August 2011

The mighty yellow metal

Gold is on the rise; is the peak in sight?

By D. Zlotnikov

It’s up. It’s down. It’s up. It’s down again. Volatility has been an inescapable part of the metals markets over the last few years. But in that time, gold has taken a pass on the roller coaster, catching a ride on the escalator instead. It’s up. It’s up again. It’s up some more!

Currently at more than US$1,550 per ounce, the price of gold has maintained its four-digit levels since September of 2009. This has led to some very unusual developments. Jon Nadler, senior analyst with bullion trader, points out that, very recently, the Western jewelry sector has become a net supplier, rather than consumer, of gold. For the first time ever, he says, scrap supply generated by people swapping their jewelry for cash has outpaced the amount of gold used in the West in jewelrymaking.

“When you look at the 1,400 tonnes of recycled gold that have flowed into the market, that’s the second largest annual supply of scrap ever,” Nadler explains. At the same time,  jewelry consumption was down 20 per cent in 2009, near a 25-year low for the industry, and has not yet significantly recovered.

With so many sellers, there must of course be buyers. Micheal George, the gold specialist at the U.S. Geological Survey (USGS), says 2010 global jewelry production accounted for 2,000 tonnes and industrial use for another 500. But investment gold accounted for around 1,500 tonnes, over 37 per cent of the pie, drastically up from the historical trend of around 20 per cent of annual flow.

Is the peak in sight?

Doubts about the health of the United States economy and the value of its dollar have helped drive investment demand for gold and its rise in value. At its current price, however, gold does not strike Nadler as a particularly sound investment. To explain, he points to the troubled economies of Europe. He suggests that Portugal may be pressured to sell off some of its gold reserves – and Portugal’s reserves are 82 per cent gold.

“Ultimately, why do you have the gold in the basement to begin with?” Nadler asks. “It is for rainy-day type of purposes, and it’s raining pretty hard in parts of Europe right now,” he says.

Another area of concern for Nadler is the gold exchange traded funds (ETFs). Combined, these hold over 2,000 tonnes of the metal. “This puts them up into the fifth or sixth place globally if they were a central bank,” he says.

Central banks, Nadler continues, have the obligation to limit sales, but ETFs do not, “and I cannot at this point project what a 200- or 300-tonne outflow from ETFs might present price-wise to the market.”

Operating on a different schedule

From the producers’ perspective, the current prices are welcome but don’t necessarily make a big difference for operations in the short term. George, at USGS, points out that it can take anywhere between 10 and 20 years from the time a discovery is made until a new mine begins producing gold. Today’s demand has certainly spurred a wave of exploration activity, but any projects that enter production in the next couple of years will likely be ones that have been in development since before the financial crisis.

One such project is the Young-Davidson Mine in northern Ontario. Currently being built by Northgate Minerals, the mine is slated to enter production in 2012, says Northgate’s director of investor relations Keren Yun. With a projected cash cost of $400 an ounce over a 15-year mine life, the mine is on track to be a financially robust, long-life operation. The company did benefit from the high gold price elsewhere, says Yun. “If the gold price, and especially the copper price, weren’t as strong, Kemess South, our long-time flagship operation, would have ended production sometime last year,” she says. “We were mining very low-grade ore that was at one point considered waste, and we still managed to produce 12,000 ounces of gold this year.”

On the other hand, the more marginal projects, as well as higher cost ones, will be under the microscope if gold does not maintain its current price level. For example, Northgate’s approach to its Australian operations might change should the price fall. The Stawell Mine, Yun explains, which is one of the deepest ramp-access-only underground mines in Australia, consumed $964 for every ounce extracted in 2010. “If the price of gold were to drop substantially, we would stop further development at the mine,” she says, “but we would continue to mine out our reserves and still make money.”

Precious metal, practical applications

It is also important to consider the industrial uses of gold, which account for as much as 15 per cent of the annual flow. Because of its high resistance to corrosion and good conductivity, gold has been the material of choice for modern electronics – everything from cell phones to laptops to televisions contains a minute amount of gold. Because the metal is also largely chemically and biologically non-reactive, it has been a favourite choice for medical applications.

Most of gold’s industrial uses have one thing in common: the users have considered, and discarded, all other, less costly, options. Most of these industries will keep on using gold, regardless of price. Time will tell whether the higher material price stifles development of new applications of the metal or drives more investment into finding viable alternatives for gold.

With roughly 0.03 grams of gold used in a modern handheld device, “urban miners” are finding value in discarded hardware. Recycling firms in Japan, for example, where phone users typically replace their handsets every two years, are producing hundreds of kilograms of gold from the unwanted devices each month. As with primary producers, recyclers face the challenge of securing the raw material. Naturally, a new generation of prospectors bearing names like and is developing to feed the demand.

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