CPM Group’s Jeffrey Christian on gold’s future

Jeffrey Christian, managing director of the CPM Group, a New York-based research consulting firm, took time out to talk to The Northern Miner about the gold price and the state of the gold mining sector.

The Northern Miner: Gold has fallen to a four-year low and miners are divesting their assets to pay down debt, while explorers have difficulty raising capital. What is bringing down the gold price?

Jeffrey Christian: Investors have focused on a strong U.S. dollar and a strong U.S. stock market, and a relatively stronger U.S. economy, compared to where it has been. They also compare the U.S. economy with that of Europe and Japan. All of that is fuelling a stronger dollar and stock market, and it will probably continue over the next six months. You’ve got short-term investors moving away from gold, and that’s the major factor driving the price down. At the same time you’ve got other investors buying gold even as the price falls. We saw the gold price fall sharply last year and a lot of short-term investors selling a lot of gold, and the price fell sharply — while a lot of other investors took it as a buying opportunity.

TNM: How does the situation this year compare with last year?

JC: Selling and buying so far this year are less intense than last year but it’s the same dynamic going on, and in the next six months you’ll continue to see weak gold prices. Exchange-traded fund (ETF) sales last year totalled 28 million oz., and this year through the end of October it’s been 2.3 million oz., so net selling of ETFs this year is less than 10% of what it was last year.

TNM: What are your price forecasts for six months from now and year from now?

JC: We think most of the gold-price decline is priced into the market already. Obviously a lot of people have watched the price fall since July and are extrapolating that decline to lower levels. We do not necessarily agree. For the next six months we’re looking for the price to find a base perhaps where it is today at US$1,150 per oz., or a little higher at US$1,200 per oz. On a longer-term basis we think the price will probably rise in the second half of next year. We don’t necessarily see it rising sharply to US$1,500 per oz. next year, but we wouldn’t be surprised to see it at US$1,300 per oz. by the end of 2015.  

TNM: That sounds optimistic.

JC: It’s not so much optimism as it is economic pessimism. Over the course of 2015, people will become more hesitant about economic growth in the U.S., and other political, economic and financial market conditions will make some investors nervous about their exposure to the U.S. dollar, the stock market and a stalemated government, and all of that will cause economic pessimism. Right now gold is suffering from the fact that people are ebullient about the U.S. economy and the stock market. That ebullience may continue for the next six months or so, but at some point people are going to look at the massive U.S. deficit, growing debt and the increasing intractability in government spending due to the political stalemate in Washington. You could see a revival in pessimism that will reflect in the gold price in the second half of next year.    

TNM: Falling gold prices have really punished the sector, and it’s not just the juniors. A number of intermediate and larger gold companies are producing an ounce of gold for an amount that is coming dangerously close to the gold price.

JC: Probably a lot of them are doing better than just scraping by on a cash-operating basis. The average all-in sustaining costs in the industry as a whole are probably close to US$1,000 per oz. So they’re not making a US$800 profit margin like they were a few years ago, but they’re still making profits on an operating basis. You do have some companies that are suffering. But the guys that are really suffering are the small exploration companies that don’t have cash flow. You have seen several million ounces of capacity brought on-stream over the last two or three years that have lower costs than some the older mining operations had. Sure some of the operating companies are not doing well, but the guys that are suffering the most are the exploration companies, because that’s where you cut first. Equity, lending and joint-venture investment have just dried up for exploration companies that aren’t generating operating cash flow. There are two different things you have to consider — the operating financials and the share price. The share price can be quite disconnected from a company’s financial performance. But yes, the share prices have been decimated.

TNM: Is there more that management can do to prevent short-term investor flight?

JC: In many cases management teams haven’t done a good job of managing their exposure to gold prices or their costs … they also haven’t managed their public image properly. There is this steady stream of mining executives walking around the Denver Gold Forum saying that costs are too high and the gold price is too low, and the industry has to contract. But then they say: ‘But we’re doing OK.’” They’re telling investors the industry is a dog. So you shouldn’t be surprised when investors say to themselves, ‘Well, if the CEOs of these companies say the industry is a dog, then I guess I should go and invest in another sector.’ The CEOs haven’t been helping matters.

TNM: Has there been much to celebrate in terms of companies cutting their production costs?

JC: Production costs are actually starting to come down more, and that’s something people aren’t looking at. They have been coming down over the last year or so. A survey of selected gold-mining companies that together account for 41% of global gold mine production showed that cash costs fell from US$733 per oz. in the second quarter of 2013 to US$616 per oz. in the second quarter of this year, while all-in sustaining costs fell from US$1,223 per oz. to US$850 per oz.

If you look at AngloGold Ashanti (NYSE: AU), I think their production costs are US$200 to US$300 less than they were a year ago but the market isn’t giving them credit for that because they are being painted with the same brush as the higher-cost producers, and they are being painted with the same brush as the exploration companies that aren’t generating operating income. And if you look at mining companies, they’re generating profits on an operating basis but they’re taking writedowns because of lower gold prices, which offset their profits.

TNM: Thomson Reuters reported that Red Kite sees the scope for gold to fall to US$800 to US$900 per oz. What do you make of that prediction?

JC: The price could drop down there, but it can’t stay down there for long. That’s too low from a sustainable point of view.

TNM: The CPM Group likes to use a measurement it calls the “risk-free” gold price. Could you explain that concept and why you see the gold price not falling below US$900 per oz.?

JC: The risk-free gold price is what the gold price would be if investors felt the world had no financial risk. So if you go back to 1997–99, the U.S. was paying down a trillion dollars of debt and generating US$250 billion a y
ear in federal budget surpluses, and you had tremendous growth in the overall economy partly because of productivity gains. You also had people promoting the concept of a new economic paradigm and that the U.S. was never going to have another recession, and so forth. And we said: ‘No, the new paradigm is marketing hype, there will be recessions and inflation at times in the future.’ During the 1997–99 period, the world was in a sweet spot economically and the gold price fell from US$340 to US$270 per oz., and stayed there for five years. That was the risk-free gold price at the time, when investors felt no risk to their financial well-being and didn’t have gold in their portfolio.

Today we think the risk-free gold price is closer to US$900 per oz. If all the governments in the world got their acts together and managed themselves in a fiscally responsible fashion, and if all the political and financial risks disappeared and investors said ‘I don’t really think I need to invest in gold,’ we think the price would be US$900 per oz. We don’t expect that to happen any time soon. Economic and political problems will keep investors interested in gold.

Investors had 0.2% of their wealth in gold in the period from 1997–99. It got to 0.8% in 2012, and in 2013 it came back down to 0.7%. So investors have more than three times as much of their wealth in gold today as they did back then in the risk-free period.

TNM: What if gold stays at the US$1,100 per oz. mark indefinitely?

JC: You’ll see some companies continue to contract production and emphasize profitability rather than counting ounces. You’ll see some exploration-stage companies being bought up by operating companies. One of the things you’ll see is a lot of these higher-cost operations that have been revived and explored four or five years ago, they’ll give up the ghost. They’ll say this property should not be developed. You’ve already seen an enormous amount of prospective capacity, if you will, written off that way, probably half of what was on the books two years ago, as stuff to be developed at US$1,600 per oz. is gone now. It’s been deferred indefinitely or put on care and maintenance, or just shut down. You will see that continue. Our view is that you’ll see mine production rise for the next two years or so. But then you’ll see mine production fall by 5 million or 10 million oz. over a decade, if prices remain at the US$1,100 per oz. level.