By: Lawrence Williams
July 25, 2013
My colleague, Alex Williams (no relation), reported yesterday on Mineweb on a great interview with Graham Birch, now a dairy farmer, but who in the past was seen as responsible for building the then Merrill Lynch – now BlackRock – Gold & General fund to its dominant position in the sector between 1999 and 2009. In the interview (see: Sloe gin and big cycles: Graham Birch on markets and gold) Birch, who continues to closely follow the sector, made some very salient comments which any precious metals investor should keep strongly in mind, particularly given the kind of gold price scenario we have seen in the past few months.
Firstly, Birch commented, that back in 1999 it was apparent that the then gold price was well below the level at which most gold mines could make money. While he felt the bigger companies could perhaps manage such a situation for a couple of years, beyond that the price levels were unsustainable at such a low level and that the price thus would surely rise.
At the time virtually all the gold mining companies were selling their production forwards at these low price levels (hedging) to try and protect themselves from further gold price falls and Birch was one of those adamant that these hedges should be unwound. In retrospect those that followed this advice prospered as the gold price then increased year on year, while those who ignored it – or were prevented from doing so through the strictures of their lenders – suffered accordingly being locked in to sales at the lower prices.
Another point made was that fund investment is for the longer term – as Birch put it in the interview, “If an investor expects my strategy to deliver results in the short term, they’re just deluding themselves. As a fund manager, I can add value by looking at long term trends.” And went on to note that over anything less than 6 months his views were “basically completely worthless.” Between 6 and 18 months, he considered them “a little bit valuable” and over 5 years, “they’re pretty valuable.” He thus decries the short termism that seems to be the mantra of many investors.
Indeed there are parallels between the current situation facing the world’s gold miners and the situation Birch came into back in 1999. Although the gold price is now around $1000 or so higher than it was then, things have changed dramatically as inflation and expectations of stakeholders have seen capital and operating costs rise enormously. Now it is reckoned by some who should know amongst the mine operators, that a good section of the global gold mining sector is not economically viable at even $1300 an ounce – certainly not on a sustainable basis if one needs to take account of new developments and expansions necessary to maintain output as older operations wind down or move into lower grade areas of the orebodies.
While the knowledge that this is the case may indeed have little impact on the metal price in the here and now, in the longer term, it surely will. Indeed the position may well be worse now than in 1999 as the number of finds of major gold orebodies is diminishing hugely, and many of those which are being found are located in more remote and/or more politically risky areas.
And, with the propensity of governments of whatever hue to try and milk the resources sector for all it can get, nearly all areas of the world carry greater political risk for new resource developments, and for existing ones, than they used to.
What this all means for the gold sector is that at some time down the road prices will again start to rise dramatically as shortages develop, while the companies try to play catch up to meet demand. With a significant new gold mine taking perhaps at least ten years, sometimes more, to come into production from discovery, it could take many years, and far higher prices, for the miners to make up the ground lost – given the lack of new mega projects and the increasing lack of success from the explorers – exacerbated by the fact that they are mostly inactive and in cash preservation mode at the moment.
We could thus be in a stalemate mode for a year or so with prices rising and falling around the current level, but as Birch noted, the current lower prices are not sustainable in the long term and we will see a recovery in the gold price, and likely one which will build again – probably back to new highs. As always the question is timing, but think on what Graham Birch says and look at it for the long term. At current levels downside has to be relatively limited, but over time the upside could be immense.