Tags: Gold | Miners | Demand | metal

Can Gold Miners Keep Up With Demand Ahead?

Monday, 06 August 2012 07:09 AM

Part of the equation for any commodities trader is to balance demand against future supply. That’s the backbone of the whole futures model. Its raison d'être is to provide producers with a way to hedge against the unknown.

Grain producers, for instance, have fixed loans for equipment and seed. But if bad weather intervenes, as we’ve seen recently with the huge drought affecting U.S. corn production, well, having sold half your output early in the year in the form of futures can be the difference between breaking even or going bust.

Gold miners face the same kinds of unknowns: Will a new deposit produce 10 million ounces, or nothing? Will buyers bid up the price of gold, or suddenly ignore the asset? How about industrial demand? Or Indian wedding-season buying?

By accepting market prices on futures contracts, the mining companies send a signal about their expectations of demand for the commodity. They are motivated, however, not to profit but to ensure that the companies are guaranteed to stay alive in tough times. Any upside is pure profit, and they can plan and invest accordingly. Since mines have production-life spans measured in decades, certainty is a form of financial luxury.

Less appreciated, however, is the risk that big miners might simply delay future production, and for all kinds of reasons. As Christopher Barker at The Motley Fool recently noted, big miners are beginning to question the rationality of putting major dollars into new projects.

He specifically mentions Barrick Gold (ABX), one of the largest miners in the world by market capitalization, which recently decided to put off development of its huge Cerro Casale mine in Chile.

“When the miner responsible for nearly 10 percent of global gold production begins to balk at major development projects in response to wildly escalating capital costs and steadily climbing production costs, the implications for future supply and price dynamics can no longer go ignored,” Barker wrote.

The implication is that rising demand for gold could ram head-on into falling supply. The dynamic of the gold market over the past few months has certainly led to weaker, not stronger, demand, and prices have fallen. Central banks had been driving the market higher, particularly emerging-market countries whose banks hold relatively little gold compared to their foreign reserves, which are heavy with U.S. dollars from years of lopsided trade.

Barker believes that a sudden change in direction for the gold price could be exacerbated by lack of gold to buy. Based on stalled projects, among other factors, he sees $2,250 per ounce gold as an “ultra-conservative” price target. Calculating from the recent trading price, hitting that number would imply a 40 percent climb for the metal.

Even from the recent all-time high of $1,908 an ounce, set only a year ago, on Aug. 22, 2011, such a move would represent nearly an 18 percent gain.

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Monday, 06 August 2012 07:09 AM
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