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In a previous article Gold Vanishing Into Private
Hoards I have examined the future of gold from the demand side. Now in Peak
Gold! I examine it from the supply side.
For the title I am grateful to Tom Szabo of www.silveraxis.com . He said in his comments dated August 3,
2007: "the unanswered question is: are we approaching 'Peak Gold'? We
often hear the term 'Peak Oil', but there are probably some pretty good
arguments against being able to predict when the 'peak' date will arrive. Certainly
no oil company has put out a prediction of peak production,
much less one predicting that oil output will drop by 10 to 15% within a
decade."
In this new series of articles I wish to provide a
definitive answer to Tom Szabo's question: yes,
we are approaching 'Peak Gold' if we have not already passed it. The
last twenty-five years in the history of gold mining has been a gross
aberration during which gold was mined as if it were a base metal, namely, at
the top grade of ore reserves (that is, most recklessly). This is in
the sharpest contrast with how gold has been mined traditionally as dictated
by the economics of gold mining, namely, at the marginal grade of ore
reserves (that is, most conservatively). The world is witnessing a sea
change: gold, having been mined qua a base metal, is once more being
mined qua a monetary metal.
By marginal grade of ore is meant that grade which
can still yield a profit (i.e., is payable), however, any lower grade
is already submarginal (i.e., is
non-payable). Clearly, marginal grade varies inversely with price: it
goes higher as the price goes down, and vice versa. Gold mining
used to be the very opposite of base metal mining which must, of necessity,
maximize profits, just like any other enterprise. Not many people realize
that gold mining is the only exception to this rule. The goal of the
gold miner is not to maximize profits. Far from it. His goal is to maximize
the life of the gold property. There are several reasons for this, the
outstanding one being that gold is the monetary metal par excellence. Whenever
private enterprise rather than the government or its central bank controls
its creation, new money is not railroaded (should we say air-dropped by
helicopter?) into circulation. Money creation is then guided by economic
rather than political considerations.
Worst grade
first, top grade last
Historically, the propensity of governments is to
debase the currency rather than maintaining its value. The longer gold stays
underground locked up in the gold-bearing ore, the longer it stays outside of
the government's reach. We must remember that gold in the ground can still be
an efficient store of value. The aberration of the last twenty-five years of
mining gold at break-neck speed, and selling it forward, in some case as much
as fifteen years of mine production, is ending. All mines will realize that
premature exhaustion of their gold property is suicidal. They will have to
learn again the wisdom of gold miners of old: worst grade first, best
grade last. Ben Franklin's dictum that "experience runs an
expensive school, but fools will learn in no other" applies here as well
and, therefore, the learning process may take some time. Be that as it may,
the smartest gold miner has probably shifted back to mining at the marginal
grade already. He reasons as follows: "If I can only keep my mine
operational long enough, dollar debasement will catch up with my submarginal grades and will make them go through a
metamorphosis. My submarginal grades of ore will
become payable. My expiring gold mine will be rejuvenated and given a new
lease on life, thanks to the misguided monetary policies of spendthrift
governments. Ergo I had better work my mine as conservatively as
possible and lengthen its working life by all available means". This
line of thinking is well summarized by the adage: "in and out of
ground gold teaches man husbandry".
Barrick
bringing good tidings for gold bugs
The present negative roller coaster ride for
monetary metals is leading to an increase in absolute terms of the price,
which appears unstoppable. (Negative, because an ordinary roller coaster ride
ends at the lowest, not the highest, level.) The latest confirmation has come
from a most unexpected source. Barrick, the gold
miner held in contempt by most gold bugs (for its presumed activities in
trying to cap the gold price, nay, to club it down) is now saying that the
price of gold will rise during the next five to seven years because supplies
from the mines will drop more than anyone in the market can anticipate. This
is an extraordinary statement coming, as it is, from a gold producer with a
millstone-size and weight of a hedge book around its neck.
As Dorothy Kosich reports
on Mineweb in her article Barrick
Opines on Gold Supply and Price (Aug. 3, 2007), during a conference call Barrick delved into its future prospects including gold
prices. President and CEO Greg Wilkins, and Executive Vice President and CFO
Jamie Sokalsky revealed that Barrick
has been "digging in very deeply on the supply side of the
business" working with a research firm to uncover evidence and trends
increasing Barrick's optimism for the future gold
price. Mark the word optimism. Perhaps it should read pessimism. Barrick's hedgebook is so
hopelessly under water that the company cannot afford to buy it back, as did Newmont making it the largest 'unhedged'
gold mine, while the going is still good. The future gold price spells
disaster for Barrick that cuts the pitiable figure
of a moose standing on the train track fixated on the headlights of the fast
approaching train.
"Timeo Danaos et dona ferentes"
Barrick is still
studying the research reports, but Sokalsky already
told analysts that "our initial analysis shows the buy side (sic)
is likely to drop a lot quicker and more than most in the market are
anticipating." While he insisted that "it is still too early to
talk about any specific numbers", Barrick's
research has uncovered much that "should be a lot more positive for the
gold price". Sokalsky has divulged that a 10
to 15% drop should occur in overall mine supply of gold within the next five
to seven years. That's a volte-face if there ever was one. Ten years
ago gold was fetching $300 an ounce and Sokalsky
boasted that if horribile dictu the gold price went to $600, Barrick would still be O.K. It could not get a margin
call on its gold leases for fifteen years. It need not sell into its hedge
book at a loss. It could always sell its output in the open market at a
profit. 'Barrick would make every cent of that
increase'.
Every cent? The gold price presently
is well over $600, and the same Sokalsky is talking
about much higher gold prices for the next five to seven years. He must have
Santa Claus for bullion banker who carries Barrick's
short position most cheerfully, regardless of staggering losses. (Since then
we have been told that there is no Santa Claus, not in the gold mining
business anyway. The bullion banks have barred Barrick
from speculating in the bond market with the proceeds from the sale of leased
gold. Moreover, they took away Barrick's freedom to
sell its output in the open market without putting a prescribed amount of
gold into the hedge book. In effect, Barrick's gold
production is in escrow. In all but name the company is foreclosed on its
gold leases. The 15-year moratorium on margin calls is a myth that has been
exploded by the market.)
Tom Szabo seems to be a
bit skeptical about Barrick
being the first to report the bad news (bad, that is, from the point of view
of those who have endeavored to cap the price of
gold during the last decade of the last century. Who knows, maybe the
research shows an even bigger than 15% decline in output, but Barrick has opted to tamper with the data in order to
show a smaller anticipated decline in gold production than justified by the
research, as part of its undending quest to keep
the lid on the gold price. Tom Szabo adds that,
joking aside, these projections are incredibly bullish for the long-term gold
price. What Barrick implies, in effect, is that
despite billions of dollars thrown at exploration during the past 2 or 3
years, there are not enough new projects even in the early discovery stage
(much less in the late development stage) to maintain the current level of
output, as production at the existing sites will start to decline in the next
few years.
I myself am also skeptical.
"Timeo Danaos
et dona ferentes"
(Virgil, Aeneid, ii.49): I fear the
Greeks especially when they bear gifts. President Wilkins is on record that,
while reducing its hedge book some, Barrick will
retain its hedge plan as an "essential risk-management tool" and a
means of "stabilizing revenues". It gives Barrick
"needed flexibility" and, Barrick's
creditors, necessary collateral. I think Wilkins should have come clean
during the conference call. The talk about 'risk-management' and 'stabilizing
revenues' is for the birds. Wilkins should repudiate the hedge plan in no
uncertain terms and put the whole unpleasant affair behind him for once and
all. Barrick and its creditors need the so-called
hedge plan as they need pain in the neck. Unless… unless… there
are yet more skeletons in Barrick's cupboard.
Logic would dictate that Barrick
lift its short hedges first, and release the research report afterwards. Doing
it in the wrong order could cost a pretty penny. Barrick
brings the dictum of Cicero
to mind: Mendaci neque
quum vera dicit, creditur (a liar is
not to be believed even when he speaks the truth).
Ruthless
exploitation
During the past twenty-five years gold was mined
following the worst traditions of ruthless exploitation of a resource. Barrick served both as brain-trust and ring-leader, by
mining gold at the top grade of ore defying the tradition and economics of
gold mining, and by promoting a thoroughly mendacious, false, and
self-defeating forward sales program under the banner of 'hedging'. At one
point during the past fifteen years Barrick had to
close down operations at no fewer than ten of its gold producing sites as a
result of exploitation, because ore reserves became submarginal
in the wake of the falling gold price. For years, Barrick
has been selling gold forward with wild abandon at ridiculously low prices,
in effect blocking its own escape route to short covering should the need
arise. It is hard to imagine a gold mine managed more incompetently from a
global point of view. Of course, Barrick's highly
touted 'hedges' are no hedges at all. In so far as they mature over one year,
and their volume exceeds one year's mine output, they are naked forward sales
misrepresented as hedges. The whole scheme has been a mindless and
extravagant exploitation of a world resource.
In all likelihood it has also been a 'gold
laundering' scheme. I have coined this expression to describe clandestine
transfer of shareholder equity, either to management (a.k.a. embezzlement),
or to an unnamed third party (a.k.a. defalcation). We do not know whether Barrick is guilty of embezzlement, defalcation, or both,
and perhaps never will.
Forewarned but
not forearmed
We need not keep guessing. I submit that Barrick has been put on notice that its so-called hedge
plan would invite charges of unfaithful stewardship as soon as the bear
market in gold is over. I warned Sokalsky in person
ten years ago at Barrick's headquarters. The
meeting took place at the suggestion of Chairman Peter Munk
with whom I exchanged letters on the matter. Sokalsky
and I discussed Barrick's hedge plan for an hour
and a half. I can testify that he understood my point very well. At the end
of our meeting I presented to him a 50-page document entitled Gold Mining
and Hedging: Will Hedging Kill the Goose To Lay the Golden Egg? which treated this issue exhaustively. He promised to read
it and to pass his comments on to me within a month. I have never heard from
him again.
In my document the process whereby a rising gold
price inevitably makes world gold output shrink (in terms of tonnes) is very
clearly demonstrated. To explain this, first I have to discuss another
remarkable difference between the ways gold and base metals are traditionally
mined. This is the deliberate variation of the rate at which mill capacity is
being utilized. The base metal miner is under constraint to mine at the top
grade of ore. But he is free to vary the rate of mill capacity utilization in
response to changing market conditions. Accordingly, he will increase it if
he has to increase output, and vice versa. Not so the gold miner, who
is under constraint to run his mill full time, as close to capacity as practicable. But he is free to vary the grade of ore at
the mill in response to changing market conditions. Whenever the price of
gold rises he decreases, and it falls he increases
the grade. He does this because the marginal grade of ore varies inversely
with the gold price. If he is to run his mine economically, the gold miner is
compelled to go after the marginal grade of ore and leave the better grades
alone. He knows that premature exhaustion of his gold mine means dissipating
shareholder equity and wasting capital resources. The prematurely exhausted
gold mine would have a lot of valuable ore-reserves left behind that would
become payable later when the dollar is sufficiently debased. But then it
would be too late. Once the gold mine is closed down, it could be
prohibitively expensive to re-open it.
Mechanism of
Peak Gold
For example, whenever the gold price rises, the
marginal grade of ore falls as heretofore submarginal
grades become payable. Since gold mines run their mills close to capacity,
output shrinks every time the gold price has reached a new high plateau,
provided that they are managed economically. Uneconomically managed gold
mines get exhausted prematurely and fall by the wayside, as they well
deserve.
Peak Gold can be confidently predicted since the
increasing gold price (an inevitable consequence of deliberate dollar
debasement) causes a world-wide shift in the marginal grade of every gold
mine. The marginal grade of ore drops. Since the combined milling capacity of
the world's gold mines is a given quantity, and it can only be increased
slowly, after a great capital outlay which management may well be reluctant
to make (as it would eat into profits and shorten the life of the gold
property to boot), the upshot is that the gold content of mill output is
falling. World production of gold shrinks (in terms of tonnes) with the rise
in the price of gold.
But what about opening new gold mines? As Tom Szabo has hinted, the artificially induced bear market in
monetary metals between 1981 and 2001 has resulted in a great reduction in
prospecting, exploration of known sites, and development of mines at proven
sites. We must realize, however, that the whole episode of explosive increase
in world gold production from 1914 through the end of the century was a great
anomaly. Even though it was engineered by governments on the warpath, the
feat cannot be repeated. The inflationary escapades of governments, either
acting in solo or in concert will of course continue. The governments can
stay on the warpath and can expand their pet welfare projects as long as they
want. In vain: the nexus between the welfare-warfare state's inflationary
design and the value of gold, or the tectonics of marginal gold ore
underground, has decisively been broken. Governments have expended their
ephemeral power to work the miracle of multiplying cash gold through
multiplying paper gold. Ditto, no longer can they pretend that gold locked up
in ore deposits below surface is a valid substitute for cash gold. From now
on it is "cash gold on the barrel". Falsecarding
in the gold business has been exposed and discredited.
The great increase in world gold output during the
twentieth century was a non-repeatable event, largely due to the inflationary
propensities of governments under the gold standard artificially suppressing,
as they did, the value of gold. This has caused a world-wide shift in the
marginal grade of ore in every gold mine. The marginal grade was boosted and,
with it, the world's gold output. That is the background that has created
Peak Gold in the first place: a reckless exploitation of a world resource
whose production would have increased much more evenly in the absence of
inflationary escapades.
But this is history. The present reality is that
uneconomic increases in production and naked forward selling are over for
good. On the supply side, limited and diminishing injections of newly mined
gold shall replace unlimited and ever increasing dumping of paper gold. When
you need gold, you demand cash gold, the supply of which from the
mines is going to decrease from now on. It is satisfying to see Barrick acknowledge this first.
Hedging proper
In the next part of this series Peak
Gold! I shall explain, as I have explained to Jamie Sokalsky
ten years ago, the principles of proper hedging. I suggested to him
that Barrick should announce a bilateral
hedge plan to succeed its notorious unilateral plan. The latter involves
short hedges (forward sales) to the exclusion of long hedges (forward
purchases). The former involves both.
Just as its forward sales are balanced by Barrick's need to market future production, forward
purchases, had they been entered, could have balanced Barrick's
future need to acquire new gold properties in anticipation of the exhaustion
of its ageing sites. Had Barrick listened to my
advice, Peak Gold would not have been to its chagrin. Not only would profits
on the long hedges have outstripped losses on the short ones; they would have
covered the hefty increases in the price that Barrick
has now to pay for new gold properties. Barrick
could have scaled Peak Gold with the flying colors,
and without a penny loss on its short hedges. What is more, it could have
plenty of money left on its long hedges to pay for the acquisition of fresh
gold properties in preparation for a bright future bringing higher gold
prices in its wake. Barrick would have been ready
for the new bull market and could contemplate its own future with genuine
optimism.
Gold Standard University Live
Session Two of Gold Standard University is taking
place between August 17 and 24, 2007, at Martineum Academy
in Szombathely,
Hungary. It
is featuring a one-week course (13 lectures) entitled Gold and Interest,
as well as a blue-ribbon panel discussion on the subject of Last Contango - Basis As an Early Warning Sign of the Collapse
of the International Monetary System. Tom Szabo
will chair the panel. He is the world's foremost expert on the gold and
silver basis who on his website www.silveraxis.com has been tracking the basis for half a year. He
is a member of the research team of GSUL.
Session Three is planned to take place in Bessemer, Alabama,
U.S.A., in
February 2008. It will feature a one-week course entitled Adam Smith's
Real Bills Doctrine. An advocatus diaboli from neighboring Mises Institute will be invited to challenge the wisdom
of Adam Smith. The session in Alabama
will also feature a blue ribbon panel discussion on the subject of True
Hedging for Gold Mines. Representatives of hedged and unhedged
gold mines will be invited to participate. The present series Peak
Gold! is a primer on true hedging.
This is a preliminary announcement only. Stay tuned.
For more information please contact: GSUL@t-online.hu
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS ARTICLE IS SOLELY FOR YOUR
INFORMATION AND ENTERTAINMENT. THE AUTHOR IS NOT SOLICITING ANY ACTION BASED
UPON IT, NOR IS HE SUGGESTING THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A
RECOMMENDATION TO BUY OR SELL ANY SECURITY. HE HAS NO POSITION, LONG OR
SHORT, IN BARRICK STOCK, NOR DOES HE INTEND TO ACQUIRE ONE. THE CONTENT OF
THIS ARTICLE IS DERIVED FROM INFORMATION AND SOURCES BELIEVED TO BE RELIABLE,
BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS COMPLETE OR ERROR-FREE, AND
IT SHOULD NOT BE RELIED UPON AS SUCH.
References
A. E. Fekete, Have
Gold Bugs Been Barricked by the U.S.? , July 12, 2007
A. E. Fekete, Gold
Vanishing Into Private Hoards, May 31, 2007
Charles Davis, So Big It's Brutal, Report on
Business, The Globe and Mail: Toronto,
June 2006, p 64.
Bob Landis, Readings from the Book of Barrick: A Goldbug Ponders the
Unthinkable, www.goldensextant.com , May 21, 2002
Richard Rohmer, Golden Phoenix: The Biography of Peter Munk, Key Porter Books, 1999
A. E. Fekete, The
Texas Hedges of Barrick, May, 2002
Ferdinand Lips, Gold Wars, Will Hedging Kill the Goose Laying the Golden Egg? p 161-167, New York: FAME,
A. E. Fekete, To
Barrick Or To Be Barricked,
That Is the Question, August 11, 2006
George Bush's "Heart of Darkness" -
Mineral Control of Africa, Executive Intelligence Review, January 3,
1997, see in particular:
Barrick's
Barracudas
Inside Story: The Bush Gang
and Barrick, by Anton Chaitkin
George Bush's 10 billion
giveaway to Barrick, by Kark
Sonnenblick
Bush abets Barrick's Golddigging, by Gail Billington
See also: http://american_almanac.tripod.com/bushgold.htm
Antal E. Fekete
Gold Standard University
aefekete@hotmail.com
Copyright © 2007, Antal
E. Fekete
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