Energy prices are a big input cost to the mining process. This may matter to you for two main reasons. First, mining is how we get our gold and silver, and higher mining costs will mean higher gold and silver prices. Second, most materials we use in industry are either farmed or mined, so rising energy costs will therefore affect the prices of all the goods we buy every day.
That is why I pay attention to what goes on at the far-left end of the supply chain for precious metals and the mining sector. What happens to prices there eventually rolls into the prices we all pay for gold and silver in the retail market. Costs are just transmitted through the supply chain to the end user. Sometimes costs can be reduced by technology, and sometimes we are all at the mercy of what the market says we must pay given supply and demand.
Energy is affected by both technology and supply/demand fundamentals. But right now, the supply/demand dynamic is having a much bigger effect on what we pay for electricity.
Energy Is Just Getting More Expensive
Energy prices have been rising dating back to last year, even before the Russia-Ukraine conflict and the repercussions to energy prices since. One of the main problems cited for higher commodity costs is higher energy prices. For example, energy makes up 15-20% of the input cost to mine metals, whether they be of the precious variety like gold and silver, or even regular base metals like iron or aluminum. Per S&P Global:
“Energy accounts for 19%-20% of copper mining costs, according to Commodity Insights data, and the industry will be spared some of the effects of rising energy prices where hydropower is a significant energy source, such as in Canada and Chile. But analysts noted most truck fleets operating in large open-pit copper mines use fossil fuels.”
Many precious metals mines are remote, meaning the geological formations of the metals did not have a modern, topographical roadmap when they formed millions of years ago. So quite often they are not near infrastructure such as highways, cities and towns, water, or sources of electricity. The miner often has the choice of paying themselves for such infrastructure, which can be an exorbitant percentage of their mining costs to make it infeasible, or they can bring the energy with them. In the case of mines, that is almost always diesel which is produced as part of the oil extraction process.
Not only is diesel used for rock trucks and other equipment, but it is used on remote sites to power equipment, offices, lights, lab equipment, and tools. Anything that you would plug into an electrical outlet is powered by diesel in many mines where extending the grid hundreds of miles into the countryside doesn’t make economic sense either for the miner or for the state which would take over maintenance of it.
The Chicken and the Egg
The problem with all of this is that for the green energy revolution that many governments want to take place, ‘dirty’ forms of energy are needed to facilitate that transition. And experts like to point out there is not enough hydroelectric, solar, or wind power available to replace fossil fuels or uranium for grid power.
Germany tried to shut down its nuclear capacity, then watched as the war also shut off their supplies of natural gas through the Nordstream pipeline. Now the country is desperately turning back to coal, perhaps the dirtiest of all available options, because they don’t have much choice. It is either that or face the collapse of their industry, which would severely disrupt the European economy for which Germany is a big manufacturing engine.
Not only that, but it will affect their central bank’s ability to manage sovereign debt crises brought on by existing economic pressures. Per S&P Global Market Intelligence:
“Taking a similar view, Chris Berry, an independent analyst, and president of House Mountain Partners said rising energy prices will hit growth and may impact the price and rollout of metal-intensive products such as electric vehicles. “If oil and gas and your commodity input costs increase across the board, it’s just going to slow growth down,” Berry said. “I don’t care what the industry is.”
Whether it is liked or not, we still need fossil fuel energy and nuclear to power our lives. And it is for this reason that rising energy costs are here to stay in the mining industry.
According to the International Energy Agency (IEA), the costs for metals used in green technologies are rising fast. Here is a chart of some of the clean energy metals affected the most so far by rising energy costs. Costs for solar panels and wind turbines are on the rise primarily due to the rise in costs of the metals and energy needed to make them.
Precious Metals
The bad news is that we still expect to see high levels of inflation in the near future. For until the prices of commodities and energy inputs into the manufacturing processes fall, the prices that consumers pay for the end products are not likely to fall either.
The cost for miners to extract an ounce of gold out of the ground, known in the industry as the all-in-sustaining cost (AISC), is going up. Part of it is due to the lack of exploration in finding big new projects with cheap gold, and the other more pressing issue is energy prices that won’t stop rising. Below is a chart of the rising costs for gold miners, courtesy of the World Gold Council.
For example, we are already seeing margin compression in the gold miners from what they bring in (revenue) to what they make (profit). As the margins continue to shrink, gold miners will have no choice but to shut down production when the mines are not profitable. Restarting mines can be a time and money-intensive process that also requires extensive work on meeting government requirements, and is not an ideal situation for the industry to be in. Below is a chart showing the shrinking margins of gold producers.
Final Thoughts
Gold and silver are getting more expensive to produce. In the case of gold, it’s price can be shown as a function of the AISC of the largest 3-4 miners in the space plus the relative demand for passive gold investment such as GLD. While I do not have space here to document that relationship, we will discuss it again in the future.
For now, just know that rising energy costs are going to make everything we buy more expensive until the current issues surrounding energy are addressed. None of the solutions posed for dealing with the energy issue are quick fixes, and with governments determined to force green energy, consumers can expect much higher prices on everything they buy for the foreseeable future.
The biggest offset a person can make is to invest in something that will also rise in price over time and holds long-term value. The first thing I think of that meets that criteria is gold. And that is why I hold it in my portfolio.
Coin of the Week
I get a lot of requests to share my favorite coin or bar that I have purchased over the years. To be honest, I tend to like them all. I am amazed at how such gorgeous designs are pressed into these metals, along with how much work it must have been to generate each unique design. Because I cannot pick just one, I am going to share a favorite with you from time to time.
This week, it’s the Britannia. These were not a staple in my early coin investing where I tended to stick to the lowest premium bullion, which at the time were the 90% “junk” coins and generic rounds and bars. But as my budget has grown, along with my appreciation for the designs, I have purchased a lot of coins from around the world.
A British transplant friend of mine remarked that he thought the Britannia’s were the most beautiful of all the designs, and while I think there are many good ones, it is hard to argue his point. The amount of detail put into that coin reflects the pride of the British people and the history of silver and gold in their society.
It is in many ways an important piece of history not only to the Brits but for us Americans who once held allegiance to the crown and have since adopted and implemented many of our Constitutional and common laws from the Magna Carta. The Bill of Rights comes to mind, for example. Therefore, I believe it is a piece of our history as much as it is of theirs.
What is your favorite coin design?