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Why Gold Will Surpass $2,250 per Ounce

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When the miner responsible for nearly 10% of global gold production begins to balk at major development projects in response to wildly escalating capital costs and steadily climbing production costs, the implications for future supply and price dynamics can no longer go ignored.

Earlier this year, I used Barrick Gold (NYSE: ABX  ) as a window into emerging trends in the gold mining industry that brought a $2,250 gold price into clearer view. I happen to think gold is quite likely to strike $3,000 or beyond before this secular bull market is through, but in the emerging dynamics of supply and demand, I see elements falling into place that could force a fairly accelerated re-pricing toward that $2,250 mark.

Accordingly, after holding my target steady at $2,000 since 2007, I'm officially raising what I consider to be my ultra-conservative price target to $2,250 per ounce. And, because the rating agencies are permitted to hint at the likely direction of a subsequent call, let's just say that gold remains on "watch positive."

At current gold prices, there simply is not enough meat left on the bone for miners after factoring in the still-escalating costs of production, the skyrocketing capital costs of mine construction, larger slices of the pie demanded by national (and in some cases even provincial) governments, etc. When taking on substantial jurisdictional and execution risk, as miners routinely do, comprehensive all-in margins must present a rational reward. Otherwise, miners will simply begin to shelve their projects, and that's precisely what we're seeing in this industry with rapidly increasing frequency.

Ceaselessly climbing costs
Readers will recall that Kinross Gold (NYSE: KGC  ) opted to defer its trio of major development projects earlier this year, after total projected costs ballooned past $6 billion. Now, Barrick Gold has decided to defer development of the world-class Cerro Casale mine in Chile (in which Kinross retains a 25% stake). Likewise, the world's largest gold producer will pass on the long-awaited Donlin Creek project, and that crushing announcement blasted shares of joint venture partner NovaGold Resources (NYSE: NG  ) to smithereens in Thursday's trading. For both project deferrals, Barrick cited large initial capital costs in its determination that they "do not currently meet our investment criteria."

Meanwhile, even those projects that are going forward are doing so with an adjusted set of economic expectations. Barrick announced a 50% to 60% increase to the projected construction budget for its Pascua Lama  project, bringing that price tag to an eye-popping range between $7 billion and $8 billion! Projected cash costs of production likewise suffered an upward revision, and Barrick pushed the timeline for first production back to 2014 from 2013. In a plan hatched years before former CEO Aaron Regent took the reins at Barrick, the company sought to manage the massive construction project internally. Recognizing that the scale of this project went "beyond the capabilities" of Barrick's in-house team, the miner will now look to contractor Fluor (NYSE: FLR  ) to take a more active management role.

Operating costs of production at existing mines continue to climb, as well and, just like the capital-cost issue, this is an industry-wide phenomenon. Even the master executors at Goldcorp (NYSE: GG  ) have run into some trouble lately, though I still consider that stock a gem among the major miners. Barrick, likewise, revised its projected costs for 2012 slightly higher and, as the rest of the pack reports quarterly earnings, I expect to find additional cost revisions.

The verdict is in: gold prices will go much higher
It's really quite simple. At current prices, the trailing trend of expanding global production is losing steam very quickly. Given the severely impaired state of the gold equity market -- particularly among the junior explorers that play such a monumental role in locating tomorrow's gold supply -- the industry's inadequate capital investment at present will not sustain the rate of discovery required to replace mined production.

Because I believe investment demand for gold will continue to grow as global currencies remain locked in a battle of competitive devaluation, I see supply and demand dynamics moving in opposite directions. In so doing, I believe those dynamics are stretching a giant elastic that will ultimately snap-back in the form of a sharp, upward re-pricing of gold. I urge investors to move into position with an allocation to carefully selected gold equities that suits their comfort level, and I encourage readers to track my ongoing coverage by bookmarking my article list or following me on Twitter.

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Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Goldcorp. The Motley Fool owns shares of Fluor. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (2) | Recommend This Article (33)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 27, 2012, at 4:52 AM, frograin wrote:

    Jurisdictional risk seems to be picking up steam these days, and I decided to go "north america only" when I reinitiated my positions a couple of days ago. Most of them are your recs by the way. Thanks for all your good work.

  • Report this Comment On July 29, 2012, at 10:05 PM, charliedawgg wrote:

    Hey, Sinch. It's oddly comforting to hear once again that the operational cost challenges are industry wide. It makes me feel a bit more confident regarding my recent purchases of Thompson Creek. I'm betting big that your spike in gold prices paired with the completion of their Mt. Millican project will provide "favorable" outcomes. On that topic, is TC still one of your picks? Thanxx again for keeping the troops informed. Cheers and best regards.

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Related Tickers

10/21/2016 4:00 PM
ABX $16.92 Down -0.12 -0.70%
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GG $15.51 Up +0.11 +0.71%
Goldcorp CAPS Rating: ***
KGC $3.92 Down +0.00 +0.00%
Kinross Gold CAPS Rating: **