Barclays on Gold debacle: Fundamental support at $1300 oz
Gold prices remain under immense pressure as, after losing 5% on Friday, prices have suffered their largest daily absolute decline to around $1350/oz today, a level not seen since February 2011. Although there has been a physical demand response to lower prices, it has not been sufficient to combat the decline. In the absence of support from physical buying, where does fundamental support materialise?
Should gold assume its commodity role, its cost of production should provide some guidance. Last year, the average cost of production was $673/oz, and the marginal cost of production (90th percentile) was $1104/oz.
Assuming sustaining capex at around $200/oz, this indicates cost support at around $1300/oz, based on last year’s data; our global database encompasses 35% of global production. Should prices dip below marginal cost, around 10% of production under our cost curve becomes cash-negative, representing an estimated 262 tonnes of cash-negative gold production globally.
The bulk of this at-risk production is from South Africa, according to Barclays database. Also putting pressure on gold prices is the acceleration of ETP outflows, which have already reached 66.5 tonnes for the month-to-date (until 12 April 2013). Nearly 320 tonnes of gold ETP holdings are cash negative below $1400/oz (assuming only those shares created above $1400/oz have been redeemed above $1400/oz, thus, this estimate is likely to be greater).
Although a reduction in mine supply would need to counter the supply from ETP outflows, this has raised the question whether producer hedging could gain traction. Hedging activity over the past couple of years has predominantly been related to project financing.
Looking at the 20-year price low in 1999, when prices dipped to $252/oz, prices traded a third above the annual average cash cost. The average cost of production was quite stable in the 1990s but has risen by an average 16% y/y over the past five years.
The marginal cost of production has risen by 69% over the past five years, rising by 15.2% last year.
“Our cycle average forecast is $1125/oz (which denotes the cost-driven estimate of the minimum sustainable price over a business cycle) before taking into consideration sustaining capex, therefore, given that cost pressures are rising and labour disruptions persist, from a fundamental perspective, support comes into play initially at around $1300/oz before a substantial quantity of mine production is put at risk.” Barclays concluded.
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