Mining sector faces tough call as gold drops

Otmane El Rhazi from The Bullion Desk.

As gold prices linger around the lowest in half a decade, the fundamental response would be to cut production, but that is unlikely to happen anytime soon, according to Erik Norland, senior economist at CME group.

Gold mining supplies have grown since 2009 on the back of record prices. But with the price of the yellow-metal down 40 percent from September 2011, the overzealous expansion during the boom times will continue to weigh on prices, Norland said.

The precious metal’s complex is largely a supply-driven market because most people wouldn’t refuse gold or silver jewelry, but the finite nature of the metals typically drives pricing. The only way to bring additional metal to the market is through mining with secondary supply appearing not to influence prices.

As financiers and bond holders piled investment into gold mines during the record highs of 2011, it created a tedious situation for miners as they are forced to extract gold even as prices collapse.

“It is worth pointing out that after gold prices collapsed in the early 1980s, mining supply continued to rise for another eighteen years,” Norland added. “This underscores the point that once capital investment goes into a mine, it becomes a sunk cost and that mine needs to continue to produce until the point at which it goes cash flow negative.”

Globally, the all-in cost of running a gold is around $982 per ounce, according to Metals Focus. However, the cash cost is $700 per ounce and this is a more relevant factor when gauging the point where gold production could be forced to cut back, Norland said.

With cash flow positive business at $1,150 per ounce, as long as the price remains near or above those levels, production should continue. However, if prices continue their precipitous fall, the mining output will be the underlying driver of market moving forward.

“If gold mining production defies expectations and continues to rise, this could put downward pressure on the price of the yellow metal,” Norland said.

(Editing by Tom Jennemann)

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