Gold: The new asset class for the confused

Lassonde is still a believer, but deconstructed shifts in its market.

“There’s been a decoupling of equities from gold prices,” he said. The supply-demand situation is clearly pointing to ever-increasing prices but not necessarily for gold producers.

Lassonde ran Newmont Mining Corp for five years (“it nearly killed me”) and is currently chair of Franco-Nevada, a company he co-founded with Seymour Schulich in 1982. Sitting beside me was another gold bug, and philanthropist, Rob McEwen of Goldcorp who now runs McEwen Mining.

Here is what Lassonde told the seminar on gold prices:

• Demand is up since 2002, but among different buyers: In 2002, 80% of gold was bought as jewellery, 5% industrial and 5% investment. By 2011, gold demand for investment purposes had jumped to 40%.
• In 2008, central banks stopped selling gold and began buying. Of the total, 58% of gold reserves were held by US and EU central banks and 2.6% by Asian central banks. “If they increase to 15% of gold reserves, or 17,359 tonnes, the gold price will increase because annual production is only 2,800 tonnes.”
• Investor demand will continue to increase. ETFs began in 2004 and total 2,800 tonnes. This is only slightly higher than Italy’s gold reserves.
• Gold’s share of asset allocation has gone from 0.5% to 2% between 1980 and 2011 and “will go to 5, 6, 7% in five to 10 years given the current environment”.
• Chinese demand is dramatically rising. The Chinese gold market is mostly jewellery but has been increasing twice as fast as the rate of increases in its GDP.
• When foreign exchange reserves rise, gold prices increase.
• When US money supply increases, gold prices increase.
• In 1980, at $800 an ounce, gold was equivalent to one unit of the Dow. Now prices represent an 8 to 1 ratio. “If it goes back to 1-1, then gold will go from $1,700 an ounce to $13,500.”
• Uncertainty in Europe will continue and Greece will have to leave the eurozone in a few years. The commodity super-cycle is not over, just taking a breather.

Lassonde discussed the challenges for gold equities:

• The decoupling of shares from bullion prices will continue because of “grade decline by 50% to 60%”. These low-yield mining reserves cost more to produce.
• New finds are “very elusive”. In 1960, every dollar spent on exploration led to a return of 105 times. In 2000, it’s only 11 times.
• Resource nationalism is reducing supply as countries ban foreigners, over-taxing them or confiscating ore bodies.
• Supply will continue to remain static or decline because the mining industry is using old exploration and extractive technologies with low grades. Massive research is needed by the industry for all metals, as has been done in the oil sector, where fracking has transformed the reserve outlook.
• Supply is adversely affected by the long lead times to production, 20 years on average. This means the net present value 15 or 20 years out destroys benefits.

Lassonde’s supply-demand analysis points to escalating prices indefinitely. But there’s a caveat of sorts.

“I don’t think we’ve reached peak gold and I believe that new technologies will come along,” he said.

He believes that universities and scientists must spend billions to devise better exploration and extraction technologies. He referred to the need for “3D seismic” in exploration, or “in situ” extraction as is done selectively in the oil and uranium sectors.

In the meantime, however, he suggested that investors and companies alike must be skeptical of many bearish analyst forecasts. Their proclivity is to forecast gold prices lower and oil prices higher, he said. Because power represents 25% of the cost of mining production, this projects a scenario of “margin compression” that is not appropriate.“This would require research into physics and electricity,” he said after the presentation. “Look at what ExxonMobil has spent in the oil industry in terms of research. Mining must do the same.”

“Everyone should do their own homework and the best gold price forecast is contango [when a curve is in contango, the futures price is greater than the spot price at contract maturity]. If the forward price is good enough for the market, then it’s good enough for investment decisions,” he said.

“If you are using $1,200 an ounce for gold three years out as your price [to evaluate a company or mining project], and if you believe that will be the price, then you should not be investing in the gold business,” he said.

Diane Francis | Oct 12, 2012 2:27 PM ET