What Is It About Gold?
In the past 10 years, the price of one ounce of pure gold has risen from less than $300 to $1,500, far outpacing the return on stocks and bonds. And yet, to paraphrase the comedian Rodney Dangerfield, "It don't get no respect" in most gatherings of professional investors. Why is that? Why is the yellow metal treasured in some quarters and disdained in others? What drives the price of gold, anyway? And is gold really an appropriate investment in the 21st century?
In this issue of the Blue Sheets we set out to better understand this unique metal and the reasons that it has been considered "precious"in all cultures since the beginning of recorded history. We'll explore the reasons that some consider gold an important asset class with unique and valuable investment characteristics, while many or perhaps even most professionals regard it as a sort of investment sideshow.
It's Not Terribly Useful
Gold is a metal, but one with special characteristics that set it apart from industrial metals like iron, copper and aluminum. Au is its symbol on the Periodic Table of the Elements; the abbreviation derives from the Latin word for gold, aurum. Gold's atomic number is 79, which indicates the number of protons in one atom. Despite the fact that gold is the most malleable and ductile of metals, its industrial uses are relatively few, limited primarily by its high cost. Total industrial demand for gold accounts fornly 10% to 12% of annual goldroduction. Year after year, about 50% or more of the world's new gold production is fashioned into jewelry.
Pure gold is bright yellow, lustrous, and it does not oxidize in air or water. Because of these properties, and because gold deposits are rare and expensive to extract, gold's principle commercial uses have always been in the fabrication of jewelry and coins. Jewelry and artwork are believed to account for more than half of all the refined gold on the surface of the earth. And since nobody throws this stuff out, virtually all the gold that was ever mined is still here.
It's Expensive To Produce
Gold occurs as nuggets or grains in alluvial deposits and in rocks. Usually, the concentration in the surrounding material is so small that deposits are invisible to the eye. In a typical open pit mine, its concentration or "ore grade" is between 1 and 5 parts per million! Underground "hard rock" mines are typically 3 ppm. Said another way, on average a mine needs to process 17 tons of dirt and rock to produce 1 ounce of pure gold!
In recent years, all the world's active gold mines have been producing a combined total of around 2,400 tons of gold per year. Using an average ore grade of 3 ppm (I cannot verify if that is the actual average, but it is a decent ballpark figure) the industry would be digging up and processing about 1,440,000,000 tons of rock and dirt to produce 2,400 tons of gold. Their average cost of production has been in the neighborhood of $500 per ounce of gold, and ¼ of the cost is energy. To achieve that efficiency, they must dig up and process rock and dirt for an all-in cost of under $30 a ton!
It takes a lot of capital to build an efficient mining operation. Newmont, one of the largest gold mining companies in the world, recently announced a $7 billion 6-year expansion program indicating capital costs of about $125 million per ton ($4,000 per ounce) of productive capacity. But even this Herculean effort would add the equivalent of only 2% to world capacity, even as older mining operations are nearing the end of their useful lives. So, while the price of bullion is high, we don't see a sudden surge in the supply of new gold.
Capacity expansion doesn't happen overnight. Besides the exploration and testing process to locate and evaluate the ore grade of a potential mine, thereare extensive governmental and environmental procedural requirements, establishment of ownership and taxation rights, and the biggest of all... the infrastructure development. This includes not only the extraction equipment and ore processing facilities but access infrastructure, which can include miles and miles of heavy-duty roads and often landing strips and helicopter pads. As much as ¼ of all gold output is estimated to come from small, low-tech "artisanal" projects; but the big, efficient mines that comply with safety and environmental regulations can take 5-10 years to actually come on stream!
It Is Scarce
A high percentage of Americans seem to own gold jewelry. There are well-stocked jewelry stores in every mall. Is "Bling" really all that scarce?