For once, let’s look at the ugly side of the tumble in gold prices, only because the story will end beautifully. The story starts with a look at gold mining companies’ reserves and resources.
Take Goldcorp Inc. (NYSE/GG) as an example. The company’s mineral reserves were estimated using gold prices at $1,300 per ounce and silver prices at $22.00 per ounce. For mineral resources the estimates were based on $1,500 per ounce of gold and $24.00 per ounce of silver. (Source: Goldcorp, last accessed July 16, 2015.) Today gold stands at $1,145 per ounce, with silver at $15.02, suggesting that Goldcorp’s reserves and resources are likely going to get cutbacks.
Mind you, Goldcorp is not the only company that valued reserves and resources at higher prices than today. In fact, most precious metal mining companies are going to get cutbacks in their reserves and resources at today’s low gold and silver prices. When that happens, these companies’ valuations are going to get hurt and their stock prices may tumble even further.
The downturn in gold prices not only threatens companies’ valuations, but may also put entire companies out of business. Just take a look at the cost per ounce of gold.
However, not everything is gloomy because market forces will come to play eventually; companies that cannot survive the low prices will go out of business, and supply will drop.
In the first quarter of 2015, Barrick Gold Corporation’s (NYSE/ABX) production had all-in sustaining costs of $927.00 per ounce of gold. (Source: Barrick Gold, last accessed July 16, 2015.)
Newmont Mining Corporation (NYSE/NEM) reported that its all-in sustaining costs were $849.00 per ounce of gold in the first quarter of 2015. (Source: Newmont Mining Corp, last accessed July 16, 2015.)
Gold Fields Ltd. (NYSE/GFI), a South African gold mining firm, reported all-in sustaining costs of $1,143 per ounce of gold in Q1 2015. (Source: Gold Fields, last accessed July 16, 2015.)
As you can see, gold prices today are approaching some companies’ all-in sustaining costs. For others, it is already below their costs. This makes lives very tough for gold mining companies. Investors realized the situation and stocks of most gold mining companies plunged tremendously over the past few years.
What does this mean for gold investors? The time to buy is when there’s blood in the streets.
You see, when a company is in trouble, it can either get itself out, or it can stay in it and eventually go bust. There have already been gold mining companies that went under: in March, Allied Nevada Gold Corp filed for Chapter 11 bankruptcy; in June, Midway Gold Corp. did the same.
If the price of gold goes down further, more companies will leave the gold mining business. This will cause a decrease in supply of gold. And if there is anything in economics that still holds true today, it’s supply and demand.
So, supply will shrink. But what about demand? Demand is going up.
For centuries, gold has been used as a hedge against inflation, uncertainty, and market crashes. In almost every scenario where investors’ wealth may deteriorate, gold has proven its ability to guard the wealth. Right now, we are in another one of those scenarios.
China’s stock market crashed big time recently. From June 12th to July 18th, the Shanghai Composite Index plunged a dramatic 32.1%! More than half of all publicly-listed companies filed for trading suspension during the peak of the crash, in an effort to prevent further tumbles in their stock prices. Trillions of dollars of market value evaporated in a just a few weeks!
What did the Chinese investors do in response? They went to the gold market. In the first four trading days in July, settlement volume on the Shanghai Gold Exchange increased by sixfold to 597 metric tons. (Source: Ifeng, July 9, 2015.)
Central banks around the world have also been hoarding the yellow metal. In the first quarter of 2015, world central banks bought 119.4 tons of gold, marking the seventeenth consecutive quarter where central banks remained net buyers of gold.
There are many more propellers for the demand of gold, such as inflationary pressures, Europe’s quantitative easing program, and uncertainty in Greece. When demand shifts upward while supply is decreasing, gold prices could soar.