Peak Gold?

Gold bug Byron King claims that there is yet another reason that gold might be a reasonable investment: declining production.

In an interview yesterday, King argues:

Because we're in a world that appears to have encountered peak gold as well as peak oil. If you look at historical production, worldwide gold output reached a top right around the year 2000–2001. Overall output has declined and we're not replacing output from the big mines of the past. Despite discoveries here and there, miners have to dig deeper and deeper into the reserves. In a big mining country such as South Africa, for example, some of the deepest mines now are at 4,000 meters. That's 13,000 feet.

Is King right?

Yes, it turns out he might be.

Mining-Technology.com stated in March 2008:

Global gold production has been in steady decline since 2002. Production in 2007 was around 2,444t, down 1% on the previous year.

Analysts note that virtually all of the low-lying fruit has now been picked with respect to gold, meaning that companies will have to take on more challenging and more expensive projects to meet supply. The extent to which the current high price of gold can translate into profits remains to be seen...

According to Bhavesh Morar, national leader of the mining, energy and infrastructure group with Deloitte Australia, frenzied exploration activity over the last few years has seen virtually all of the easy harvest been picked with respect to gold...

The high price of gold is however encouraging more adventurous projects, be they more challenging financially, geologically, geopolitically or all three. New projects for gold and other resources are mushrooming throughout Africa, China, the Middle East and the former Soviet Union; all areas where sovereign risk is potentially very high.

Zeal Speculation and Investment wrote in July of this year:

Miners have the same geological landscape to work with today as those miners thousands of years ago. The only difference is the low-hanging fruit has already been picked. Gold producers must now search for and mine their gold in locations that may not be very amenable to mining. Many of today’s gold mines are located in parts of the world that would not have even been considered in the past based on geography, geology, and/or geopolitics.

And these factors among many are attributable to an alarming trend we are seeing in global mined production volume. According to data provided by the US Geological Survey, global gold production is at a 12-year low. And provocatively this downward trend has accelerated during a period where the price of gold is skyrocketing.

You would think that with the price of gold rising at such a torrid pace gold miners would ramp up production in order to profit from this trend. But as you can see in this chart this has not been the case, at all. Not only has gold production not responded, but it has dropped at an unsightly pace that has sent shockwaves throughout the gold trade.

As the red line illustrates gold’s secular bull began in 2001, finally changing direction after a long and brutal bear market drove down prices to ridiculous lows in the $200s. To match this bull the blue-shaded area provides a picture of the corresponding global production trend. And you’ll notice that in the first 3 years of gold’s bull production was steady. This is not a surprise as you figure it would take the producers a few years to ramp up supply. But instead of supply increasing in response to growing demand and rising prices, it took a turn to the downside. And what’s even more amazing is the persistence of this downtrend. Since 2001 gold production is down a staggering 9.3%! In 2008 there were 7.7m fewer ounces of gold produced than in 2001.

Also in July, Whiskey and Gunpowder posted a chart on historical gold production, and argued for decreasing production:

Take a look at the chart below from Macquarie Research, depicting world gold production 1850-2008...



[Click here for full chart]

For example, look at the very steep rise in gold output during the 1930s. That was during the depths of the worldwide Great Depression.

In both the US/Canada (blue area), and the rest of the world (gray area), people were digging more and more gold. The Soviets (purple area) increased their gold output too, courtesy of Joseph Stalin and his Gulag. Desperate times call for desperate measures, I suppose. Will that sort of history repeat this time around?

Or look at that massive run-up in gold output from South Africa (green area) in the 1950s and 1960s. That was during a time when South Africa was instituting its post-World War II system of apartheid. Labor was cheap (sorrowfully cheap), and quite a lot of international investment poured into South Africa without moral qualm. The South Africans dug deep and just plain tore into those gold-bearing reef structures of the Witwatersrand Basin.

But notice how quickly the South African gold output declined in the 1970s, as the mines got REALLY deep and the rest of the world began to institute sanctions against South Africa over its apartheid system.

And then look at the Gold Price run-up that followed in the late 1970s. It was a time of inflation, mainly coming from the US Dollar. Yet world gold mine output was dropping as well. Falling output, plus monetary inflation? The Gold Price skyrocketed. Another bit of useful history, right?

Now let's focus on more recent history, since about 1990. There were large increases in gold output from the US/Canada (blue), Australia (gold) and Asia (China orange, non-China open bar). By 2000 or so – the world production peak – Gold Prices were down toward $300 per ounce and below.

But as the chart shows, in the past 10 years, gold output has shown a marked DECLINE in the major historic Gold Mining regions. The prolific gold output from the US/Canada, Australia and South Africa has followed downward trends. Sure, these regions still lift a lot of ore and pour a lot of melt. But the production trend is DOWN.

The US/Canada, Australia and South Africa all have well-established and (more or less) workable mining laws – despite the best efforts of many current politicians and regulators to screw it all up. These historically producing areas are politically stable. Overall, there's good mining infrastructure, with road and rail networks, power systems, refining plants, a vendor base, mining personnel and access to capital.

But that's not the case in many areas of the developing parts of the world. Political stability? Security? Infrastructure? Transport? Power? Refining? Vendors? Personnel? Capital? Everywhere is different, of course. But overall, the entire process is much more problematic. So there's a lot more risk. When you move away from the traditional mining jurisdictions, the whole process of exploration, development and mining is more expensive.

Thus, the new gold discoveries of the future are going to lack some (if not most, or perhaps all) of the advantages of the developed mining world. That means that the ore deposits of the future will have to offer much higher profit margins, based on size and ore grade, to compensate for the increased risks. Too bad Mother Nature (or Saint Barbara, who looks after miners) doesn't work that way.

It also means the timeline to develop the mines of the future will likely be stretched over many years while political, legal, bureaucratic, logistical and social issues are ironed out.

The key driver for the future of worldwide gold supply will be DECLINING output overall over time.

Of course, if the price of gold warrant ramping up then production will increase. Just as with discussions about peak oil, the issue is not that the resource is totally running out, it is that it will be more and more expensive to extract.

I know that there have been warnings about peak oil since at least the 1970's. Top experts now say peak oil is real. See this, this and this. But I am not an expert on oil or gold.

Note: I am not an investment advisor and this should not be taken as investment advice.

Print this post