Thursday’s Rally in Gold
and Silver – Temporary Strength or the End of Correction?
By Przemyslaw Radomski, CFA
The only thing
that’s free right now is the air that we breathe. Other than that it costs to
manufacture every object and commodity in the world. It takes a certain amount
of money to extract a barrel of crude in Saudi Arabia, to make a car in Detroit,
or produce an iPad in China.
There is also a
certain cost to producing an ounce of gold. It doesn’t grow on trees. Tiny
nuggets don’t rain down from the sky. It costs to explore. It costs to extract.
It costs to finance loans and it costs to pay royalties. There are additional
costs such as administration, equipment, environmental remedies and others.
These are called the “all-in” costs.
Mines age and get depleted and extracting the gold gets more challenging and
costly over time. Average grades of ore have fallen by 30% since 1999, according
to GFMS, a consulting group, making it more difficult to extract gold and from
ever greater depths. Finding new deposits is becoming harder. If in 2002 gold
miners spent $500 million on exploration, by 2008 they were spending $3 billion,
but finding much less.
So how much does
it cost to make an ounce of gold today?
That is an
interesting question because just like a car manufacturer will not sell a car
for less than it costs to produce it, neither will mining companies sell gold
for less than it takes them to extract it from the ground. And the cost of
production is rising due to lower grade ore and the rise in the costs of
compliance and remediation. As gold
prices soared over the past decade, production costs inched higher including the
prices for equipment, materials, labour and energy.
According to a recent Forbes Magazine article both Barrick Gold
and Goldcorp, the largest mining companies, project that their all-in cash costs
will be between $1,000 and $1,100 an ounce for 2013.
In 2012, mining companies reported all-in costs such as: GG $1,082, Barrick
Gold, 1,227, Yamana Gold $1,247, IAG $1377, and Agnico-Eagle, $1,343.
According to the
Forbes article, a survey of 60 gold mining companies, apparently less efficient
than the giants, resulted in an average production cost of $1,391. That is
uncomfortably too close to where the price of gold was at the bottom this year.
Of course, it’s possible that if the price of gold were to drop,
mining companies could become more efficient and thus cuts their costs and be
more profitable. It makes sense that the inverse may be true as well, that as
prices were rising, mining companies expanded and
perhaps operated at high capacity the mines that are the most expensive to run.
production is currently around 2,500 metric tons per year. The all-time high was
reached in 2001, with 2,600 metric tons of gold production worldwide. It is
interesting to note that production in 1900 was around 400 metric tons per year
when the price per ounce was about $19 an ounce.
Financial Times story last month says that earnings data are confirming that
the decade-long expansion in the mining services industry is all but over. The
reduction in mining investment is severely affecting demand for equipment such
as trucks, shovels and underground machinery. Caterpillar, the world’s largest
manufacturer of earthmoving equipment, has reported a 45 per cent drop in
profits in the first quarter.
Does the cost per ounce of mining an ounce of gold provide a
floor for the price? One can argue that
theoretically the price could go lower than the cost of manufacture, but it
couldn’t stay there for long. Mining companies would have no incentive to
extract the gold and it would remain buried underground. They would have to cut
capital spending, defer exploration and capital development programs and
probably cut dividends. There would be a decline in supply and after a while,
when demand would outstrip supply, the price would climb up again.
The abovementioned facts suggest that sooner or
later the price of gold (and – with it – the whole precious metals sector as
well) will start to rise again, to cope with the rising costs. But these facts
alone cannot help us estimate the
turning point itself – let us then move on
to the technical part of today’s essay to see what immediate future holds for
the yellow metal.
metals sector moved higher on Thursday, but the question is if the move was
significant enough to change the short-term outlook for gold and silver. It has
been – as we wrote in our
previous articles – bearish, as far as
short and medium term are concerned. Let's examine the situation.
There was a breakout above the
declining resistance line in gold and silver – however, it was invalidated on
volume in GDX was significant during
Thursday’s rally but it was surprisingly small in case of GLD ETF. It was
average in case of the SLV ETF. Therefore, the breakout (even though it was
not invalidated on Friday in case of the mining stocks) is not that reliable
in our view.
The USD Index declined quite
significantly on Thursday and yet we saw a rather average move higher in gold,
so we decided to analyze the relative performance (USD - precious metals) more
thoroughly. USD closed approximately at the 83 level, something it had
previously done on May 10. On May 10 gold, silver and the HUI Index closed at:
$1,448, $23.88 and 280, respectively. This means that
mining stocks are where they were back
then and gold and silver are considerably lower now. This does not bode well
for the precious metals in the short and medium term.
We have previously mentioned the
reverse parabola in the GLD to GDX ratio which meant that miners were
declining more and more rapidly relative to gold. This parabola was broken on
Thursday, which is a bullish sign - not a strong one, but still.
The move higher in silver just
ahead of the cyclical turning point is actually a bearish phenomenon. If the
price is to reverse its direction shortly, then if the most recent move is up,
then the reversal should take the market lower. The previous cyclical turning
point in silver worked in this way and it worked only too well. Silver's price
plunged at the cyclical turning point after moving slightly higher - to the
20-day moving average. The chart below illustrates the situation (charts
(and, naturally SLV ETF) moved lower on Friday, which may mean that the next
downleg has already started.
up, at this time we still think that the breakout in
precious metals is not in and that lower values of silver will be seen before
the next big rally emerges. So far the USD-gold link is a strong indication
against going long and we don't think that the odds for the decline have really
changed. Not only have we seen a long-term breakout in the USD Index, but we
also see that gold and silver are responding more significantly to dollar's
rallies than to its declines.
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Thank you for reading.
Have a great and profitable week!
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Trading Website - SunshineProfits.com
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All essays, research and information found above represent
analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits'
associates only. As such, it may prove wrong and be a subject to change without
notice. Opinions and analyses were based on data available to authors of
respective essays at the time of writing. Although the information provided
above is based on careful research and sources that are believed to be accurate,
Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or
thoroughness of the data or information reported. The opinions published above
are neither an offer nor a recommendation to purchase or sell any securities.
Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw
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