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Fool’s Gold

By April 4, 2023April 5th, 2023featured articles

The gold price has perked up recently and sits just 4 per cent below the all-time high posted back in mid-2020 at $2,064 an ounce, a high that has been tested a number of times since.

Recent strength in the gold price probably reflects investor suspicion that the Federal Reserve will soon have to ease up on its interest rate hikes and the rising risk that inflation will become embedded.

The US Federal Reserve is talking tough, but it is between a rock and a hard place, in my view. Mounting US Government debt, a still large budget deficit, which adds to that debt annually, and the need to refinance a substantial proportion of that debt over the next 5-7 years at higher interest rates, all suggest that the US will continue printing huge quantities of dollars, and well beyond the level needed to accommodate the natural increase in trade.

In addition, central banks’ buying of gold has been strong now for over a decade and the West’s restrictions on Russia’s dollar reserves held via western banks following its invasion of Ukraine can only encourage more of the same from similarly non-democratic regimes. Both Russia and China continue to be large buyers of gold.

In that regard, it will be interesting to see whether the gold price finally breaks through its old 2020 high at this time.

The gold miners, in contrast, have not really benefitted as much as one would have expected from the underlying strength in the gold price. Over the past year, the Philadelphia Gold & Silvers Miners Index is down circa 20 per cent.

This largely reflects the increase in costs across the gold mining universe given the rise in energy prices and cost inflation in general. According to the World Gold Council (see chart), the all-in sustaining cost (AISC) of producing gold has increased from $947 an ounce in late-2019 to $1,289 by late-2022. That’s a 36% increase and has hit the miners’ margins directly. 

However, this increase in miners’ costs has had no real impact on the precious metals’ royalty and streaming companies. We label these companies as equity-like financiers to the gold and silver mining industry. For the equity capital provided, companies like Franco Nevada, Wheaton Precious Metals and Royal Gold take a portion of the miners gold and silver output, and avoid the risks associated with actually producing the gold and silver.

They have proven to have the better business models within a tough industry. It may surprise some readers to know that the Philadelphia Gold & Silver Miners Index has made little progress since the mid-1980s (see chart).

Bitcoins are supposedly the new digital gold, and the price of bitcoin has also picked up lately. Bitcoin remains the only truly decentralised digital currency that can be traded between two parties over the Internet without any other party involved, so that there is no counter-party risk and no dependence on governments or banking systems.

Neither gold nor bitcoin produce any income, so both are hard to value in a traditional sense. In gold’s case, one can point to its cost of production ($1,289 an ounce). Even if gold was never again wanted as money, it would still be needed as jewellery and in critical industrial applications, so that its cost of production could be considered its base intrinsic value below which new gold supplies would dry up.

Bitcoin fans argue that the supply of bitcoins is limited to 21 million, so that they will always retain a scarcity factor, and one that is even better than gold, given that the supply of gold has been increasing at 2 per cent annually for many decades. It’s a neat argument.

But not neat enough for this writer. Gold is impossible to create artificially and does not perish with time. In contrast, bitcoins have been created electronically and if replication is possible, and I have yet to be convinced why bitcoin cannot be replicated, even in some other decentralised cryptocurrency form, the new supply would likely be unlimited, in which case the price of bitcoin would head to zero.

Time may prove me wrong, but I’m happy to avoid this particular financial innovation.

Rory Gillen
4th April, 2023

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