The New Case for Gold


"Is gold expensive, and should we head for the exits? Not necessarily."

Sydney Morning Herald, Nathan Bell

If you're buying gold, or thinking of doing so, it's probably because you believe gold isn't a commodity at all. Instead, you may think of it as a de-facto currency.

But after rising almost 700% since 2000 and 25% over the last 12 months, is there still a case for it?

While more money than ever is being spent on gold exploration, supply has barely risen, partly because mining costs have risen dramatically.

The marginal cash cost of production is a more difficult number to pin down. Some argue that average cash costs in the industry are only US$500 an ounce; others insist that costs are above US$1000.

Our estimate is about US$700 an ounce but it's the cost of additional supply—the marginal cost—that drives prices, not average costs.

On top of cash costs we must add capital costs, replacement and discovery costs and a rate of return, which means a price of between US$1000 and US$1200 may encourage new supply.

That's far higher than at any other time in history but a fair way below current prices of about US$1500 an ounce.

Does that mean gold is expensive and we should head for the exits?

Not necessarily.

The case for gold has therefore changed. A year ago, it was possible to buy gold below the marginal cost of production. Today, that's not possible.

Buying gold now is a far more speculative activity as a result, one based on views about how governments will solve emerging debt problems than anything else.

Gold could still be worth buying as insurance against currency debasement, but with a price above the marginal cost of production, it isn't for everyone.

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