry average all-in sustaining cost (AISC) to produce an ounce of gold peaked at almost US$1,250 in 2012. Today it is below US$1,100.
Fiscal prudence has returned as a key characteristic. Miners have abandoned growth for growth's sake and instead are only looking to invest where strong returns are possible. Innovation and high margin ounces matter.
Stepping back further, mining is weighed down by social distrust and misunderstanding. To change that will require action from all of us.
Yes, it sucks that the average person hates mining yet consumes far more metal than he or she realizes. But that hatred has roots in mining's dirty and profit-driven history, which is not too distant a history at that.
Things are different now, but it is miners' responsibility to spread that message.
It is not easy: mining is an easy target and we are reticent to defend ourselves.
But the opposite is even more unappealing: continued years of limited investor interest and restricted capital. If it can't be grown, it has to be mined. Isn't that a reality worth defending?
Defending mining is not just about debating issues. It is also – perhaps more so – about including more people in the process and benefits.
Jeannes told the crowd about a poll he had taken during his talk at the World Economic Forum in Davos. He posed this motion: shareholder value maximization has failed as a source of long-term wealth creation and social benefit.
No fewer than 70% of the people at the Davos talk agreed.
"The fact is, there are a lot of people out there who think this and that is something we have to understand," Jeannes said. "I think we're too insular. We think, 'If we can just convince the First Nation down the road' or 'If we can just convince the people in the town' then everything will be ok.
"What I now believe is we have to convince a lot more people in order to be given the broad social license that we need. We have to conduct our business in a way that benefits more than just our shareholders."
Investors reading this may be thinking, Yes, sure, but spending time and money building broad social license is not going to help ABC's share price right now. And no, it may not help tomorrow.
But in today's mining world, it will not only help ABC in the long run – it is essential. ABC may have a project with great geology but if the company fails to foster good relations, the project is doomed. No major will ever want to buy it. If ABC tries to build it alone, no government will permit it.
On the flip side, a real effort to bring stakeholders together, to listen, to incorporate needs into planning, to spread benefit and work together – that adds real, tangible value to a project. It increases the odds of a takeout, of finding a development partner, of sourcing project capital.
And every success story, every company that builds real bridges and garners real public support makes mining just a bit more acceptable and spreads the wealth just a bit farther.
It is slow and at times frustrating, but it is the only way to recast mining's dark, dirty reputation. It is how to pave the way forward for the sector as a whole.
To profit along the way will require investors who look beyond geology and taxation and infrastructure to include local relations, which provide real, essential benefit but that are very hard to enter into a spreadsheet or model.
So: we're at peak gold. Production is set to decline in the face of steady or rising demand, which will push prices up. But we learned in the last bull run that a rising gold price doesn't ensure gold equity performance. To find that, investors have to search out controlled costs, margin-focused management, and companies truly invested in social engagement.
It is shocking that gold equities only achieved a quarter of what gold gained during its historic bull run. Shocking and unacceptable.
When gold gets going again, companies have to do things differently. No growth for growth's sake, no low-margin developments, no top-of-the-market acquisitions, and no corporate social responsibility as an afterthought. Any company that operates in 2015 like it's 2005 will flounder and fail.
But those that innovate, reach out, act with prudence and accountability, and plan for the long term will have a hell of a ride.
Thank you so much for this important insight. It makes complete and makes the decision complex....The newsletter is incredible, your insight is very fun to read.
Great job Gwen... you are becoming the most credible in the world at this... Bravo