Plunge in Prices Renders 50% World's Gold Output Unprofitable

Kristian Rouz — Rapid appreciation of the US dollar during the past 18 months has triggered a significant drop in commodity prices, including metals, with gold currently selling at its 6-year lowest. Many miners have reported the unprecedentedly declining profitability of gold extraction. The price revolution underway might be the most significant since the early 15^th century, when the abundance of gold imported from Americas flooded the European market, triggering shutdowns of the local precious metal production.

As the US Federal Reserve nears its policy decision on a possible hike in borrowing costs first time since 2006 amidst favorable macro data, the dollar has feverish demand, and rates speculation keeps gold prices at their multi-year lows, while production costs are still high.

Spot gold is now selling at $1,057.45/oz, the cheapest since 2010, when most advanced economies were struggling in between the consequences of the Wall Street crash and the onslaught of the European debt crisis. Now, as the world's major economies are a lot healthier, a shift in global demand from material assets toward safe haven financial instruments is dictating another drop in prices, potentially a more dramatic one.

Spot gold price crashed 11 percent in mid-October from near $1,200/oz to just below $1,100/oz, and the prevalent trend is pessimistic for miners. During the past years, gold had climbed from $253.30/oz in 1999 to $1,920.80/oz in 2011 as the international industrial production was rapidly expanding amidst the Asian manufacturing boom.

However, the rapid expansion in Asian manufacturing has by now all but worn out, and while gold could have remained an alternative non-financial safe haven asset, the current US Federal Reserve's policies have undermined the yellow metal's prominence. The US dollar has been skyrocketing since mid-October when Washington hinted the hike in base interest rates is likely in December, and this past Friday alone the dollar added 0.3 percent against a basket of its 10 major peers. The greenback is now at its strongest since at least 2004.

"We haven't seen the dollar at these levels for a very, very long time," Bart Melek of the Toronto-based TD Securities Toronto said. "The market is expecting the Federal Reserve to be fully on the bandwagon."

The US economy is accelerating, so is the Eurozone. Even Japan has neared a 'full employment', promising economic expansion in the short-to-medium term. Consequently, financial instruments originating from these economies are hot, while gold is suffering a massive sell-off. International miners, already battered by a lingering crude oil oversupply, are facing even tougher times ahead.

"The more we continue to produce unprofitable gold, the more pressure we put on the gold price," Mark Bristow of Randgold Resources Ltd. said. "In the medium term, it's a very bullish outlook for the gold industry. The question is, how long are we going to supply it with unprofitable gold?"

By now, gold miners have already cut their investment in lower-quality ore extraction, concentrating on premium ore, the practice known as 'high grading'. Such a practice is harmful for the industry's future as limiting the production outlook as premium gold mines exhaust fast, and further exploration and extraction would require an even bigger investment. Meanwhile, investment resources are already scarce, and while the unfavorable situation lingers, a decline of the entire industry is at stake.

Gold has always been believed to be the type of asset that meets robust demand no matter the circumstances. However, monetary tightening measures in the US and crash currency devaluations in many nations have brought a dramatic change to the picture. Gold is one of the most passive assets, almost a non-yielding one, and the current economic situation requires greater returns from investment activity for the players just to survive. Gold as an asset does not ensure commercial survival any longer.

According to Randgold, roughly 50 percent of the world's gold producers will have to stop their operation as their output does not meet commercial demand. Mergers and acquisitions are in line for the mining industry, and a monopolization, albeit supporting prices, would also invoke even more volatility to the market, while the downward pressure on gold prices is set to persist.

Still, there are some bright spots in such a murky landscape. After a massive currency devaluation, Australia is experiencing robust mining activity, having boosted their gold output to 73 tonnes in Q3 this year, an annualized increase by 2 percent.

"The declining value of the Australian dollar has once again been the great savior of our gold sector and of the local resources industry in general," Sandra Close of the mining advisory firm Surbiton said.

However, the wave of devaluations across the world, reflecting the global strive for competitiveness, is only a temporary relief for the industry. Australia produced a total of 285 tonnes of gold in 2014, while mainland China, the world's top gold producer, shipped some 450 tonnes. A decade ago, the industry was dominated by the likes of South Africa and the US, but material assets are no longer in rife demand in advanced economies as their volumes are limited and thus irrelevant to flexibility standards in the present-day financialized world.