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Although gold knocked on the door briefly during 2011, I am waiting until my long-standing price target of $2,000 per ounce is finally breached before I revise my conservative long-term price objective. In the meantime, my uninterrupted gaze across the gold market's fundamental landscape sees a steady trend toward de-risking of the $2,250 mark as a very conservative basis for a follow-on target.
I have discussed on countless occasions the key macroeconomic trends supporting sustained appreciation in the gold price, and I am well aware of just how contentious a topic it can be. But the fact is that investment demand for gold continues to expand, particularly in the East, where China is poised to surpass India as the world's foremost source of gold demand. Global mine supply, meanwhile, is struggling to keep up in an atmosphere of rising production costs, escalating mine-construction costs, and diminishing frequency and scale of new world-class discoveries.
Although the gold-price outlook can never be divorced from prevailing macroeconomic trends, I spot $2,250 gold coming into clearer view through a comprehensive examination of mining-industry fundamentals. The world's largest gold miner -- Barrick Gold (NYSE: ABX ) -- released its quarterly and annual results this week. Although I am not a shareholder, I continue to track Barrick very carefully as an effective harbinger of emerging industry dynamics. Barrick delivered another solid year in 2011, growing adjusted net earnings by 33% despite essentially flat production volume year over year. And by replacing the year's production of 7.7 million gold ounces to stand with nearly 140 million ounces of gold in reserves, the company reminds observers that meaningful volumes of gold can still be found ... but at what cost? For those interested on forecasting the gold price trend, that is the question to ask.
Observable cost inflation
Barrick's total production cost for 2011, which accounts for depreciation and other items, rose 14% year over year from $552 to $630 per ounce. The less inclusive total cash cost of production came in at $460 per ounce, or 12.5% higher than the year before. For 2012, Barrick is targeting a further increase of between 13% and 22% for a targeted cost range of $520 to $560 per ounce. And this is from the producer with a massive edge in terms of economies of scale over its smaller competitors. To make a long story short, the industry is experiencing significant upward pressure on operational cost structures.
At the same time, capital costs for mine construction are going through the roof. The conceived price tag for construction of NovaGold Resources' Galore Creek joint venture with Teck Resources (NYSE: TCK ) has increased by 373% since 2006 to reach a whopping $5.2 billion. The estimated cost to construct Barrick's 75%-owned Cerro Casale project in Chile has tripled since 2007 from $2 billion to $6 billion. Kinross Gold recently opted to reassess its entire growth pipeline in response to severe rates of cost inflation. In my recent interview, Thompson Creek Metals (NYSE: TC ) CEO Kevin Loughrey lamented, "We are living in a world where mining projects are expensive to build and getting more expensive."
The rising long-term floor beneath gold prices
The all-in cost of gold production is a crucial metric for establishing just where the floor beneath long-term gold prices stands. As the long-term breakeven price for the mining industry, it represents a price level below which new mine supply to replenish existing production will tend not to come online. Fools may recall that discussions of industrywide all-in costs in the range of $700 to $800 per ounce back in 2008 proved very instructional in forecasting the range in which the cascading gold price would ultimately recover its footing.
Taking into account the substantial trailing cost inflation, would you believe that the industrywide all-in cost of gold production today is already trending closer to $1,200 per ounce? In a recent interview with Mineweb's Geoff Candy, AngloGold Ashanti (NYSE: AU ) CEO Mark Cutifani corroborated another recent estimate by IAMGOLD (NYSE: IAG ) CEO Stephen Letwin that places the all-in cost of production for the industry at about the $1,200 mark. Cutifani states: "The average cost to produce an ounce of gold, all up, everything loaded, is about $1,200 to $1,250." However, reminding observers that the industry cost of capital belongs in the equation, he adds: "$1,650 is only just returning the weighted average cost of capital for the industry. So for the industry to keep its nose above water and even hold the current production base, I think $1,650 is a minimum gold number that we need to work from on a real basis."
For the millions of gold skeptics out there who perceive the current gold price as a wildly inflated speculative bubble perched above a cavernous lack of fundamental footing, Cutifani's well-informed perspective must give one a moment's pause to consider that the price is barely sufficient to maintain existing production volume. Cutifani goes on to forecast an annual gold-price increase of "about $150 a year over the next four or five years." From the baseline of $1,650, this perspective results in an outlook for $2,250 gold within about a four-year timeframe. When gold does finally surpass the $2,000 mark, I look forward to issuing a new target at that time, and certainly Cutifani's view from inside the gold-mining industry will inform that deliberation process.
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