The Best Way to Profit from Gold’s Supply Crunch

by Byron King, Daily Reckoning

I want to give you some perspective on the gold space. This pertains to any gold investor, whether in big miners (like a couple I name below), or the small, junior-space plays.

I came away from Vancouver last week, at the Sprott Natural Resource Symposium with the distinct impression that we’re looking at better days ahead for gold, and soon. Gold discoveries are drying up, and really good, new plays are few and far between. We’re looking down the barrel of a severe supply crunch, with many implications. Of course, you have to separate the spin from the reality of what’s happening out in the field.

…I foresee a much better play for gold on the up-side, versus the down-side.

Here’s some background, pertinent to large cap and small cap investing. Just last week, we had several company announcements that seem to tell the market exactly what it wants to hear – which is worrisome, in a way. That is, miners are telling the market that things are improving, while they cut costs and goose the bottom lines. Great, right? Well, yes and no.

Barrick Gold (ABX:NYSE) and Kinross (KGC:NYSE), for example, had good news for the markets last week, particularly on their respective costs per ounce of production. Barrick claims that its all-in sustaining cost per ounce of gold was $865 in Q2, well below its previous guidance of $920 to $980. Kinross claims all-in sustaining costs per ounce of $976 in Q2, down from $1,001 in Q1.

So costs are down, which is supposedly good, right? Hold that thought.

By comparison, Agnico Eagle Mines (AEM:NYSE) produces gold at an all-in sustaining cost of $626 per ounce, which is quite a difference from Barrick and/or Kinross. Right away, Agnico offers a more robust case for a long-term miner that can compete in whatever the markets throw its way.

Let’s drill down, so to speak, into what’s happening. Basically, when I see big miners cut costs of production dramatically, inside three months, outside of some sort of exploration coup or true production miracle, I have to wonder if they’re playing tricks on us.

That is, are miners, for example, “high-grading” the ore body? Just digging out the best ore, and leaving the lower-assay material? If so, then they’re showing a financial improvement now, at the expense of long-term reserve and resource numbers. They’re robbing the future, so to speak.

This kind of number-crunching is part of another worrisome trend. The fact is that, over the past 25 years across the world, gold discoveries – both resources and audited reserves – have fallen. Gold discovery numbers are not keeping up with annual gold production. In fact, as the following graph shows, the trend of declining gold discoveries has accelerated recently.

Note how the annual amount of gold discovered has declined, while output has remained pretty much steady, even in the face of soaring prices. That’s not what they teach in Economics 101.

Meanwhile, out in the field, it takes more and more time and money to bring a discovery to production – a decade and more. You have to deal with longer government permitting times, opposition from environmentalists, “social license,” higher capital costs, sites in remote areas, difficulties with building a workforce and numerous other issues. There’s no resolving these kinds of problems any time soon. Hey, come back in 2025, maybe, and we’ll revisit that graph.

With gold, we’re looking at a supply crunch; it’s looming out there NOW, like a dark shadow, and it’s just a question of time before it hits home in the daily gold price quote.

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This reinforces a point I’ve made again and again, in both my large cap newsletter, Outstanding Investments and in the smaller trading newsletter, Real Wealth Trader. The future of mine output looks grim; miners will each have to deal with their own business issues. But right now, the prospects for physical gold – refined metal above the ground – are strong. There’s a severe drop in output baked into the cake already, even if the industry changes very little.

Looking ahead, I foresee a much better play for gold on the up-side, than versus the down-side. Yes, we’ll likely have up and down trends; but over time, expect gold prices to rebound from the current $1,300 range, eventually moving to $1,500, $2000 and even $3000. This is purely a “supply“-based forecast.

As for demand? Well… when the financial-side of the investing world catches on, the number could be even higher.

Eventually, even the dimmest bulbs in the world of monetary control and financial analysis will break the gold-code. They’ll figure out that gold reserves are declining and not being replaced. Meanwhile, the current gold doldrums are your chance to accumulate strong plays in the world of mining shares, as well as physical gold for safekeeping.

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