Fantastic gold predictions are almost everywhere you look.
“The numbers are saying gold at $3400-$3600 and silver at an astounding $226-$240 which we have difficulty even thinking of yet alone predicting,” was one such prediction by analyst Roger Wiegand.
It’s easy to understand why people are predicting these kinds of giant steps, of course. With the US financial system crumbling into chaos and wishful thinking, gold is, once again, emerging as the last money standing. It wouldn’t be the first time. The history of gold as money, in coin form, runs roughly 2633 years, from about 700 BC to 1933 AD – surviving centuries of man’s financial shenanigans.What currency can boast that?
Not a one. So maybe with everything going on, with the media using such terms as, “meltdown,” “financial Armageddon,” “collapse,” “crisis,” “banking emergency,” and with the president spending like it was just simple Monopoly money, we can feel pretty good about gold’s upside.
But maybe, just to be prudent here, we should look at gold’s downside.
Put a Floor Under It
A floor?
Try explaining that concept to the stock market.
Even so, gold may actually have a floor, a price that would stubbornly resist dropping should there ever be pressure on it to do so. To be specific, this support would come in the form of gold’s production dynamics.
Let’s set the stage. The thing to keep in mind here is that gold, unlike every currency ever known to man, cannot be inflated. You can’t turn a $20 Double Eagle into a hot air balloon. You can’t pump water into a gold bar. There’s only so much of the shining stuff in and above the ground.
And it’s this rarity that’s made the precious metal so valuable over those 2633 years.
It’s also this rarity that tends to fix the production cost of gold at roughly $750 an ounce. Here’s how Michael Rozeff from LewRockwell.com explains it.
“The costs of gold production vary among producers. I examined the production in ounces and the accounting costs of production for six large producers for the years 2005-2007. I obtained the total costs as reported on income statements and divided them by the production in ounces. I found that those costs were $570-$600 an ounce. Another source confirms my estimate with a number of $591 an ounce. That is not the total cost. The cost of the capital should be figured in. That raises costs to $700 to $750 an ounce, using a 10 percent cost of equity capital. The CFO of the largest gold producer (Barrick) estimates the cost of production at $700-$800 an ounce ‘easily.’ ‘To us that's the long-term break-even cost to the industry...below $700/oz to $800/oz long term, the industry doesn't make money.’ I conclude that an estimate of $750 an ounce for the total production cost of gold is not unreasonable.”
So what would happen if Obama actually managed to pull an economic rabbit out of his hat and, though it strains the imagination, started turning things around? What if gold returned to just being its safe, dependable and profitable old self again and not the investment superhero it’s been over the past couple of years?
What if gold plunged in value, in other words?Well, if it did descend below the magic $750 production cost, producers would, yes, tend to stop producing.
Production has been anemic as it is, even with gold topping $1,000 an ounce. In 2008, gold production followed a multi-year swoon, falling by 88 tonnes (a tonne equals 2,204 lbs) even while mining production costs rose 24 percent. If gold fell below $750, producers would likely just sit on their mines and let the world fight over the above-ground supply.
Now, granted, the actual industrial use of gold isn’t so great that it alone would ever drive the precious metal’s price to the moon. Still, if production halted at $750 gold, the law of supply and demand would kick in fairly quickly and, unless the economy were completely and convincingly fixed, there’d always be nations, investors and collectors eager to add more gold to their holdings.
So a drop in supply would likely put the shine back on gold.
Then Why Was Gold So Low Between the Bubbles?Given that, why was gold at $255 as recently as April 2, 2001?
Two reasons. First, oil was a lot cheaper back then, averaging in the mid-$20s through 2001. That was significant because energy is key to the production of gold—cheaper energy, cheaper gold. While oil has dropped significantly from its monstrous 2008 highs, it’s doubtful it would ever fall enough to permanently lower the price of gold production.
Secondly, gold mining production was far greater back then. Simply put, the access to in-ground gold was “easier” in those days. Miners didn’t have to go quite as deep. For us to return to that time, there would have to be a blitzkrieg in the discovery of new gold sources, something that’s not very realistic.
Does gold have a floor? The answer is probably yes…although, given the economy these days, we may never really find out.