They're Taking Less Gold Out Of The Ground

Global Mine Output Is Flat or Falling.
According to Gary Dorsch of Financial Sense, “Global gold production was down 3% in 2006 and is nearly flat this year.” What’s more, Barrick Gold CEO Gregory Wilkins recently told the press, “There’s not much gold out there.” According to Financial Sense’s Tony Allison, Barrick expects “gold production will fall 10-15% below market expectations over the next three-five years.”
There are some places where gold production is rising. For example, according to the International Herald Tribune, “China will probably overtake the United States as the world's second-biggest gold producer this year… Production could rise 8%, to a record 260 tons this year, from 240 tons in 2006, said Hou Huimin, deputy head of the China Gold Association. U.S. output should be about 250 tons this year.”
But for every success story, there are more mines that are drying up. South Africa is the gold mining kingpin, but probably not for much longer. According to Bloomberg, “South African production -- 134 tons in the first six months of 2007 -- has dropped by almost a third since 2002,” as mining companies have been forced to dig deeper. In fact, South Africa’s output is down to its lowest level since 1922.
One reason why production isn’t ramping up with gold prices is there are fewer mining companies. The 20-year bear market in gold forced many marginal mines to close. And over the past 15 years, a wave of mergers has created a bunch of mega-sized gold miners. While the top five each produce between 3.5-7 million ounces out of the ground every year, they’re more likely to concentrate on working their existing mines and buying up other mines, and focus less on new exploration.
Pace of Dehedging Is Picking Up
When miners sell forward, or “hedge,” their gold production, it adds more gold to the market. When they dehedge, it removes gold from the market.
The latest data, from the second quarter of 2007, show that gold dehedging quickened its pace, with 5.4 million ounces being removed from the market. This has a net effect of a reduction of 15% of hedged positions, and is way up from the net dehedging of less than 2 million ounces in the year-earlier period. There are now 31.2 million ounces of hedged gold production, according to Virtual Metals in London.
With gold prices headed higher, gold miners know that the earlier they close out hedge positions, the cheaper they’ll be able to do it and the better for their bottom lines. Expect more dehedging going forward. What effect does this have? Less forward sales of gold reduces future supply and adds more volatility to prices.
Central Bank Sales Fill the Gap … for Now
According to the International Money Fund, “Gold holdings by central banks and other government organizations declined for the eighth straight year in 2006... Bullion holdings were 867.6 million ounces last year, down 1.2% from 2005, the lowest since 1948.”
The largest sellers of gold among the central banks are in Europe. But they’re not selling at the pace they once did. Central banks were net sellers of 11.4 million ounces of gold in 2006, lower than the 20.6 million ounces in 2005. This year, European central banks are selling on average 6.8 tons per week, on pace with last year.
Meanwhile, the Russian central bank periodically adds to its gold stockpiles, and the markets are keeping a watchful eye on China, whose percentage of gold as part of its cash reserves is way too low. Ordinary Chinese are already picking up the pace of gold buying. If the Central Bank gets into the mix, that could really light a fire under prices.
The bottom line is that as 2008 rolls in, $800 gold is likely to be the new baseline for the yellow metal, and here at Sound Of Cannons, we will look for opportunities to take advantage of it