Investors have recently been disappointed by the gold miners’ inability to control costs.
With miners’ profitability naturally at risk if there is a decline in the gold price, the sector has experienced a sell-off. The response of mining management teams across the industry is to prioritise cost-control.
An effective and immediate way of reducing costs is called ‘high-grading’; essentially all mining teams are now focusing on the highest-grade, most profitable operations at the expense of production volume.
Marginal deposits are scrapped from the business plan and unprofitable operations are shut-down. This strategy will increase miners’ profits and also inevitably cause a significant decline in global production.
Consensus among generalist investors is that gold reached a near-term peak in 2011 when it spiked at $1927/oz and is now in decline. This is based on apparent stability in the eurozone and confidence that the debate on the US fiscal cliff and sequestration will be resolved in a satisfactory manner.
However, it is likely that macro events will disappoint and impact the market negatively, dragging the European or US economies back into recession and forcing central banks to intervene in new, radical ways. Such developments would spook the market, encouraging investors to turn to gold as the ultimate safe-haven.
According to the latest figures from the World Gold Council, demand for gold is at an all time high and should economic events take a disappointing turn causing a flight back to gold, demand levels could exceed supply. The increased demand could coincide with supply of the metal falling as a result of miners’ newly implemented cost control strategies, hence creating a global supply crunch.
This scenario is a recipe for the gold price to reach highs, potentially of as much as $2,000/oz.