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Gold is Not like Oil – Fracking Won’t Uncover More Gold
The price of oil has fallen much faster than gold over the past year, partly due to the seemingly unlimited new oil resources available through “fracking,” a process which includes horizontal drilling and hydraulic fracturing of rock deposits. Those processes have made the theory of “peak oil” a shambles. There is no end in sight of the possibility of new supplies of petroleum products, despite their currently-low prices.
The same is not true of gold. At the recent gold-oriented New Orleans Investment Conference, mining consultant Brent Cook made this clear in his talks to the somewhat-subdued audience of gold mining share enthusiasts. What he said was incredibly bullish for the price of gold, in the long run, but this does not mean that most of the current gold mining operations will make money. Most will likely fold up shop.
There has long been a conflict between gold mining shares and gold bullion, in the sense that gold bullion investors should be quietly rooting for a reduction in newly-mined supplies, since that will inevitably boost gold’s price. In the opposite camp, those who favor gold mining shares are desperately seeking new discoveries. The result of this conflict is that that any index of gold mining shares has collapsed since 2011, while the price of gold has merely corrected. In the last six months the “Gold Bugs” stock index (HUI, in blue) has declined 31.83%, vs. a 3.67% decline gold, as reflected in the GLD ETF (red line).
In New Orleans last week, Brent Cook explained that “we’ve hit peak economic gold discoveries, but unlike the new fracking technologies that saved the oil industry, there’s no fracking technology to coax mineral wealth from ever-deeper deposits.” He pointed out that we reached the peak discovery boom in 1995. Since it takes about 20 years for a discovery to reach peak production, the peak in production is slated to occur this year, 2015. From now on, we’re likely to see far less gold coming out of the ground.
Here’s a chart Cook shared with New Orleans attendees regarding the correlation between peak discovery of gold mining properties (in 1995) and the resulting peak production in new gold supplies (in 2015):
The concept of “peak gold” was first advanced by Goldcorp CEO Charles Jeannes about a year ago. (Goldcorp is the world’s largest gold producer by stock market capitalization.) He said that gold production would soon taper off, not expand. This doesn’t mean we’re running out of gold. As Brent Cook explains, “we’re not running out of gold. We’re finding gold deposits, but most of them are not economic.” He used the example of ocean water: “There are 20 million tons of gold in ocean seawater, but there are only 13 parts per trillion, so it will never be economic to mine,” at least in our lifetimes.
Put frankly, there is no more surface gold to be found, and there is very little gold to be found within a few dozen feet of the surface. New deposits are only available deep underground. The environmental and social risks are great, so there is a rising tide of resistance against disruptive geologic exploration. As disappointing as this may be to mining stock investors, it could be a long-term boon to bullion investors.
All the low hanging fruit in the gold fields has long ago been picked. After the Cold War ended in 1990, many formerly unexploited lands opened up for exploration. The gold-mining community, according to Cook, “found a lot of deposits sitting at the surface in jurisdictions that were once inaccessible,” but that is a finite number that is now reaching its limits. He says “we’ve nearly exhausted the surface and are forced to drill for blind deposits through barren rock using really esoteric methods. The odds of success are much lower, and the costs are much higher.” Decades ago, geologists spoke of ounces of gold per ton of ore. Today, they speak in terms of gold grams per ton. (There are one million grams in a metric ton.)
One gram of gold is currently worth about $35, so the economic benefit of mining that gram depends on how much costs you must expend to find it and extract it. If the gold is too thin or too far below the surface of the earth, the mining company will lose money extracting it at the current price of gold, so they will not take the necessary steps to find and extract that gold, thereby limiting the new supply of gold.
Gold is Down Far Less than Most Other Commodities
Since 2011, gold has lost about 40% from its peak, but it is down far less than most other commodities because of this unique fact – that gold is very hard to find and mine in an economically sound manner.
The benchmark CRB Commodities index, which tracks 19 leading commodities is down 59% since 2008. As recently as early 2014, the CRB index was around 310 while gold was peaking at $1380 (during the Russian crisis with their accession of Crimea and threatened annexation of Ukraine). Since then, gold is down 17% to $1140, but the CRB index is down 37%, so gold remains the star of the commodity family.
Many analysts have said something to the effect of “the cure for low gold prices is…low gold prices,” meaning that the supply will dry up at these low prices, eventually pushing gold prices higher. It’s important to realize that this won’t happen overnight. The gold discovery process is long and laborious. It will take a long time for the mines to throw up their hands and give up, and then it will take a long time for them to get back into production once the price of gold rises. They will likely be cautious at first.
Gold should continue to “fall less” than other commodities until the time that it begins rising more consistently, based on the erosion of new supplies in the coming decade. Now is the time to begin or continue to accumulate gold as a prudent hedge against future currency erosion and low cash returns.
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