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Ultimately the value of metals will be set by the approximate costs of production.
gecko109
Posts: 8,231 ✭
I heard the said a few days ago, and it really bothered me to no end. Partly because the statement.....from a purely logical standpoint.....makes all the sense in the world. But then its contradicted by the "laws" of the real world.
For example, the cost of production (extraction) of a barrel of oil is significantly less than $100, yet people will generally not value that commodity strictly on production costs alone. It costs the FED approximately 6 cents to produce a photograph of Ben Franklin, yet that "commodity" has a value of $100. I could go on with dozens more examples of how cost of production does not relate to final valuation.
But in 2007-08, something happened in the real world that supported the above claim. The housing market tumbled. Was the reason because a home should be valued in relation to what it cost to build one? I dont know, but Im willing to bet that was at least part of the reason for the collapse. Why would a person spend $250,000 on a Cape Cod style home built in 1952 when a brand new....larger home....could be built today for about the same cost?
Anyway, what is YOUR interpretation of the statement in the title of this thread? Does it have merit? And if so, how much merit? Is that possibly what caused the recent correction in silver prices? Did some of the top paper investors all wake up one morning and think....."hey, this stuff costs about $15/oz to mine"?
Discuss.
For example, the cost of production (extraction) of a barrel of oil is significantly less than $100, yet people will generally not value that commodity strictly on production costs alone. It costs the FED approximately 6 cents to produce a photograph of Ben Franklin, yet that "commodity" has a value of $100. I could go on with dozens more examples of how cost of production does not relate to final valuation.
But in 2007-08, something happened in the real world that supported the above claim. The housing market tumbled. Was the reason because a home should be valued in relation to what it cost to build one? I dont know, but Im willing to bet that was at least part of the reason for the collapse. Why would a person spend $250,000 on a Cape Cod style home built in 1952 when a brand new....larger home....could be built today for about the same cost?
Anyway, what is YOUR interpretation of the statement in the title of this thread? Does it have merit? And if so, how much merit? Is that possibly what caused the recent correction in silver prices? Did some of the top paper investors all wake up one morning and think....."hey, this stuff costs about $15/oz to mine"?
Discuss.
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One issue is that metal bullion is fungible, and the cost of production will be more related to the price (holding supply and demand constant for the moment) than an example like real estate, where every house is different, or a manufactured good, where brand, quality, finish, and "popularity", as well as expertise required and difficulty of production may vary.
Liberty: Parent of Science & Industry
1. uncontrolled fiat money and unregulated otc derivatives distort the price of everything. It's difficult to discover the true market price of anything with all the
speculation in both directions to obfuscate it. What we have each day is the latest in a sequence of manipulated prices.
2. current production costs may have no bearing on total world supply remaining, current inventories, and potential substitutes. Supply and demand often lag each
other by significant amounts. And often times those lags are created by both #1 and #2.
So the "ultimately" will occur when we fix our paper-derived instruments once and for all.
roadrunner
When it is hard to increase supply (and there are not substitutes), demand will be the long term driver of price, and price can stay forever well above production cost.
Liberty: Parent of Science & Industry
Obviously, "at the margin" high gold prices means more production will come online. But that production will be sold into the market at whatever cost the market is paying. Over time it may cause gold prices to decrease. But the bull market in gold in the 1970s and the current bull market really have little or nothing to do with changes in production costs. Gold didn't suddenly become easier to mine in the 1980s and 1990s when prices fell.
Obviously, "at the margin" high gold prices means more production will come online. But that production will be sold into the market at whatever cost the market is paying. Over time it may cause gold prices to decrease. But the bull market in gold in the 1970s and the current bull market really have little or nothing to do with changes in production costs. Gold didn't suddenly become easier to mine in the 1980s and 1990s when prices fell.
In a perfect, undistorted world, prices are set at the interesection of supply and demand. Unfortunately, none of us live in such a world, esp. with regard to PM's. How did JPM & Co. having $190 BILL in silver otc derivatives in July 2008 "help" find the intersection of silver supply and true demand? Note, at the time that amounted to 13 yrs of annual world silver production shorted. It helped just as much as the too big to fail banks having $180 TRILL in otc interest rate derivative contracts in determining accurate interest rates to guide investment activity. The supply and demand curves I learned in economics 101 back in the 1970's have become a joke when it comes to many commodities, interest rates, and other key financial markers.
Since the world's gold inventory only increases by about 1-1/2% per year, it could be said that over a 3-5 yr period, all the gold in the world has been "discovered." The 1-1/2% increase per year has no significant effect on existing supply (ie inelastic supply). During the gold run up from 1967-1980 there was no real increase in mining production. The miners were slow to react and production didn't peak until 1985-1986, long after the pog peaked in Jan. 1980. It's following the same path today with gold production essentially being unchanged or falling since 2001. While the arm chair economists expect supply to pick up as the price rises, it hasn't been the case for gold. Gold miners are running into a huge number of obstacles including ore grades being about 1/3 of what they averaged just 10 yrs ago. The number of big discoveries have tailed way off. When the gold prices tailed off into the later 1980's and 1990's the miners let infrastructure fall apart as they played the gold carry trade to make money. High prices today in gold (ie 6X 2001 prices) have lead to no increase in gold production. I'm sure it will eventually increase over the next 3-10 yrs with production peaking long after the gold price has peaked. There are some huge deposits on the drawing board that should come to market in the 2016-2021 time frame. Of course by then, the gold price could be $3,000/oz or higher. Even so, production might increase to 2 to 2-1/2% per year rather than the current 1-1/2%.
Can someone explain how unregulated otc derivatives in quanities that dwarf years of annual production "help" to discover the true price intersection of supply and demand? Did these
financial tools help to discover the true price of homes back in 2004-2007?
roadrunner
If the demand for pickled turnips is very low, but the cost of making pickled turnips is very high, pricing pickled turnips according to cost will not force people to pay the high price.
If the market says that the price of gold is $1500 and Miner A can produce it for $1,000 an ounce, he will sell it at $1500 an ounce and make a nice profit. His costs do not determine the price.
If Miner B has an old, deep mine that costs $2,000 an ounce to produce, he still has to sell at $1500 ounce. His choices are to keep operating at a loss and gamble that he will hit the mother lode, or gamble that the price of gold will go up to $2000 an ounce before he runs out of capital, or shut down. His costs do not determine the price.
Liberty: Parent of Science & Industry
<< <i>The supply and demand curves I learned in economics 101 back in the 1970's have become a joke when it comes to many commodities, interest rates, and other key financial markers.
...
Can someone explain how unregulated otc derivatives in quanities that dwarf years of annual production "help" to discover the true price intersection of supply and demand? Did these
financial tools help to discover the true price of homes back in 2004-2007? >>
RR, I don't doubt that the big banks have played games in an attempt to manipulate the price of commodities. I am skeptical of the claim that they've always tried to manipulate prices downward. Seems just as likely they would want a lot of volatility - up and down, and repeat. Whatever it takes to bring in the profits. The big banks don't have national interests... their interest is making money. If that means investing in Cambodian pig futures or Latvian real estate, they will do it.
I would agree they probably manipulate in both directions, but with a preference to one side. But I disagree that they don't have national interests. JPM and Goldman Sachs performing the will of the FED and Treasury is certainly supporting govt's interest. And no doubt there is plenty of it going around. Being a henchman of the federal govt comes with perks, such as socialized losses and plenty of guaranteed profits on can't lose deals. The more they deal on behalf of the govt, the more profits they make. It's all part of being too big to fail. In case anyone didn't notice, those banks have gotten even bigger as hundreds of smaller banks have beem shuttered by the FDIC.
roadrunner
<< <i>... and if Miner C can mine gold for $1100, he might be willing to sell it for $1450 and undercut miner A.
Riiiiiiiiiiiiiiiiiiiiiiiiight........................
<< <i>... and if Miner C can mine gold for $1100, he might be willing to sell it for $1450 and undercut miner A.
If any forumite wants to undercut the competition, I would like to purchase your gold at the $1100 level. Thanks for your interest.
I'm undercutting TheBigB at $1125. Something tells me this is how the real market works and it won't be long before a long chain of undercuts
completes up around $1500/oz.
As long as there are numerous central banks willing to buy gold, the undercutting game is quite limited. There is a growing list of nations (and funds)
that have increased their holdings of gold in the past 2 yrs.: China, India, Mexico, Russia, Saudi Arabia, Kuwait, and Mauritius. But these are only the
nations reporting their buying to the IMF. Of course, we have no list of nations reducing their gold exposure due to IMF approved double counting of leases/swaps.
China would take all they could get but want to do it beneath the radar and ideally during pullbacks in price. They need to at least double or triple their current
reserves in order to become a serious world monetary player.
roadrunner
If someone values something far under market then he's never able to execute a purchase
so there is no demand. If he values something over market then he will probably purchase
the item and continue to purchase it until the price nears his estimation of value or his esti-
mation of value shifts or changes. It's irrelevent that someone thinks a product is worth far
less than market because he won't own it in order to sell it.
But peoples' estimation of the dollar and silver are constantly changing as time goes by. It
takes time to get used to new price levels and this is exascerbated by changes in supply as
price fluctuates. Many people will feel they have to buy milk for their baby and price becomes
virtually irrelevent. Others will substitute. This means supply is dependent on price since more
demand results in higher production. This is of course seen in silver as well though it requires
the perception that prices will remain advantageous to commit the capital to begin mining or
even to seek deposits. Much of the silver supply is the result of scrap while very little milk
will come from other sources.
I believe to an unparalleled extent the price of silver today has more to do with inertia than
any other factor. People have percieved its value as between about 15 min and 8 hours wages
since the beginning of time. It is in this range because it is this range. It is stuck because of
the perception that this is its value. As it approaches the higher side there are sellers and as
it drops there are buyers.
Current production costs are always irrelevent in pricing unless there is pure competition and
ample ability and supply to meet demand. While demand for milk is fixed by the amount six
billion people can drink in a day there is no real level where silver might be said to be ample.
If supplies were far highr then we might use it far more extensively since it makes great wire
and nice foil. It could be used to back currency. The minimum amount necessary to run the
economy is likely only 2/ 3rds of current production but we are actually consuming all of it. Put
it this way; if it were very easy to mine and cost only pennies the price would still be through
the roof if the demand were higher than total mining.
In a nutshell all prices are set by supply and demand but both supply and demand are both
set by perception. Cost of production indirectly affects the supply. Markets can be highly ef-
ficient when they are based on pure competition and are largely unregulated but these factors
affect few markets now days so we have perception and inertia.
Those selling can pretend that they mined it themselves too.
Editted to add: I would like to salute both roadrunner and cladking for their contributions to our precious metals discussions.
but, along with supply and demand curves, one might consider the availability of replacement and substitue supply for the asset
the relatively recent sharp rise in PM prices will have caused at least some new supply to be developed, at production prices between 700 and 1200/oz.
that metal should be coming to market eventually. sure demand may overcome the new supply or at least counterbalance it, but if a hot new bubble forms in a different asset class, the demand component among the non-catatrophists in the investing world may wane..
Liberty: Parent of Science & Industry
Probably a very negligible difference. Whatever hits the drawing boards today is years down the pike. The miners have been wallowing in rising costs for the past
several years and hence the reason why gold bullion has out-paced miners for a couple of years. Until mining costs drop (ie oil costs, labor, materials, supplies, etc.)
don't expect too much out of the miners. Gold doubled in price from 2001-2005 yet production didn't change. Gold doubled again in price by 2008 and production
didn't change. Gold has gone up another 50% since the peak in 2008 and gold production really hasn't changed. So what kind of price will it take to increase production
and how many years will that be?
Considering that 166,000 tons of gold exists above ground and only 2500 tons is added per year (approx 1-1/2%), it really doesn't matter whether production next year
is 2500 tons or 2800 tons, or even 3,000 tons. The driving factor is the 166,000 tons already in play. World gold value is increasing about $120 BILL/yr. per year. That's a
far cry from the total increase in fiat, credit/debt, derivatives, and entitlements each year. Just in the past several months M0 (money base) increased by hundreds of billions of
dollars. That's just the USA and not the rest of the world.
roadrunner