In this second part of our updated gold price framework we take a deep dive into the true energy exposure of gold mining companies. We find that gold miners are not just exposed to significant direct energy costs such as fuels and power; their indirect energy exposure is even larger. Our bottom up analysis shows that ~50% of production costs of the average gold miner are closely linked to energy prices. This is in line with the findings of part I of our gold price framework which showed that a 1% change in longer-dated energy prices impacts gold prices by about 0.5%.
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In the first part of this report we reviewed the gold pricing model we introduced last year and developed it further. We highly recommend reading it here to get a better understanding of the findings presented in this report. Using econometric tools, we showed that changes in energy prices – more specifically longer-dated oil prices – are a major driver for changes in the USD/gold price (with changes in real interest rates being the other main driver). In the second part of this report we take a more qualitative and comprehensive approach by examining the true energy requirements of gold mining.
The statistical analysis of gold prices in the first part was complicated by the fact that price data is often hard to get, incomplete or sometimes non-existent. However, the same problems are compounded when it comes to actual data on energy consumption by the gold industry. Gold producers are not required to disclose their energy consumption. And even if they were, it is far from clear what they would have to report and whether they would even have the data.
Data on direct energy costs in the form of fuels and power is relatively easy to find. It becomes obvious that gold mining is energy intensive when looking at the direct energy exposure, that is the fuel and power consumption of gold producers. Even comparably simple open pit mining consumes a lot of fuel for trucks and excavators and underground mining consumes electricity for cooling in addition to that. The processing of the gold ore is also highly energy intensive. Most large gold mining companies report these direct energy costs in one way or another. Typically, these reported costs are somewhere around 15-25% of all-in operating costs at current energy prices but have been higher in the past when energy prices were higher than today.
But gold mining is also energy intensive beyond the diesel and electricity that is consumed to mine and process the gold and cool the underground mines. Gold mining requires a lot of energy intensive resources and materials such as steel, chemicals, cement and tires and also machinery (trucks, excavators, mills) which consume energy in the manufacturing process. Ultimately even wages partially reflect energy costs as changes in energy prices affect the living costs such as housing and food of workers. We call these the indirect energy costs. We presume that the companies don’t even know themselves what the true energy exposure of these costs is. However, for this report, we meticulously dissected the expense side of the income statements of the largest gold producers in the world in order to estimate how much these indirect energy costs drive the expense side of gold mining.
Our bottom up analysis shows that ~50% of production costs of the average gold miner are closely linked to energy prices. This is in line with the findings of part I of our gold price framework which showed that a 1% change in longer dated energy prices impacts gold prices by about 0.5%.
How does this bottom up analysis tie in with our gold pricing framework? We used our gold price model to analyze how much of the major moves in gold prices since 2001 was driven by changes in longer dated energy prices. Our model predicts that USD610/ozt of the total gold price increase from 2001-2008 was driven by rising longer dated energy prices. In contrast, using the results of our bottom up analysis that energy costs account for about half of gold production costs, the move in energy prices would explain USd570/ozt. We get to similarly close outcomes for other major upside moves as well as downside moves (see Figure 1).
Neither our top down gold price model nor the bottom up analysis presented in this report should be misconstrued as a trading tool. Instead, it is a very useful framework for determining where are in the gold price cycle. Energy prices are clearly one of the most important drivers for gold prices. The bottoming of longer dated energy prices therefore has reinforced the floor for gold prices set by real-interest rates. We believe that the low in longer-dated energy prices is behind us and will likely have to move sharply higher over the long run (will dive deeper into this in the third and last part of this report). This, combined with the view that real interest rates have little upside but a lot of downside from here, plus the persistent risk of new and untested unconventional easing measures by central banks, leave the outlook for gold prices skewed sharply to the upside. In other words, there is a strong asymmetry for the gold price outlook.
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This Hedgeye Guest Contributor research note was written by Stefan Wieler for Goldmoney Insights. Wieler was previously a senior commodity strategist at Goldman Sachs. This piece does not necessarily reflect the opinion of Hedgeye.