Matt Insley

Today I’d like to cover the “cure” for what’s ailing the gold markets. If you’ve been around the markets for a while you likely know where I’m going with today’s article.

But before we get to the fix for the gold market, let’s cover another important question…

What’s for lunch?!

A few weeks ago you would have caught me drinking ice-cold chocolate milk. I must admit, chocolate milk isn’t my normal ice-cold beverage of choice.

It is however my 10-yr old nephew’s favorite – who I was looking after that day – and lemme tell you, that boy can put away some chocolate milk!

So there we were hanging out, drinking our brown milk, when the taste hit my lips. I instantly teleported through the wormhole to the last time I had a chocolate milk – back in grade school. It’s amazing what a once-forgone taste or smell can do to you.

Ah, I remember the good old days of school lunch. Sitting at a table with friends, getting a break from the drone of teachers and in general living the easy life! Heck, I even had an affinity for the school menu.

Frankly I don’t know why school lunch got such a bum rap. I loved it – every day was different, you could mix and match your pizza or steak sub with a pretzel or apple – and of course, you got the choice of chocolate milk. Mmm. Mmm. Mmm.

Plus, 15 years ago, my last soirée of school lunchdom, you could get all of that for just $1.60.

That’s when I turned to my nephew and asked, “hey how much is school lunch these days?”

“Three dollars” he said.

Holy cow. Three dollars? I was incredulous. Sure, three bucks is a steal for a normal, outside-of-school lunch. But comparing apples to apples, that means lunch prices in Baltimore County have surged 87% in just 15 years! That’s insane.

It also brings us back to the topic of today’s article – so let’s move from chocolate milk to gold!

According to the U.S. inflation calculator, the rate of inflation over the past 15 years was a “mere” 42.8% — which accounts for about half of the 87% surge in prices. I guess the other reason for increased prices comes down to local/state/federal bureaucracy or just good old shadow inflation.

That being said, 42% in 15 years is the hefty cost of holding U.S. dollars. That’s a losing bet if I ever saw one – and it’s written plain as day on the government’s CPI inflation calculator.

But, had you paid for the same school lunch in gold, the price wouldn’t have risen at all. In fact, it would have dropped.

That’s the lesson we can learn from a small carton of chocolate milk. [And I shouldn’t need to remind you that the same buffoons that allow 42% inflation in 15 years not only control the price of school lunch but could also have an effect on your fixed income retirement. Ugh.]

Needless to say, gold should still be a part of your investment philosophy. And today there’s reason to believe gold is due for a turnaround, too. After all, there is a “fix”…

The Cure For Gold’s Woes

In short, there’s a “cure” for what’s been plaguing the gold market this week. As I hinted above, if you’re familiar with the markets you’ll likely know where I’m going with this.

Indeed, gold’s precipitous drop has even made many a DRH faithful walk down the stairs, twist the combination on the padlock, throw aside the “fake-out-a-burglar” riches, and take a long hard look at their bullion.

But there is a cure for gold’s spring fever. In fact, it’s the same cure that can help spur any market-based commodity higher…

As the saying goes: the cure for low prices is…. low prices.

The main fundamental reason I urge you to hold on to your ounces today is simple. With gold’s recent pullback a lot of marginal miners and even some of the big guys are underwater on their current gold production. That is, it costs the miners more today to mine the stuff than they can expect to get from the market.

Below is a chart we’ve previously shared that shows how much big miners pay to get gold out of the ground. It’s the most important chart you’ll see on gold today.

As you can see, 2012 costs were over $1,400 on average – and today costs could be even higher. Simply put if prices remain below that level, mines will begin to shut down.

According to Bloomberg, as much as 30-40 percent of mine production becomes marginal with a price below $1,300 per ounce.

That’s horrible news for marginal miners — it’s also bad for big miners that need to cut marginal projects.

But it’s good news for the future price of gold.

You see, over the past 10-years the price of bullion has traded slightly above mine costs. It’s a natural relationship – if you can’t mine the stuff for a profit you simply shut down operations. Indeed, if prices remain low or trend lower, we’ll see a lot of projects canceled or back-burnered.

This potential cut in mine operation will lead to a large cut in supply – something that could be very supportive of prices over $1,400.

It’s the same stuff we see in the oil market. I don’t expect prices to ever drop much below $60 for long-term. The reason is simple: under $60 drillers stop drilling. Then after time, supply tightens up and prices rise again.

That said, today’s safer gold bet is in bullion, rather than miners. Other than the low-cost guys a lot of miners could be in trouble at sub-$1,400 prices – that’s especially true at sub-$1,300.

For the bargain hunters out there, you could look at a low cost player like Franco Nevada (FNV.) Franco isn’t a normal miner – instead it’s a “streaming” or royalty company. They sponsor early phase development in return for 2% (or so) of the mine’s future output.

Franco doesn’t have capital costs or operating costs and when you add it all up they are one of the lowest-cost ways to play gold. But since the beginning of the year, like a lot of the regular miners, their share price has been cut nearly in half. Indeed, for a turnaround play it may be worth a look.

In the meantime, keep your hands on your bullion and your eyes on the price action in the coming days/months. If prices fall below $1,300 I don’t think they’ll stay there long.

Keep your boots muddy,

Matt Insley

Original article posted on Daily Resource Hunter

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Matt Insley

Matt Insley is the managing editor of The Daily Resource Hunter and now the co-editor of Real Wealth Trader and Outstanding Investments. Matt is the Agora Financial in-house specialist on commodities and natural resources. He holds a degree from the University of Maryland with a double major in Business and Environmental Economics. Although always familiar with the financial markets, his main area of expertise stems from his background in the Agricultural and Natural Resources (AGNR) department. Over the past years he's stayed well ahead of the curve with forward thinking ideas in both resource stocks and hard commodities. Insley's commentary has been featured by MarketWatch.