The startling surprise is that a
ten year sustained gold bull market has not been sufficient to shift the growth
in production upward at all. During the
same period, half the world’s population is increasing its purchasing power at
the effective rate of twice that of the growth in gold supply. However you play with the numbers, the reality
is that the retail gold market has become far larger and deeper during this
time and that has allowed central bank holdings worldwide to become unwound.
I would say that above ground
holdings are now no longer available to make up any shortfalls. The same thing has happened to silver when
the overhang from the photographic industry evaporated in the last decade.
Quite simply, a global population
of seven billion consumers will all reach purchasing parity over the next
thirty years easily outstripping the industry’s capacity to supply new gold as
it has been doing over the past decade.
These numbers tell us that the
mining industry will be shifting to a much higher gold price structure over the
next decade as this all unfolds.
As an old mining hand, I know
just how difficult it is to establish meaningful reserves in gold. We are already leaching nearly barren rock
for a few dollars worth of gold. We are
not likely to be able to lower the cut off grade by twenty percent in order to
increase minable tonnage ten fold on a ten fold increase in throughput as we
are actually doing in the copper industry.
The fact remains that we once
again need a technological breakthrough that releases p[previously unrecognized
gold into the market or a surprise geological discovery that breaks previous
records. That is actually possible
except it is also self limiting in time.
We are bullish on gold. Most market commentary on gold has centred on
the direction of US dollar movements or inflation/deflation issues. We go
beyond this to examine future mine supply, which we think is just as important
a driver. Our comprehensive study of 375 gold projects supply suggests a very
limited production growth profile for the next five years. A ten-year bull
market in gold has done little to drive gold production. The gold miners are
running to stand still. A lack of funding from equity markets and a shortage of
large gold mines makes it difficult for the industry to compensate for the
depletion caused by aging mines and falling grades. In our base case, our
375-mine supply model shows net production growth of 3.6% pa. over the next
five years.
Our IRR analysis shows that for the major gold projects under
construction, for which the acquisition cost of gold resources has already been
spent, the gold price would need to be US$1,400/oz in order to generate a 20%
IRR, which is usually the minimum return requirement. For greenfield China
We believe that these factors – limited gold production, buying by
central banks and increasing demand from India and China – can potentially
drive the gold price to US$5,000/oz, as highlighted in our commodity team’s
earlier report, Gold – Super-cycle to extend above US$2,100/oz (17 April 2011).
We believe the best ways to invest in the gold cycle are buying
physical gold (a safe asset) or investing in junior gold miners (highest
leverage to the gold price) that are 1-2 years away from production. We are
cautious about the gold majors. Project plans of the big five gold producers by
market cap suggest an average production CAGR of only 4% in the next five
years. They need to depend on expensive acquisitions in order to grow further.
As a form of affirmation, the share price index we constructed for the gold
majors underperformed the gold price by 147ppt over 1995-2011.
Gold mine production – subdued growth in next five years This report
focuses on the gold mine production trend in the next five years and addresses
the key issues that drive demand. We studied 345 gold mines as well as 30
copper and base-metal mines with significant gold credits, such as Grasberg in Indonesia
Gold mine production CAGR for the next five years will be 3.6%, going
by our base case, or down to 1.2% CAGR, under our bear-case scenario. Even our
bull case has gold mine production growth at only 5.6%.
There are very few large gold mines commencing operations in the next
five years. Only seven gold mines (green or brownfield) and one copper/gold
mines (the Oyu Tolgoi Mine in Mongolia
Our analysis of the major gold projects shows they can generate an
IRR of 19% at the longterm gold price of US$1,400/oz, below the gold companies’
IRR of at least 20%. For
greenfield projects going forward, the gold price needs to be nearly
US$2,000/oz to produce a 20% IRR.
Gold production growth = 3.8%
US$1400/oz to justify construction of major gold projects
Central banks change from net seller to net buyer
We recommend investing in either physical gold or junior gold miner
From our analysis, the regions that could contribute the most to gold
mine production growth are Asia (29% of total five-year global volume growth),
Africa (23%), North America (17% mainly Canada )
and South America (12%).
The average grade (weighted by resource size) of the gold mines in
our database is
3.5g/tonne, which reflects the grade of the gold reserves. The resource
grade is typically
lower than the reserve grade.
We conclude that gold production growth will be limited, which will
continue to fuel the gold cycle.
We believe demand will be driven by continued growth in per capita GDP
in China and India
Ironically, central banks, which collectively had been net buyers of
gold until 2010, would also be a powerful force driving gold demand.
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