Peak gold

What will happen to gold if the concept of 'peak oil' hits bullion miners...?

A LITTLE MINERAL DISCOVERY can go a long way toward reviving a national economy, which is great news if you're Ecuador.

   But what if you're not Ecuador? What if, say, you're South Africa, a country that's been pulling valuable things out of the ground forever?

   The Chamber of Mines (an excellent title, and I think all of us would love to be the Chief Executive of the Chamber of Mines, if only for the cocktail party blank stares) reported that South African gold production continued a disturbing trend: year-on-year production is down 7.5%, and the quality has gone to pot.

   But it all fits into a bigger picture. From the report:

   "The tons of ore processed through the mills rose by 1.5% year-on-year to 12.9 million tons in the second quarter of 2007. However, the 8.4% decline in average grade mined to 4.2 grams per ton meant that actual kilograms of gold produced declined by 7.1%. This decline in the average grade mined to 4.2 grams per ton was facilitated by the 17.3% increase in the rand gold price received by the mining companies to R144 254 per kilogram. This in turn allowed mining companies to mine lower-grade ores that had previously been uneconomic to mine."

   What does that mean?

   Well, it means that gold is starting to look a bit like oil. With oil, if wells run dry, the market notices and the price goes up. That higher price supports efforts to extract energy in less-efficient ways, which is why spending on oil drilling is up. Similarly, spending on gold mining was up 50% last year.

   But unfortunately, as the "peak oil" folks know all too well, at some point you reach the point of diminishing returns. And eventually, higher prices form a kind of social tax, shifting consumption-and-demand patterns across wide swaths of the population.

   Eventually, with oil, alternative energy will no longer be a nice idea; it will be the only idea.

   And gold? What happens when demand shrinks – something more likely to happen in the non-industrial gold sector than in oil? It's an entirely different scenario. Precious metals, and particularly gold – which is hoarded for jewelry, teeth and for its own sake as a monetary proxy – have no substitute. As Hard Assets Investor has reported before, gold is valuable primarily because everyone thinks it should be. If we truly start seeing a peak-gold phenomenon, with less and less supply available to the world, one of two things has to happen:

1. People will bid the Gold Price up to ridiculous highs, because there's less and less supply coming out of the ground; or
2. People will simply stop believing gold is valuable.

   We're not inclined to think that gold's multi-millennia of crowd-madness is going to end anytime soon, but then again, the report on South Africa's continued woes came the same day as the report that gold demand for jewelry is on the wane, despite the big-daddy of gold consumption, India, showing reasonably strong sales going into festival season.

   Of course, as a gold investor, these things fall under the realm of very big-picture, very long-term headaches. The short-term headaches remain labor disputes and the never-ending dance about gold vs. inflation.

   Recent market turmoil and the Federal Reserve's hand-wringing have simply made these more interesting times.