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Gold and Mining Costs

December 8, 2007

Tags Production TheoryValue and Exchange

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?

To his credit, Embry understands that gold demand is important in determining the price. However, he then proceeds with a lengthy discussion of why the cost of production is really much higher than $350. 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.

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