Focus on Fundamentals; Gold Supply Likely to Shrink

While analysts and investors debate the latest jobs report, or obsess over the most recent Federal Reserve announcement, it’s easy to overlook the basic fundamentals of the gold market. With that in mind, consider this recent news: one of the world’s top gold producers says market dynamics may well lead to shrinking gold supplies in the future.

Randgold Resources Ltd. CEO Mark Bristow told Bloomberg that half the gold mined today is not viable at current prices. In other words, many mines aren’t even hitting their break-even point on half of the gold they dig out of the ground. That means new supplies of gold could begin to dry up in the near future.

Amplifying this problem is the fact that many companies have already mined the easily accessible ore on their claims, leaving only gold that will prove much more difficult and expensive to dig out of the ground, according to Bloomberg:

Gold miners buffeted by the drop in prices are shortening the life of mines by focusing only on the best quality ore, a practice known as high grading, which will restrict future output and support higher prices, according to Bristow. He said in a presentation to bankers in Toronto that the industry life span is down to about five years because companies have been aggressively high grading at the expense of future production.”

The latest World Gold Council Report hints at the coming supply squeeze. Year-on-year quarterly mine production shrank by 1% to 828 tons in the third quarter of 2015:

The long term indication is that supply will remain constrained as the mining industry continues to proactively manage costs and optimize its operational performance…The reductions in expenditure on activities such as exploration and development will likely have a detrimental effect on production levels in the future.”

Some experts even predict the world will soon reach what is known as peak gold. This means that the amount of gold being pulled out of the earth will begin to shrink every year, rather than increase, which has been the case since the 1970s

Chuck Jeannes announced in September that he believes the world will reach “peak gold” either this year or next. Jeannes serves as the chief executive of the world’s largest gold mining company, Goldcorp, so he certainly understands the dynamics of gold supply. And last April, Goldman Sachs analysts predicted gold production would peak in 2015, saying there are “only 20 years of known mineable reserves of gold and diamonds.”

Meanwhile, gold demand continues to surge. Global gold demand in the third quarter of this year grew a healthy 8%.

Given all the data, it appears the gold industry will soon enter a long-term and potentially irreversible period of tight supply, even as demand remains robust. Investors would be wise to take note of the the fundamental dynamics on both supply and demand side of the gold market, and not just focus on the current economic data or the most recent Federal Reserve pronouncements.

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