Tuesday, December 3, 2013

Greed is... Gold?

My favourite financial site, ZH, has reported that gold is closing in on the marginal cash cost of gold, with CAPEX excluded.

Now, let's pause for a moment and think about this. The current spot on gold is now 1220 USD/oz. The estimated marginal cost of gold is about $1250-1350 which includes CAPEX of a $100 or $200.

Gold at the current spot price costs more than the most expensive mine currently in existence. What does that mean? It doesn't take a math genius to know, the mine will stop production because it is no longer profitable to mine the gold anymore.

Back on 18th April, they had a post showing the gold cost curve estimated for Dec 2012 for a variety of mines, pictured below.

The main thing to see here is that the bars represent the cost of mining gold, and the thick horizontal blue line was the spot rate, of $1400, which would have already knocked some mines out of production since now we're at $1220, which is better represented by the thinner blue line. However, since the start of 2013, gold mines have been cutting down on costs, so the costs should have dropped, but not drastically.

Now, see this graph by Kimble:

The fib extension is met by 2 support lines at roughly the spot price yesterday, which was $1235. I think that this is the current marginal cost of mined gold.

Now, see this graph from TheDailyGold.com:

And where does the support line comes in? The low $1100s! Which I think is the marginal cash cost

So, here is my hypothesis. After looking at the combined analysis from different independent sources above, I think that the current marginal cost of gold of the last producing mine is now at $1235. If this support is breached on a weekly level, it does expose the $1125 cash cost, which excludes CAPEX. This means that you're pretty much buying gold without any of the fixed costs price tag on it, which makes it, very very attractively valued.

Of course, that doesn't mean that the prices of gold can't push lower. But with every lower push, more and more mines will be getting kicked out of production, reducing the supply of mined gold. If supply drops, prices increases. If gold prices hit $1000, a third of the mines would be out of business. At $880, the last line of defense, less than half the mines will still be functioning.

My best bet and prediction is that the price of gold is going to continue to drift lower, not going lower than $1145, definitely not closing below $1155. This price target should be hit either in the last week of December, or by the end of the first week of January. I can't call the bottom with any accuracy, but I would guess between $1180-1155. After this is hit, I honestly expect a spectacular rally over the next year or two.

This is my call, and I am going to show my commitment to it by purchasing gold miners at that price target. I have held the notion that gold (and therefore, gold stocks) are grossly oversold and unloved. After watching this video, I am quite certain that if price drops lower and hits my target, the downside risks are greatly muted. At my price target, I will be dipping my toes into the water, because who knows how long gold will remain range bound before it finally takes over. If I can see that the trend is reversing, I will slowly scale in.

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