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Will Peak Gold Come to the Rescue?

There has been much talk of peak gold in the past couple of years. This being the time when global gold new output starts to diminish whereas annual production has mostly risen for decades. This has been brought about by a period of consolidation, and stockholder demands for debt reductions, with the prospects of profitability improving and dividend flows increasing, from the world’s major gold miners.

Heretofore the mantra had been production expansion at almost any cost. However institutional and shareholder pressure, together with banks and other capital sources now reluctant to lend the huge amounts of money needed to develop new mega-mines (and the major producers don’t tend to be interested in smaller projects) has meant big new mine production increases have been diminishing and will do so in the future at a potentially alarming rate. Up until the past couple of years, major capital-intensive new developments had been deemed necessary to meet inevitably declining production from older mines due to declining grades and closures.

But austerity measures forced on many of the major gold producers in this manner have led to other, perhaps unintended, consequences with a knock-on effect on global gold future output in the long term. Big capital projects have been shelved or canceled altogether. Exploration expenditures have been cut back with the consequence that virtually no new mega gold production projects are in the pipeline. Meanwhile, the major producers have been much more circumspect in assessing the values of their exiting mines and closing down unprofitable or marginal operations, or divesting them to perhaps more flexible junior and mid-tier mining companies which may have more efficient cost structures. The result has been that for the first time in years many of the gold majors are reporting production declines, although on the positive side almost universally there has been a huge reduction in debt.

But total global gold production has not yet been falling, although it may have just about plateaued. Why? Initially, at least there were sufficient big new projects already in the pipeline and too far down the road to be shelved. Their coming into production, and building up to full capacity, has countered the declines from aging operations and closures. Furthermore, there have been some significant new, mostly high grade, smaller projects coming on stream in countries like Russia, Australia, Canada and parts of Africa which have been offsetting declines elsewhere. But how long can this balancing act go on?

Not long we think, and the recent very significant dip in the gold price could accelerate closures and write-downs unless there’s a very rapid gold price recovery – we don’t think this likely to happen until after the Labor Day holiday early next month and maybe not even then – but the turnaround when it happens could be significant. In the meantime the gold price has been hard hit by the rising dollar which has been strengthening against many other currencies – some of which have been adversely affected by the Trump trade tariffs This followed several months of dollar weakness which, at the time was accompanied by a rising gold price.

Why we think the rise in the dollar index, and the consequent fall in the gold price, will reverse in due course is because the Trump trade war is likely to accelerate U.S. inflation. Imported goods will become more expensive, as will any U.S. replacements, and rising inflation will likely hit consumer spending which is recessionary and could thus have an adverse impact on the dollar. But this will take a little time.

But back to the question posed by the title of this article. The answer is thus no in the short term but probably yes definitely in the longer term. Mind you if gold continues to decline at the current rate this could bring forward uneconomic mine closures and speed the whole process up.

It’s an arguable point as to whether the gold price decline (measured in dollars) is actually a case of the dollar index rising rather than gold falling, given the two, are generally inversely related. However in the case of the recent gold price decline gold has perhaps been falling at a slightly faster rate than the dollar has been rising. But when it all settles down, as it inevitably will, we may well find that the percentage change in the gold price will largely match the changes in the dollar index.

Some commentators will argue that much of the above is irrelevant anyway as both the gold price – and the dollar index – are open to manipulation (suppression in the case of the gold price) by the big bullion banks at the behest of the central banks, and ultimately of those governments which matter. But ultimately supply/demand fundamentals will be key and providing demand holds up – indeed we think it will increase over time as more and more people move into the gold buying classes in the world’s major population growth areas – there would likely then be a huge change in the price pattern.

Peak gold will thus become a major contributor to potential gold price growth, but perhaps any significant gold output decline may take a few more years yet. But when global gold production does eventually start to turn down it may do so with a vengeance. Lack of investment in big new projects coupled with diminished exploration could lead to a real shortage of metal as aging mines run out of ore. And when the gold price starts to move up materially, which will indeed stimulate new project development and increased gold exploration, there will not be many, if any, big new projects waiting in the wings to plug the supply/demand gap. With ever increasing lead times to bring a new mine into production, it will be some years before the improvement in exploration activity can lead to any significant new production.

What is unclear at the moment is when global gold output will actually start to turn down with some smaller increases from the countries noted above tending to counter the downturns elsewhere. This year, projections suggest that global gold output volumes will perhaps be marginally above those of 2017 – in other words, we are probably just about at the top of the gold production curve - so peak gold, or thereabouts is probably with us, or very close. But it is when the accelerating gold production downturn starts to happen that we are likely to see the significant climb in the gold price purely as a result of supply/demand fundamentals and this may well not be until 2020 or beyond. But when it does kick in we could well see some substantial gold price increases occurring quite rapidly.

As ever, gold should thus be seen as a long-term investment and big short-term gains tend to be illusory unless there is some significant short-term geopolitical event to stimulate the metal price. Failing this once peak gold is recognized as having happened and annual gold production levels start to fall at an accelerating rate that is the time it will have the decisive impact on the gold price that many have been predicting. But not quite yet!

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