Morningstar Cuts Long-term Gold Price Projection

Our equity analysis team has reduced its long-term gold price forecast to better reflect marginal costs of mine production

Elizabeth Collins, CFA 7 April, 2011 | 10:09AM

We're reducing our long-term gold price forecast to better reflect our view on the marginal cost of mine production, which we estimate at $1,100 per ounce in real terms. We believe this focus on marginal analysis, while not without its shortcomings, is the most appropriate method for analysing gold miners and the best means for separating firms that are favourably positioned from those threatened by higher costs or weakening production.

We admit that forecasting gold prices is a tricky proposition. Unlike other metals, gold is rarely consumed--almost all of the gold ever mined remains in use as jewellery or as bars in bank vaults. Therefore, the amount of gold theoretically available for sale dwarfs mine output--at roughly 30,000 metric tons, central bank holdings alone amount to 12 years of global mine supply. Investment considerations can seem to affect gold prices more than the traditional commodity pillars of supply, demand, and marginal cost. As such, the combination of a weak US dollar, low or negative real interest rates, and macroeconomic and geopolitical uncertainty are commonly cited reasons for rising gold prices as investors flock to the yellow metal as a safe haven investment.

Despite clear deficiencies, we believe that a study of marginal costs, supply, and demand remains the best method for forecasting long-term gold prices. This methodology is especially useful for identifying low-cost miners and ones with favourable growth opportunities. While global mine supply has recently increased in response to higher gold prices, miners are still caught in a fierce battle against lower ore grades, higher capital costs and longer lead times, and a lack of meaningful exploration success. This has put pressure on both supply and costs. Meanwhile, demand for gold should be supported by exchange-traded funds (which make gold investing convenient for individuals) and the rise of the emerging market middle class as a source of jewellery demand.

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About Author

Elizabeth Collins, CFA  is an associate director of equity research with Morningstar.

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