-- Posted Friday, 2 March 2012 |
The history of gold mining has been well-documented for thousands of years. And with the demand for this most precious of metals going nearly as far back as human history, miners have ventured to just about every corner of the planet in their quest to find it. Yet unlike the miners of yore that were commanded by kings, today’s miners are commanded by profits.
Like in any business, gold miners do what they do in order to make money. If they can sell their product for more than what it costs to produce, then they ought to see profits. But unlike any business, gold mining is a complex endeavor with a myriad of variables that can radically affect operations on virtually a daily basis. This makes miners’ financial affairs far from cut-and-dry.
Gold miners can’t just set up a factory anywhere they want to produce their product. They must go to the gold, which doesn’t always exist in optimal settings. Often these settings have big risk on a jurisdictional basis, within the borders of countries that may not have reliable or stable governing bodies and/or regulatory systems. And gold certainly doesn’t care if the rocks that hold it are located in harsh environments or rough terrains.
Operational settings present a whole different set of variables. Believe it or not, gold mining is not an exact science. Though geologists have come a long way in modeling deposits, engineers have come a long way in mine design, and metallurgists have come a long way in processing techniques, when you are dealing with the unseen there is just no way to completely avoid pitfalls.
No matter how many drill holes pierce a deposit, it is impossible to know the exact characteristics of every portion of an ore body. Though most operations are pretty well dialed in, if the rock types and/or grades don’t exactly line up with the mine plan, the economics can waver significantly.
But the biggest variable of all for the gold miners is price volatility. Unlike most other businesses that have some degree of control over how they price their products, sans hedging gold miners are slave to the daily futures activity of their underlying metal. If gold’s price is $100 lower from one week to the next, they get $100 less for their gold.
Nevertheless, the allure and beauty of this business is upside price potential. And in a secular bull market, the miners are more than willing to deal with all the variables involved in producing gold. From its low of $256 in 2001, gold is up an incredible 640% to its recent high. And as you can see in the chart below, gold’s ascent has been consistent and reliable now for a decade.
Commodities price volatility can drive miners batty. And in a bear market hedging, or selling production forward, only provides so much protection. If the miners don’t have quality assets and capital reserves, then not even the most intricate hedgebook can protect from insolvency over a long period of declining prices. In a bull market though, the miners tend to ditch their hedges and ride the wave to legendary profits. And this bull’s wave has been fantastic.
Since 2001 the annual average gold price has been up every year for 10 years running. And we’re not just talking a typical “cost-of-living” inflationary increase like you might see at your favorite retailer or restaurant. Over the last decade gold has been averaging a 19%+ year-over-year increase. If you’ve been investing in the physical metal like we recommended our newsletter subscribers do back in 2001, you’ve outperformed the markets tremendously.
As for the gold miners, they’ve had a pretty good run themselves. In fact, their stocks comprise one of the best-performing sectors of the last decade. The notion of profits leverage has made them incredibly attractive to investors and speculators, and thus many gold stocks have seen 1000%+ gains over this time, well outpacing gold.
