RE:Connecting Otso Gold - Article 8 ARTICLE 8 - WHAT SETS GOLD PRICES IS A KEY COMPONENT TOWARDS UNDERSTANDING GOLD MINING VALUATIONS
(LAIVA IS NOT CORRELATED TO GOLD PRICES AT ALL. ARTICLE 9 ON TUESDAY WILL COVER WHY IS IT NOT CORRELATED.)
This is holiday reading guys. Saw some comments posted by fellow shareholders on Valuation scenarios to be built on current gold prices. Such a view is incorrect and an in-experienced view bereft of how risk investors invest into gold mines. Some opinions posted are very linear straight forward DCF numbers at best. Valuation of Laiva given the nature of its history and given the nature of its complex ore is highly non-linear. Gold mining valuations of huge mining conglomerates are non-linear. Juxtapose Laiva in the universe of Gold Mining Properties globally and we are not even a tiny little spec of sand in the desert. Point being made is how non-linear should Laiva’s valuation methodology should be. Such straight lined valuation punts on Laiva place by fellow shareholders (or perhaps fellow insiders) beg to be placed amongst summer interns of students in B-Schools. Valuation issues on Laiva is much more complex and needs more sophisticated tools to understand why we are at a disgusting 0,06CAD today when we should be at-least at 0,22CAD today. Straight laced analysis can be trashed right away. Waste of time.
Lets understand a few basics on Macro Economic issues. At the beginning, we were down at $250 an ounce in the late ’90s, early 2000s. It went as high as $1,900 an ounce, sort of by 2011, halved back down again to about $1,000 an ounce, and that went back up to $1,500 an ounce. And today breaking the key $1500 & $1800 technical barriers. It is an incredibly volatile business environment in which to try and operate Laiva. What drives prices through these wild swings? Imp is not to forecast Gold prices. Imp is to understand what sets gold prices. Typically Gold Mines will never be risk invested on spot gold prices. For the uninformed they would be typically discounted by Investors to the extent of 20%. Thus if the Gold prices are now at USD1900, the Investment case would be stress tested on USD1500. Comments posted on Investment case to be based on spot gold prices by fellow shareholders do not understand how risk capital is raised in Gold Mining.
Thus this Article is devoted first towards understanding what sets gold prices?
Unlike typical commodities that have their prices driven by simple supply and demand balances, gold is different. It’s a financial commodity. As a result, those typical relationships of supply and demand don’t really apply.It is more nuanced. It’s a reflection not only of supply and demand but also of macroeconomic factors. On the one hand, you have traditional demand in the form of jewelry, in the form of industrial applications. You have financial demand in terms of people putting their assets into ETFs [exchange-traded funds], and then obviously, central-bank purchases, as well.
It’s those two different factors that play in—that help drive the gold price. Over the past two or so years, where you’ve seen gold prices react to movements in the interest rate by the Fed [Federal Reserve Board] and also gold prices move notably up on the back of economic uncertainty, be it around the US economy, be it around the Middle East—or the geopolitical environment.
What’s really interesting about gold prices, if you look historically—over the last 50 years—is when, in real-dollar terms, gold prices hit around $1,800 per ounce, both in the early 1980s as well as in the early 2000s. These were periods of incredible stress within the global economy.
The 1980s followed the first oil crisis in 1974 and then the second in 1980. This drove hyperinflation. Similarly, if we move to 2011, what really drove prices up here were the negative yields and low interest rates—in many cases negative. It’s typically when you see those stress factors coming through, and it’s not necessarily the same ones at a particular point in time that move prices up. As investors look for new investments, away from equities and bonds, they tend to move into gold as a safe haven.
There’s just one other factor that we think is going to be interesting to monitor moving forward, which is dedollarization. We’re aware that, over the past 50 or so years, the dollar has been the reserve currency, and the commodities have been priced in dollars. What we’re seeing, potentially, is a move to dedollarize the global economy. We think that that’s going to increase the role that gold has: maybe not moving back to a gold standard but certainly having a larger role to play, which we think would be positive for gold prices.
The issue that the gold companies are facing is really about economical reserves and Laiva is no different. It’s a classic conundrum in the mining industry: you’re obviously producing from your reserves, so you need to continue to build reserves in order to keep production at the same levels or to increase it. In the gold industry, in particular—over the past five to seven years is, as exploration budgets and investment into exploration were cut, mining companies were basically digging into or exhausting their existing reserves. What we see today is that the reserves that they have on their books are around 25 percent lower than they were back in 2012—and, in reality, are at 2007 levels. In simple terms, cutting back on exploration over the short term is creating a problem for the long term. Is this really a function of just spending less on exploration? Or is there a sense here of, like, the easy gold fields have been found, and it’s just become harder to find big fields?
If you look at the historical track record of exploration, what we saw was, between the 1970s and 1990s, it was really a golden age for exploration. There was at least one $50 million-ounce gold-deposit discovery each decade and at least ten $30 million-ounce deposit discoveries.What we’ve seen since the 2000s is that discovery find rate has really dropped off. In fact, the industry has failed to find any $50 million-ounce and above deposits or, indeed, $30 million-ounce and above deposits. Bottomline: It’s getting harder and harder to find these significant gold reserves and deposits.
The industry also went through a structural change in the 2000s in which companies learned that the return on investment when looking for these greenfield projects was significantly low and pushed much of that burden to junior explorers. Junior explorers with tight funding—particularly when you see downward pressure being put on them—have left the market, which has left a void. At the same time, your major gold companies moved from a methodology of looking for these greenfield projects to looking around their existing assets and exploring the brownfield opportunities. That hasn’t led to any significant resources and reserves being identified.There is slowly a shift and a realization by the industry that it needs to look in new areas, undiscovered areas.
The name of the game and again Laiva is no exception is to get your cost base down: your cost per ounce, get it down as far as possible to give you more margin and more flexibility for when the inevitable downswing in the gold price comes.
Another glaring fact hidden or hitherto not taken into gold price analysis is the recycling of gold? We know that gold doesn’t tarnish—it doesn’t decay. That’s one of the reasons it’s been valued through the ages. Do circular-economy principles play a big role here? Is the flow of previously used gold back into the system significant? Recycling’s a very interesting topic. Roughly 190,000 tons of above-ground stocks currently exist within the market. Most of this is toward the jewelry sector because of what is being held by people globally. There are also some that are being held by investors—you know, retail, financial, and in the space of ETFs and central banks.
Now, why this is interesting is that the above-ground stocks significantly outweigh what is currently consumed on an annual basis. The gold industry currently consumes between 4,000 and 4,500 tons of gold in a given year. About half of that comes through jewelry, and about two-thirds within that space is particularly linked to Chinese and Indian jewelry consumption. Theoretically, you could have a situation in which no mined supply is needed, and all of your demand can be pulled from what’s being held in above-ground stocks.
Just to make sure the math right here. We’ve got about 190,000 tons above ground, which, because gold does not tarnish or decay, is probably close to the sum total of the gold ever mined. Then, on the other hand, demand for gold in a year is only about 4,000 tons. Thus in principle, if a lot more gold came back onto the market, we wouldn’t need to mine anything for years.
If you run an analysis looking at what’s historically happened, and there are two interesting insights here. One is that recycling peaked in the 2000 to 2011 period, when gold prices rose to roughly around $1,750. About 1,400 tons of gold reentered the market at that point in time. If we look at the jewelry stock over time, only about 1 to 2 percent of annual jewelry stocks ever return. We see that there’s a “stickiness” to recycling. In short, will we ever see a situation where recycling will feed the full requirements of demand in any given year? Highly unlikely. Theoretically, it could play out, there will be a situation where it’ll be a more important role within the gold industry going forward.
Happy Holiday Reading. Laiva is interesting but it also is a very nuanced investment deal. Placing straight laced valuations stories around numbers as if Laiva is a structured gold mining company with a portolio of 10 gold properties and cash costs of 850 and ounce and a mine life of 8-9 years surely calls for day dreaming or an analysis theoretical to experienced to experienced hands. First understand what sets gold prices before commenting on gold prices looking at London Metal Exchange spot prices.
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