Gold and Mining Costs
Gold fund manager John Embry writes in Investors Digest of Canada, Gold Gleams as Influence of Central Bankers Wanes. Embry cites another analyst, Leonard Kaplan, who asks, why should gold cost $700 when an ounce can be mined for $350? Embry counters with
- In the case of gold, if paper money is being aggressively debased and investors choose to seek protection in the ultimate monetary safe haven, what does the cost of producing an ounce have to do with the price if demand overwhelms supply?
While the price of gold, like all prices, is determined by supply and demand, many analysts make the mistake of focusing on mine supply, rather than total supply. The price of is determined by the demand to hold stocks of gold and the total supply of gold. Newly mined supply has very little influence on supply because the above-ground stock is so large (about 60-100x) in relation to annual mine production. All that annual mine production does is to dilute the total supply by about 1% per year.
There is a relationship between supply and the cost of mining but it is the opposite of the one that Mr. Kaplan suggests. Whatever the price of gold, the cost of operating the marginal gold mine will rise until it is a bit less than the price of gold. This is because a deposit that is not economic to mine at one price will become economic to mine at a higher price. As long as "not much" gold (in relation to total supply) can be mined at the higher price, the price will be "not much" influenced by mine supply.
Comments (6)
In a more general sense, according to Austrian price theory, is not demand the final determinant of price?
At least according to the price theory that perhaps has been best crystallized by Murray Rothbard, the cost of production is not relevant in determining price. The prices of the factors of production are determined by the demand for the final consumer good that they contribute to producing; factor costs do not determine the price of the good that they produce. The causality flows from the demand for the final consumer good to the factors of production, and not in the other direction.
Published: December 8, 2007 4:15 PM
This post seems to have italicized the entire front page.
Just a heads-up.
Published: December 8, 2007 4:43 PM
What is so frustrating about the current economic discussion is that most of these matters were settled in the 19th century. Its as though marginal utility and economic rent are unknown concepts right now.
Published: December 8, 2007 5:21 PM
Robert,
I think that you're wrong in effectively saying that the low ratio of mined gold to existing gold stores is what allows the price to be well above the marginal cost.
Market prices are determined at the margin. A gold store whose owner is neither willing to buy nor sell at the current market price cannot directly affect the market price.
If a space ship from Mars comes down and raids the existing gold stores and takes away enough gold so that the remaining stores are no larger than the current annual mine output, the price certainly wouldn't FALL to the marginal cost level, it would likely rise.
When a mine can produce gold at a marginal cost below the market price, it will first sell enough gold to pay its operating costs, and its investment or other costs, and then will produce more gold only if it makes operational sense to do so. The mine then has the choice of holding the additional gold itself, or selling it at the market price and holding the dollar proceeds. This choice depends on its outlook for the price of gold.
Using the current $700+ dollar price for referenxce, the mine will only produce gold at a marginal cost up to $700+ IF ALL of its current production and holdings are being sold at the market price. If the outlook for the gold price is such that some gold is already being held for potential price appreciation, you might as well hold the underground reserves as well without expending the cost of extraction. At least that is a possible hypothesis.
Regards, Don
Published: December 8, 2007 11:26 PM
To prolong Don Lloyd's remark, this point is discussed in Lawrence White's "Theory of monetary institutions". He distinguishes between gold stock supply and demand, and gold flow supply and demand. The gold stock corresponds to monetary holdings. The gold flow demand corresponds to uses which consume gold in an almost irreversible manner. Although a shift in the stock demand can temporarily boost the market price, in the long run it will tend to be determined by the gold flow market. This acts as a stabilizer of prices under a gold standard. Is this correct?
Published: December 9, 2007 1:17 AM
I may be mising a point here however the above comments seem to miss that the worlds population is expanding and not a constant. History tells us that people always utilize gold either in commerce, industry, or jewellery that would say there is a constant increasing demand though not any significant use in commerce at this time.
Dave
Published: December 9, 2007 7:20 PM