Gold markets and urinals...
16 February 2010
Sean Russo
How I had to travel to Cape Town to realise the gold market and football stadium urinals have much more in common than it might first appear.
FROM a distance it might be easy to imagine Indaba is nothing more than an excuse for Europeans and Canadians to fly south for a brief respite from the winter chills and let’s face it, Cape Town is certainly a fabulous place to do just that. I love the place. If you’re a soccer fan go straight there for the World Cup and skip Johannesburg.
More often than not I am a cynic about the real value of conferences. As a second timer I am a big fan of Indaba and the enthusiasm with which its participants throw themselves headlong into the 4-5 days. Its new organisers could learn a thing or two from those who run Diggers. The booths are tiny and crammed in. I actually got lost and had to draw on my scouting days to orient my map and find my way to the exit. The catering whilst plentiful on the days they chose to serve it (I am sure many of Tuesday’s hangovers could be directly attributed to the absence of any lunch on Monday) was in a room almost completely devoid of chairs or tables. Some people had to resort to sitting cross legged on the floor to eat it. But these are small things that should be easily fixed and it didn’t seem to dent attendees’ enthusiasm.
In keeping with the diversity of the continent the range of dress was extreme; shorts to caftans. At first it was disturbing how many people were wearing suits (at Diggers it’s very helpful to be reminded whose speaking on any given day by simply glancing around to find the 10 guys in suits). I think the dress code reflects there’s a lot of serious business going on. It’s a centralised roadshow where the investors share the travel load and miners can move around their investor universe by moving from room to room rather than city to city and country to country. By comparison, talking to clients it’s not unusual for an Australian junior to do 50-60 meetings across US and Europe in eight cities over two weeks. Indaba can deliver the same outcome. Indaba is like luxury cruising to a roadshow’s bus ride!
Some things don’t change. Wherever miners congregate hedging is a subject on which most agree and all have a hard luck or disaster story (dilution disaster stories don’t seem to feature as I would think they should but I was talking to managers not owners). Hedging: don’t do it, terrible, irresponsible, not what the shareholders want (still I haven’t seen the poll of shareholders to confirm this).
One wise sage said the gold industry would hedge if only they could be confident that their unhedged and variable cost base wouldn’t exceed the prices they could lock in by hedging. Wow, I did a double take, did he really say that out loud. That he’s worried his costs in the next two or three years could sensibly exceed the $US1200-1300/oz certain revenues that have been on offer this year? I can’t seriously believe he does and yet still persists in investing in companies denuding their resource with those expectations, but that’s what happens once miners sign up to that great pissing competition to be the world’s biggest gold miner.[ad]
It’s a nice line to excuse away not locking in record prices by suggesting margins on average will be the same as they were at the lows of late last decade, but if people actually believe it there’s a much bigger problem brewing for the industry.
It’s a position closely related to the suggestion gaining currency, certainly it was mentioned on several occasions at Indaba in my earshot, that the gold price can’t fall very far, if at all, because the new higher full cost of mining and replacement effectively insures a price floor around $US800-900/oz! Yes, you understood that correctly. The gold price can’t fall because if buyers don’t pay that price or more the big gold miners (that’s big as measured by tonnes, trucks and mouths to feed, not profits) will simply take their bats and balls and go home. The arrogance is overwhelming. All around the world companies strive to bring costs down, to hold or stimulate demand for all manner of goods and services, because they recognise buyers make markets and as a seller you are nothing without them. All the while, many of our biggest miners seem to think that the buyers of their commodities are blessed to have them to doing their dirty work.
In my opinion and experience the price of anything is what someone is willing to pay. At the moment hedge funds, investors and buyers of gold and gold jewellery are willing to pay more than the current cost of production. If they decide to quit those positions (some of which have been accumulated over the last 5-7 years at price averages well lower than here) in volumes greater than new hedge funds, investors and buyers of jewellery want to buy, those sectors currently on the demand side of the ledger will become direct competitors of producers seeking to sell. I believe one should not discount they can and will sell at prices much lower than the current costs of mining experienced by the majors to clear those positions if they have to.
Sure, it may not last, but the question is how many months of operating losses can some of these gold mining companies (or their bond holder/lenders or other stakeholders) tolerate?
Paul Burton of GFMS put it very well in his Monday presentation when he presented a case that said gold may hold or go higher if buyers continue to buy (there it is again, whatever the driver, buyers make markets –if you still doubt me say Beta recorder out loud) but should the recent buyers of gold – roughly 42-45% “investors” and roughly 42-45% jewellery demand – turn net sellers there could be and has been on occasion an almost complete absence of buyers for gold.
Burton cited the example in early 2009 where we now know by examining the actual physical flows that jewellery scrap coming back to the market equalled new jewellery demand, essentially eliminating jewellery as a source of demand for a quarter. That’s almost half of expected purchases! Luckily, investment demand picked up but only after the price black-holed to levels that found new buyers.
Heaven help big gold (all unhedged gold producers actually) if net investment and net jewellery flows both sum to zero in the same quarter. In days gone by if prices fell sharply producers would simply withdraw from the spot market and deliver everything into that safety net called hedging, effectively starving the market of supply, slowing the fall and removing selling pressure until prices rallied as buyers gathered composure and worked, saved and bought some more gold, each day, each week, each month.
In today’s unhedged world gold producers must sell gold every day, every week, every month, without rest. They must accept the price of the day or accumulate mined gold above ground while absorbing the transformation costs. On the other side of the ledger investment buyers needn’t buy, jewellery needn’t be bought, and both bought previously can be sold. As Burton presented, the ETFs have created a position, whilst favourable to prices to date, that now results in an estimated 6000-to-8000 tonnes (that’s 192-256 million ounces, or about 2.5 to 3.5 years current mine supply) being only one mouse click away from the market should the holders of those bars or shares backed by bars see better value elsewhere. Paul’s observation should be taken seriously by all gold producers who have no safety net.
If nothing else please understand the potential it suggests for price volatility in coming weeks and months. Think about the likely difference at the urinal at a World Cup Final being played at Cape Town’s new stadium 15 minutes before half time and then at half time.
It is true that in and of itself these volumes on the sideline are not bearish but if gold miners think the gold price cannot fall below the cost of production they are being naïve in the extreme. In the absence of new and ever growing demand prices cannot rise. When prices stop rising many investors who trade momentum slide slowly and then more quickly to the exit and momentum reverses. If the recent gold buyers turn sellers it could be a race to the bottom in short order and here with just a touch of irony it’s worth reminding you hedge (in the loosest possible use of the word) buybacks have been a key driver of upward gold price momentum and that cycle has all but run its course.
Whether prices are trending up or down medium to long term I believe the producer attitudes I observed at Indaba and the supply demand statistics I heard have the combined ability to make the gold market much more volatile than most participants anticipate or handle.
Back to the urinal. When you have to go you have to go! When you have to sell you have to sell. Either way please don’t get caught at the end of the queue if you don’t have it in you to hold on much longer than you expect. In that context consider just a little bit of hedging appropriately structured might be as valuable as an empty bleach bottle used to be on The Hill in the good old days at the SCG.