Gold miner Newcrest Mining Ltd.
(ASX:NCM) is optimistic on the gold price in 2013. And like a pilot
fish benefitting from following sharks around, mining services
provider Ausdrill (ASX:ASL) will likely get its share of the spoils
too.
Let’s start with the first
question everyone asks a gold mining company executive whenever they
meet one: Where is the price of gold heading?
At the Mines and Money Conference
in Hong Kong yesterday, Greg Robinson, CEO of Newcrest Mining, gave
the answer every gold investor loves to hear: between $1,500 to
$2,000 per ounce in 2013, reports
Bloomberg.
“If I look at the preconditions
for the gold price in the medium term,” Robinson made his case at
the conference, “I think about monetary supply, currency
devaluation, interest rate, inflation, political economic drivers.”
“I’m confident about the gold price. I expect [it] to stay strong
for the medium term,” Bloomberg
quotes.
Notice that the reasons he and many
other gold mining executives repeatedly give to back their
expectations for higher gold prices have recently become long-term in
duration. They don’t so much cite short seasonal demands that can
lift gold prices for a few weeks or months. Today, they cite mostly
macro-economic conditions that, once set-in, will exert upward force
on the gold price for years—such as inflation and weakening
currencies.
This
means there is a whole new multi-year phase to the gold price that
has only just begun. “There [are] more reasons to own gold today
than there have ever been,” Eric Sprott, Chief Executive Officer
and Senior Portfolio Manager at Sprott Asset Management, claimed at
the conference. “I hardly think the crisis is over. The crisis is
in full bloom,” quotes Bloomberg.
Now, if such demand by itself isn’t
ample enough cause for a rising gold price, then just factor a
shrinking gold supply into the equation, and you will really have a
case then.
One major cause for a shrinking
gold supply is the recent 18-month stagnating gold price. In fact,
gold is currently trading at a discount to its future value. At the
conference, Robinson described the effect, as quoted
by The Australian
newspaper. “Investors and market analysts are forecasting steeper
‘backwardation’ of commodity prices.”
Pause right there. What is
‘backwardation’? “A market is ‘in backwardation’ when the
futures price is below the expected future spot price for a
particular commodity,” defines
Investopedia.
This means that a gold futures
contract is currently trading below the price where gold is expected
to be at when the futures contract expires. It is cheaper today than
it will be at its expiration.
Hence, gold producers are reluctant
to sell too much gold just now. Why lock-in a futures delivery
obligation at today’s futures contract prices when spot gold at the
time of that future delivery will be much higher then?
The consequence of this is lower
than optimal revenue for the producers, as Robinson explained,
“Recently the combination of lower commodity prices and inflating
costs has resulted in lower profits and cashflow for all major
companies. The project capital commitments and cost overruns have
been aborting the cashflow the industry has been producing,” quoted
The Australian.
At today’s low spot and futures
prices, gold miners will sell only the bare minimum they need to keep
them in business. They are saving the bulk of their inventory and
un-mined reserves for the bigger payoff down the road.
In turn, the consequence of lower
sales revenue means shareholders are not getting very much return on
their investment at the present time, as The
Australian confirms,
“The drop in prices and revenue had meant the resources sector had
not been able to reward shareholders with high dividends or capital
returns.”
Extend the consequences chain a few
links further and you can see that investors will not be readily
forthcoming with new investment capital for such dismal returns as
the miners are currently delivering. And less investment capital
means fewer new mines opening for business, as Robinson summed up:
“The lower revenue drivers
coupled to the current high cost of operations leaves new projects in
a long taxi queue for approval and funding and that queue will
continue to grow in the short term,” quotes The
Australian.
Hence, lower commodity prices mean
lower sales revenue, means lower returns, mean less available
investment capital, means fewer new mines, mean a falling supply that
cannot keep up with a rising demand. And this is great for the gold
price.
We can expect, then, that since
gold
producers
are expecting higher commodity prices in the near future, they will
want to prepare themselves now by increasing their output capacity
and profitability. This is precisely what Robinson reported the
industry is doing.
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