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Gold fund manager John Embry
writes in Investors Digest of Canada, Gold
Gleams as Influence of Central Bankers Wanes. Embry cites another
analyst, Leonard Kaplan, who asks, why should gold cost $700 when an ounce
can be mined for $350? Embry counters with
In the case of gold, if paper money is being
aggressively debased and investors choose to seek protection in the ultimate
monetary safe haven, what does the cost of producing an ounce have to do with
the price if demand overwhelms supply?
To his credit, Embry understands that gold demand is
important in determining the price. However, he then proceeds with a lengthy
discussion of why the cost of production is really much higher than $350.
While the price of gold, like
all prices, is determined by supply and demand, many analysts make the
mistake of focusing on mine supply, rather than total supply. The price
of is determined by the demand to hold stocks of gold and the total
supply of gold. Newly mined supply has very little influence on supply
because the above-ground stock is so large (about 60-100x) in relation to
annual mine production. All that annual mine production does is to dilute the
total supply by about 1% per year.
There is a relationship between
supply and the cost of mining but it is the opposite of the one that Mr.
Kaplan suggests. Whatever the price of gold, the cost of operating the
marginal gold mine will rise until it is a bit less than the price of gold.
This is because a deposit that is not economic to mine at one price will
become economic to mine at a higher price. As long as "not much"
gold (in relation to total supply) can be mined at the higher price, the
price will be "not much" influenced by mine supply.
Robert Blumen
Robert Blumen is an independent
software developer based in San Francisco, California
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