Good news for gold

If you ever have the chance to camp near an old gold or silver mine, take advantage of it. I did it years ago. Not only is it a great experience, but it also made me a better investor in metals.

Why? Well, there’s nothing like seeing a long-dead, abandoned mine with your own eyes. You realize, in a visceral way, that someone made a best guess calculation about supply and demand decades ago, and they guessed wrong.

That has also been the case in recent years, with gold prices well below 2011.

But that is about to change …

My camping trip was somewhat spontaneous. I was in Reno for a conference. A friend of mine had a topographic map of some ancient mines in the high desert of the Santa Rosa Mountains, about four hours north.

We drove up, camped in the middle of the sagebrush, and the next morning we climbed a steep slope to a small plateau. That’s where we find the mine entrance (closed with dynamite), an old wooden cabin and other collapsed remains of the operation.

We also found the mine’s “power plant”: the long-rusted skeleton of a Model T, sitting on blocks. Instead of wheels, it had large conveyor belt spindles bolted to its shafts!

It’s a long distance, in terms of time and technology, from that old mine to the massive industrial leachate gold mines that dot northern Nevada today.

But long multi-decade cycles of supply and demand, boom and bust, remain. And while few outside the industry are talking about it yet, the seeds for the next boom are already in the air.

The reason has to do with global production.

Golden Peak?

According to industry experts, leading investment bankers and others, 2015 will be the peak year for global gold production.

If you believe in the common sense idea that a large supply equals lower prices, then that’s the bad news.

The good news? Those same sources say that production is much lower in 2016 and beyond.

Nevada’s gold mining statistics tell a small part of the story.

Last month, the state’s minerals division added its gold production statistics for 2014: it fell to 4.9 million ounces, the lowest in 27 years.

But here’s the biggest trend: Nevada’s total production peaked in 1998 at nearly 9 million ounces. Since then, gold production has declined in 12 of the last 17 years.

What’s going on? Simply put, the areas with the highest grade minerals have been systematically excavated. And because Nevada contributes the majority of US gold production, US production data tells a similar story.

The statistics for Australia and South Africa are very similar. Gold production in South Africa peaked in 1970. Australia surpassed in 1997.

For a long time, the production of China and Russia filled the void.

But with gold prices falling, more mines closing, and mining companies wisely avoiding new projects, the “production cliff” (as some analysts call it) is finally at our doorstep …

• Goldman Sachs, in a March report, sees only “20 years of known exploitable gold reserves left in the world.” The bank has seen fewer and fewer discoveries of new gold deposits since 1995.

• Earlier this month, National Bank of Canada analysts told The Financial Post: “It’s not about whether the production cliff will occur or even when. It’s really a question of how companies respond.” According to the bank, world gold production will fall dramatically in the coming years.

• Also, a Grant Thornton analyst told AustraliaMining.com that “2015 will be the peak in global gold production.”

A hidden gold buffer

So if that’s the case, you say why haven’t we seen higher prices yet?

One big reason is the influence of “scrap gold” on the world market. All of those melted earrings, bracelets and dental fillings are a major source of supply, up 36% in 2011 and 2012.

But that fountain is also constantly drying up. In 2014, only 28% of the world’s gold supply came from recycled sources. The World Gold Council noted that the supply of recycled gold reached its lowest level since 2007.

Those trends continue in 2015. The group says that the supply of recycled gold fell 3%, and another 8%, in the first two quarters of the year (year on year).

Supply contraction will lead to higher prices

Here’s one last point: it takes time for new information to filter into any market. The rise and fall of gold prices? That’s old news by now, totally discounted in the price of the metal and its miners.

But what is it that most people still don’t realize (and would hardly believe if you told them)? The “production cliff” of gold fits the bill perfectly. As new data confirms the forecast, expect this to be a major new catalyst for gold prices in the coming quarters.