GOLD and Precious Metal

From 1492 to 1600 less than 23 million ounces of gold were mined throughout the world. In the 18th Century the New World’s mines accounted for 80% of world production which was 48 million ounces. Most of the mining was done by indigenous or African slaves.

By 1994, total world production was approaching 50 million ounces annually. Of this, South Africa produced more than 30 million ounces - six times more than the former USSR, which is the next largest producer. Canada, the US, and Australia (in that order) are the next largest producers. The extensive gold reefs of the Witwatersrand in the Transvaal and similar deposits in the Orange Free State made South Africa the greatest gold producing area in the world. The gold bearing reef extends from the surface in some areas to far below the surface. Most of the surface gold has been removed, and gold in this area is now obtained from deep underground mines at great expense.

During 1994-98 central bankers were dumping gold and many South African mines were closed because at $300 or so per ounce, gold could not be mined profitably. The miners (mostly indigenous Africans) were sent back to their homelands with lump sum payments as high as $2800 after thirty years of service.

South Africa is once again the largest gold producer in the world. In 2005, 2,518 tons were mined, and South Africa produced 12% of the total. The best estimate is that 155,500 tons have been mined throughout history. About 64% has been produced since 1950.

It may be interesting to compare the actions of the central bankers who were dumping gold to the CEOs of contemporary US companies who were actively buying back shares of their companies at 1998’s prices i.e., why weren’t the bankers dumping gold when it cost $800 an ounce and why weren’t the CEOs buying when the DOW was at 700? Also noteworthy was an early 1998 article in Barron’s which stated that short sellers of gold had shorted one year’s world production of gold.

Consider the November 1999 fundamentals of gold. All the gold in the world amounts to about 120,000 tons worth about $1.3 trillion. Contrast this to the world’s stock market capitalization which is over $25 trillion. In 1999 the world’s gold mines produced about 90 million ounces or about 2,600 metric tons (1 metric ton = 2204.6 lbs). What’s troubling here is that 1999 production was/is almost double that of 1994.

It seems that producers are finding cheaper ways to mine gold. In the third quarter of 2004, Newmont was mining gold in Indonesia at a cash cost of about $115 an ounce; in Peru, $140; in Uzbekistan and Turkey, $170; in New Zealand, $205; in Australia, at varying sums from $225 to $310; and in Nevada, $290. Newmont expects $200 at a big mine due to open in 2006 in Ghana. These figures reflect varying currencies, wage levels and ore quality as well as geology. Non-cash operating costs, mainly depreciation, add $30 to $60 to all these figures. The average quoted cash costs to produce gold in 2005 were $339 per ounce, which included depreciation, amortization, reclamation, and mine closure costs.

During the Summer of 1999 gold fell to about $250 an ounce when bankers announced they were going to dump as much as 100 tons per year on the market in the future. Later they recanted and gold shot to well over $300 per ounce as the shorts scrambled to cover their positions. What’s really noteworthy here is how a small supply change can effect the price. To put this into perspective recognize that India, a poor country with a per capita GDP of $300, bought 800 tons of gold in 1998. That’s one gram of gold per person. If everyone in the world decided to buy one gram of gold per year it would amount to about 6,000 tons, or more than two times the 1999 supply of newly mined gold.

There are at least two ways to buy gold; gold and precious metals stock and/or funds and gold bullion. To date, I’ve limited myself to Vanguard Gold and Precious Metals Specialized portfolio but began to question this strategy after reading an article by John Markese in the AAII Journal in which he stated that if you’re going to buy gold you’re better off buying bullion. His reason is that gold stock behaves as gold does in a bull market i.e., it goes down and gold stock behaves as stock does in a bear market i.e., it goes down. According to John, you can’t win with gold stock. I’m not sure I agree with this but I am thinking of supplementing the gold stock with gold bullion.

It’s Jan. 2008 and I have not yet purchased gold bullion, nor do I believe I will in the foreseeable future. Gold bullion was priced at $288 per ounce when I first recommended Vanguard Gold and Precious Metals in Dec. 1997. At the end of 2007 it was priced at $833 per ounce. If you had purchased Gold Bullion in Dec. 1997 you’d have a total return of about 189% (excluding storage and transaction costs); if you had purchased Vanguard Precious Metals you’d have had a total return of 720%. Contrast this to the 76% TOTAL return of the S&P 500 since Dec. 1997.

The Economist called gold's 2003 ascent a sucker's rally: The world's central banks hold about 30,000 tons of gold in their vaults but they're not buying more. Indeed, the long term outlook for gold might mirror the fate of silver. A century ago, banks hoarded silver but now silver is worth what it was at the beginning of the 19th century. By this measure, if banks were to abandon gold, it would be worth about $68 an ounce. Will they? We'll have to wait and see, but, in the meantime, I've "taken some profits".

For the record, my Vanguard Precious Metals Fund is less than 2 to 3% of my total stock portfolio and I have no intention of changing that allocation by a significant amount. FYI, Burton G. Malkiel, author of A Random Walk Down Wall Street, recommends putting about 5% of a total portfolio into gold.

Henry Wirth · Dec. 1997

Revised Sep. 1998, Nov. 1999, Jan. 2002, Jun. 2002, Jan. 2004, May 2004, Jan. 2005, Jan. 2006, Jan. 2007, and Feb 2008

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