A Floor in the Price of Gold?

www.rufftimes.com

We believe gold is wonderfully poised for future price increases. Even so, should it somehow fall, does gold have a floor, a price that would stubbornly resist further retreat? The answer is likely yes…and that support might come in the form of gold’s production dynamics.

Let’s set the stage. The thing to keep in mind here is that gold, unlike every currency ever known to man, cannot be inflated. You can’t turn a $20 Double Eagle into a hot air balloon. You can’t pump water into a gold bar. There’s only so much of the shining stuff in and above the ground.

And it’s this rarity that’s made the precious metal so valuable for over 2633 years of history.

It’s also this rarity that tends to fix the production cost of gold at roughly $750 an ounce. Here’s how Michael Rozeff from LewRockwell.com explains it.

“The costs of gold production vary among producers. I examined the production in ounces and the accounting costs of production for six large producers for the years 2005-2007. I obtained the total costs as reported on income statements and divided them by the production in ounces. I found that those costs were $570-$600 an ounce. Another source confirms my estimate with a number of $591 an ounce. That is not the total cost. The cost of the capital should be figured in. That raises costs to $700 to $750 an ounce, using a 10 percent cost of equity capital. The CFO of the largest gold producer (Barrick) estimates the cost of production at $700-$800 an ounce ‘easily.’ ‘To us that's the long-term break-even cost to the industry...below $700/oz to $800/oz long term, the industry doesn't make money.’ I conclude that an estimate of $750 an ounce for t! he total production cost of gold is not unreasonable.”

So if gold did descend below the magic $750 production cost, producers would, yes, tend to stop producing.

Production has been anemic as it is, even with gold topping $1,000 an ounce. In 2008, gold production followed a multi-year swoon, falling by 88 tonnes (a tonne equals 2,204 lbs) even while mining production costs rose 24 percent. If gold fell below $750, producers would likely just sit on their mines and let the world fight over the above-ground supply.

Now, granted, the actual industrial use of gold isn’t so great that it alone would ever drive the precious metal’s price to the moon. Still, if production halted at $750 gold, the law of supply and demand would kick in fairly quickly and, unless the economy were completely and convincingly fixed, there’d always be nations, investors and collectors eager to add more gold to their holdings.

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WHAT TO DO ABOUT IT

Well…if you own gold, sit back, put your feet up, and pat yourself on the back (if you can reach back that far). You can feel good about your decision to add gold to your portfolio, come what may.

And if you don’t own gold, now’s certainly not too late. With so much going on, with today’s printing presses producing tomorrow’s inevitable inflation, the demand for gold is not likely to be heading south any time soon. If it did, as the above indicates, there may still be strong resistance at the $750 to $800 level, which could be a very comforting thing.