Something needs to change quickly or the precious metal mining industry is finished. In the course of my research on the why I have looked closely at the world of pricing.
Any senior executive will tell you that you set the pricing of your product based on what the market will bear. If your variable costs exceed your revenue you have a limited life unless the government subsidizes you. The point is you set the price! The market will quickly tell you whether that price is acceptable or not.
In the case of crude oil, the cost of drilling a well from 2000 to 2007 literally went vertical from $500,000 to $4,000,000(EIA). If you wish to know why the price of crude oil exploded, look no further than the cost of production. The futures market does not set the price of crude oil. It follows the cost of production. The same can be said for agriculture although true pricing is complicated with subsidizes everywhere. Futures markets prices are dictated to based on availability of product relative to demand (costs matter). Futures markets are not meant to dictate price. If tomorrow oil went to $30 everything being constant, see how much oil gets pumped. Would none suffice?
Which brings us to the curious case of gold and silver. Today, the price of the two precious metals is double digit percentages below the cost of production for the industry as a whole. Global production of the two metals have experienced the same cost curve associated with crude oil. However, the price of both the metals themselves and MORE IMPORTANTLY the producers have plummeted the past two years. The cost curve did not.
Take a step back and ask yourself whether you would ever own a business where the price of what you sell is dictated by forces outside your control and have no bearing on your costs! How exactly are you supposed to finance operations? How much oil would the majors produce if they lost money drilling and refining it? How many acres of corn would global farms produce if the cost of growing and bringing to market was double digit percentages below their selling price?
While the ETFs and the importation curbs of India have distorted the supply and demand figures, what has not changed is the cost curve. What this means is the precious metal miners are price takers via the futures market and that must change. Precious metal mining companies have to take the power away from speculators, banks and central banks following FX crosses or how they feel about gold on a given day or week. It is no way to run a business.
The cost of mining silver globally with all in costs is in the range of $23 an ounce. If miners believe they are powerless, eliminate the supply. Once the world realizes electronics need silver they might get the point. It's a business, start operating it like one.
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