Everyone loves to hate gold shares

Usually the best time to buy is when nobody else wants to, and the worst time is when everyone wants to.

It is funny to hear the media narrative on South Africa’s gold companies.  Analysts keep penning op-ed pieces about what a bad buy the gold companies are.  You’ve heard it all before.  Costs are too high, labour’s too troublesome, the gold’s too deep, the technologies don’t exist, etc etc.

The problem is, this is a static view.  It assumes technology doesn’t change and that the price will remain stagnant, leaving South Africa’s thousands of un-mined tons condemned to a perpetual subterranean rock-trapped existence.

But when has this ever been so.  If investors had based their investment decisions on technologies that existed in the 1800’s who would have bet on the mining houses?  If investors made their decisions on $20 or $35 gold, surely gold mining would have looked like a bad bet?

Now, there is no doubt, mining gold in South Africa is hard.  Most of the un-mined gold is still probably below 4-5km deep, not a very hospitable depth.  Aside from the soaring temperatures at those depths which require incessant and expensive air cooling systems, miners have to deal with incredible rock pressure loads, which make reinforcing the walls and roofs of your tunnels that much more expensive and dangerous.  Gold mining in SA is not for nancy-boys.

Just sinking a new shaft and bringing a mine to viable production requires billions of rands and years of work.  Gold miners won’t invest in new projects until they are sure of one thing:  That the price will rise, keep rising, and stay rising.

Right now miners’ hedging activity would suggest that there is a strong view that gold prices will keep rising, but they cannot be sure of this, and until gold has spent many months at attractive levels the mining houses won’t even consider sinking new expensive shafts.  Gold has spiked up comfortably above $1000/oz in recent weeks and may even test $1500/oz soon.  Will this lure miners?  I don’t think so.  Not yet.  They want to see the price get to $2000/oz, maybe even $2500/oz, and then stay there for a long time, demonstrating very little tendency to fall too far.  Only then will mining houses tentatively move to haul out much more gold from tougher depths.

This process will take long.  Very long. 

Not only will miners be reluctant to sink new shafts and dig deeper, but when they finally do commit to this it will take 5-7 years before that operation is producing bullion for the market.  You don’t need to be a genius to work out that in a world demanding ever increasing quantities of gold, the shockingly poor supply fundamentals of the world’s largest gold reserve country have to be incredibly gold price bullish.

Those horrible supply fundamentals do make the gold companies’ shares look like a fools buy for now.  But it is an investors great folly when he only lives in the now.  Gold prices will rise in rand terms, and probably with increasing intensity in the years ahead.  This should keep mine earnings afloat until the price becomes right to dig for more gold.

When the companies enter this phase, and bullion soars past the R18000/oz mark, then the hoards will want to buy the gold companies again.  SA can once again become the world’s largest producer of gold and financial inflows and export earnings will be considerable enough to make it very difficult for the rand not to strengthen.

Why not buy early and buy cheap?