I am having a hard time balancing record gold prices with the rapid growth in capital costs. On one hand, record gold prices should be able to support new mine development, but on the other hand, the huge expansion of oil & gas development in Alberta and continued development in other Canadian industries have driven costs so high to a point where very little is feasible.
Looking at the stream of new company press releases, the mining industry has gone into a panic-and-shock stage of project development. It seems nothing will move forward unless construction has already been started.
One reason why gold projects are not bankable is that any feasibility study assumes gold prices will go back down; according to conservative analyst consensus, gold prices cannot stay high forever. To make a gold project feasible, it must have a 14% internal rate of return (IRR) at $1,000 per ounce of gold. Yet it will also have sky high CAPEX costs. The problem is capital must be sunk today at record costs, yet the revenue is projected over 20 years at discounted expected gold prices.
Currently, a significant number of major new gold projects will not be built. What could change is the cost of construction; it can and will eventually come down. Labor costs will also decrease since supply/demand is very quick to adjust in the construction industry. Analysts could get more comfortable with sustainable high gold prices.
The markets will change and costs will change. Gold prices could increase even further. I expect large marginal projects will retain significant option value, but will be deferred for the next 1-2 years. In my next blog post, I will discuss option value vs. net present value (NPV).