In this report, we study the cost of production of Gold.
As a commodity, gold price should be above its cost of production. The idea of this article is to study the cost of production of gold.
In the first section, we will show that gold price is heavily correlated to oil, and thus to the cost of energy.
In the second section, we will show that the AISC (all-in sustainable cost) is heavily correlated to oil, plus an intrinsic inflation rate of 7%.
In the third section, we will show that the marginal cost of production of gold is 1855 US$/oz.
In the fourth section, we will recompute the AISC of the major miners from their earnings results, and show that the average AISC should be 1,017 US$/oz.
1. Gold and oil prices are correlated at 88%: buying gold is equivalent to buying oil
The chart below shows the long-term evolution of the prices of gold and the prices of oil, and shows how oil and gold are extremely correlated. The average 365-days correlation between Oil and gold price over 70 years is 88%.
The first significant jump occurred when the prices of gold and energy were multiplied by 10 in the 1970s (see chart below) during the oil shock of 1973 when the members of OPEC proclaimed an oil embargo. By the end of the embargo in March 1974 the price of oil had risen nearly 300%. In 1979 the second oil shock was due to a fall in oil production and the war in Iran.
The second significant increase happened from 2000 to 2012, following the soaring demand from China, and the money printing everywhere in the World (see chart below).
The conclusion is that buying gold is equivalent to buying oil in the long run. Because the cost of storage of oil is 6% and the cost of storage of gold is only 0.35%, it is much more efficient to buy gold than oil as a hedge to energy inflation.
2. AISC has an intrinsic inflation rate of 7% annualized
According to the World Gold Council the All-In Sustaining Cost (AISC) is an advanced metrics used by mining companies to report their cost of gold mining. AISC is an extension of currently existing “cash cost” metrics which includes sustainable production costs too.
The AISC peaked in 2010, and then fell due to the fall of oil prices. But we can see on the chart that the AISC did not fall as sharply as the oil price. This is because there is an intrinsic inflation of the gold price of 7%.
We computed the 7% intrinsic inflation rate of gold as the increase between AISC 2017 and AISC 2005, because oil had the same price in 2017 and 2005:
The conclusion is that gold price in the past 20 years has had an inflation cost of 7% on top of the energy cost. This is mainly due to the decrease of the grade of the mines: the amount of gold for each ton mined has decreased sharply. In 2000 the average grade for gold was 19 g/t and in 2020 it was 6.5 g/t. One should mine 3 to 4 times more mineral in order to extract the same quantity of gold as per 20 years ago.
3. The marginal cost of production of gold is 1855 $/oz
The real cost of production of gold is the cost of production of the most expensive mines. Indeed, if the production amounts have to be maintained at current levels, the most expensive mines have to be profitable, and gold price should be higher than their cost of production.
The AISC of the 10% most expensive mines in the world is 1855 US$/oz.
Any buyer of a commodity should watch carefully the cost of production. Having a price under the cost of production is not sustainable for a commodity, either the production is bound to fall, either the price of the commodity will rise.
4. Credibility of the AISC
We recomputed in the table below the implied AISC of the most expensive mines for 2020 (should it not be the biggest gold producers instead of the most expensive mines?). We find an average of 1,017 US$/oz. The thinking is simply: we take the earnings of the company and we divide by the amount of gold produced. Obviously, we need companies which produce only gold.
The value we find by this thinking is 3% above the value given by the officials in section 2. It is not too far, so it validates the data. But it shows also that not all the cost are taken into account in the AISC, and we should inflate it by a good 3%.
Gold is a perfect hedge against energy inflation, since it has the same performance during periods of large spikes, but its storage cost is minimal (0.35%) and it does not suffer from depletion.
Gold itself gets harder to produce, and has an additional inflation rate of 7% on top of the energy inflation rate, from which it provides protection.
The current price of gold is around its marginal AISC of 1855 $/Oz. This means the commodity is not expensive at current levels.