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The Impact of COVID-19 Shutdowns on the Gold Supply Chain

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Gold Supply Chain Covid-19

Sprott
Global Business

How COVID-19 Shutdowns Impact the Gold Supply Chain

Chains are only as strong as their weakest link—and recent COVID-19 shutdowns have affected every link in the gold supply chain, from producers to end-users.

Increased investor demand for gold coupled with a constrained supply has led to high prices and a bullish market, which has been operating despite these pressures on the supply chain.

Today’s infographic comes to us from Sprott Physical Bullion Trust and it outlines the gold supply chain and the impacts COVID shutdowns have had on the gold market.

The Ripple Effect: Stalling a Supply Chain

Disruptions to the gold supply chain have rippled all the way from the mine to the investor:

  1. Production
    Some gold mines halted production due to the high-risk to COVID-19 exposure, reducing the supply of gold. In many nations, operations had to shut down as a result of COVID-19 based legal restrictions.
  2. Delivery
    Strict travel regulations restricted the shipment of gold and increased the costs of delivery as less air routes were available and medical supplies were prioritized.
  3. Refinery
    Refineries depend on gold production for input. A reduction in incoming gold and the suspension of labor work shortened the supply of refined gold.
  4. Metal Traders
    Towards the other end of the gold supply chain, traders have faced both constrained supply and increased cost of delivery. These increased costs have translated over to end-users.
  5. The End Users
    Higher demand, lower supply, and increased costs have resulted in higher prices for buyers of gold.

Gold: A Safe Haven for Investors

As the virus spread around the world threatening populations and economies, investors turned to safe-haven investments such as gold to hedge against an economic lockdown.

This increase in investor demand affected the four primary financial markets for gold:

  1. Futures Contracts:
    A futures contract is an agreement for the delivery of gold at a fixed price in the future. These contracts are standardized by futures exchanges such as COMEX. During the initial periods of the pandemic, the price of gold futures spiked to reach a high of US$70 above the spot price.
  2. Exchange-Traded Funds (ETFs):
    An ETF is an investment fund traded on stock exchanges. ETFs hold assets such as stocks, bonds, and commodities such as gold. From the beginning of 2020 to June, the amount of gold held by ETFs massively increased, from 83 million oz to 103 million oz. The SPDR Gold Trust is a great example of how the surge in ETF demand for gold has played out—the organization was forced to lease gold from the Bank of England when it couldn’t buy enough from suppliers.
  3. Physical Gold for Commerce and Finance:
    The London Bullion Market Association (LBMA) is a market where gold is physically traded over-the-counter. The LBMA recorded 6,573 transfers of gold amounting to 29.2 million oz ($46.4 billion)—all in March 2020. This was the largest amount of monthly transfers since 1996.
  4. Coins and Small Bars:
    One ounce American Gold Eagle coins serve as a good proxy for the demand for physical gold from retail investors. The COINGEAG Index, which tracks the premium price of 1 oz. Gold Eagles, spiked during the early stages of the lockdown.

Each one of these markets requires access to physical gold. COVID-19 restrictions have disrupted shipping and delivery options, making it harder to access gold. The market for gold has been functioning nonetheless.

So how does gold get to customers during a time of crisis?

Gold’s Journey: From the Ground to the Vault

Gold ore goes through several stages before being ready for the market.

  1. Processing:
    Gold must be released from other minerals to produce a doré bar—a semi-pure alloy of gold that needs further purification to meet investment standards. Doré bars are typically produced at mine sites and transported to refiners.
  2. Refining:
    Refineries are responsible for turning semi-pure gold alloys into refined, pure, gold. In addition to reprocessing doré bars from mines, refiners also recycle gold from scrap materials. Although gold mining is geographically diverse and occurs in all continents except Antarctica, there are only a handful of gold refineries around the world.
  3. Transportation:
    Once it’s refined, gold is transported to financial hubs around the world. There are three main ways gold travels the world, each with their own costs and benefits:

    • Commercial Flights:
      Cheapest of the three options, commercial flights are useful in transporting gold over established passenger routes. However, the volume of gold carried by a commercial flight is typically small and subject to spacing priorities.
    • Cargo Planes:
      At a relatively moderate cost, cargo planes carry medium to large amounts of gold along established trade routes. The space dedicated to cargo determines the cost, with higher volumes leading to higher shipping prices.
    • Chartered Airlines:
      Chartered airlines offer a wider range of travel routes with dedicated shipping space and services tailored to customer demand. However, they charge a high price for these conveniences.

After reaching its destination via air, armored trucks with security personnel move the gold to vaults and customers in financial hubs around the world.

The World’s Biggest Gold Hubs

The U.K.’s bullion banks hold the world’s biggest commercial stockpiles of gold, equal to 10 months of global gold mine output. London is the largest gold hub, with numerous vaults dedicated to gold and other precious metals.

Four of the largest gold refineries in the world are located in Switzerland, making it an important part of the gold supply chain. Hong Kong, Singapore, and Dubai are surprising additions and remain significant traders of gold despite having no mines within their borders.

COVID-19: The Perfect Storm for Gold?

As countries took stringent safety measures such as travel restrictions and border closures, the number of commercial flights dropped exponentially across the world. For the few commercial airlines that still operated, gold was a low-priority cargo as space was dedicated to medical supplies.

This impeded the flow of gold through the supply chain, increasing the cost of delivery and the price of gold. However, thanks to the diverse geography of gold mining, some countries did not halt production—this helped avoid a complete stall in the supply of gold.

The COVID-19 pandemic has created the perfect storm for gold by disrupting the global supply chain while investor demand for gold exploded. Despite heightened delivery risks and disruptions, the gold market has managed to continue operating thus far.

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Mining

How to Avoid Common Mistakes With Mining Stocks (Part 4: Project Quality)

Mining is a technical field that manages complex factors from geology to engineering. These details can make or break a project.

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Quality Mining Projects

Mining is a technical field and requires a comprehension of many complex factors.

This includes everything from the characteristics of an orebody to the actual extraction method envisioned and used—and the devil is often found in these technical details.

Part 4: Evaluating Technical Risks and Project Quality

We’ve partnered with Eclipse Gold Mining on an infographic series to show you how to avoid common mistakes when evaluating and investing in mining exploration stocks.

Here is a basic introduction to some technical and project quality characteristics to consider when looking at your next mining investment.

Mining Project Quality

View the three other parts of this series so far:

Part 4: Technical Risks and Project Quality

So what must investors evaluate when it comes to technical risks and project quality?

Let’s take a look at four different factors.

1. Grade: Reliable Hen Vs. Golden Goose

Once mining starts, studies have to be adapted to reality. A mine needs to have the flexibility and robustness to adjust pre-mine plans to the reality of execution.

A “Golden Goose” will just blunder ahead and result in failure after failure due to lack of flexibility and hoping it will one day produce a golden egg.

Many mining projects can come into operation quickly based on complex and detailed studies of a mineral deposit. However, it requires actual mining to prove these studies.

Some mining projects fail to achieve nameplate tonnes and grade once production begins. However, a team response to varying grades and conditions can still make a mine into a profitable mine or a “Reliable Hen.”

2. Money: Piggy Bank vs. Money Pit

The degree of insight into a mineral deposit and the appropriate density of data to support the understanding is what leads to a piggy bank or money pit.

Making a project decision on poor understanding of the geology and limited information leads to the money pit of just making things work.

Just like compound interest, success across many technical aspects increases revenue exponentially, but it can easily go the other way if not enough data is used to make a decision to put a project into production.

3. Environment: Responsible vs. Reckless

Not all projects are situated in an ideal landscape for mining. There are environmental and social factors to consider. A mining company that takes into account these facts has a higher chance of going into production.

Mineral deposits do not occur in convenient locations and require the disruption of the natural environment. Understanding how a mining project will impact its surroundings goes a long way to see whether the project is viable.

4. Team: Orchestra vs. One-Man Band

Mining is a complex and technical industry that relies on many skilled professionals with clear leadership, not just one person doing all the work.

Geologists, accountants, laborers, engineers, and investor relations officers are just some of the roles that a CEO or management team needs to deliver a profitable mine. A good leader will be the conductor of the varying technical teams allowing each to play their best at the right time.

Mining 101: Mining Valuation and Methods

In order to further consider a mining project’s quality, it is important to understand how the company is valued and how it plans to mine a mineral resource.

Valuation

There are two ways to look at the value of a mining project:

  1. The Discounted Cash Flow method estimates the present value of the cash that will come from a mining project over its life.
  2. In-situ Resource Value is a metric that values all the metal in the ground to give an estimate of the dollar value of those resources.

Mining Method

The location of the ore deposit and the quantity of its grade will determine what mining method a company will choose to extract the valuable ore.

  1. Open-pit mining removes valuable ore that is relatively near the surface of the Earth’s crust using power trucks and shovels to move large volumes of rock. Typically, it is a lower cost mining method, meaning lower grades of ore are economic to mine.
  2. Underground mining occurs when the ore body is too deep to mine profitably by open-pit. In other words, the quality of the orebody is high enough to cover the costs of complex engineering underneath the Earth’s crust.

When Technicals and Quality Align

This is a brief overview of where to begin a technical look at a mining project, but typically helps to form some questions for the average investor to consider.

Everything from the characteristics of an orebody to the actual extraction method will determine whether a project can deliver a healthy return to the investor.

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Gold

Comparing Recent U.S. Presidents: New Debt Added vs. Precious Metals Production

While gold and silver coin production during U.S. presidencies has declined, public debt continues to climb to historically high levels.

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Gold and Silver Coin Production During U.S. Presidencies

Recent U.S. Presidents: Debt vs. Coins Added

While precious metals can’t be produced out of thin air, U.S. debt can be financed through central bank money creation. In fact, U.S. debt has skyrocketed in recent years under both Democrat and Republican administrations.

This infographic from Texas Precious Metals compares the increase in public debt to the value of gold and silver coin production during U.S. presidencies.

Total Production by Presidential Term

We used U.S. public debt in our calculations, a measure of debt owed to third parties such as foreign governments, corporations, and individuals, while excluding intragovernmental holdings. To derive the value of U.S. minted gold and silver coins, we multiplied new ounces produced by the average closing price of gold or silver in each respective year.

Here’s how debt growth stacks up against gold and silver coin production during recent U.S. presidencies:

 Obama's 1st term (2009-2012)Obama's Second Term (2013-2016)Trump's term (2017-Oct 26 2020)
U.S. Silver Coins Minted$3.7B$3.3B$1.4B
U.S. Gold Coins Minted$6.7B$5.1B$2.9B
U.S. Public Debt Added$5.2T$2.9T$6.6T

Over each consecutive term, gold and silver coin production decreased. In Trump’s term so far, the value of public debt added to the system is almost 1,600 times higher than minted gold and silver coins combined.

During Obama’s first term and Trump’s term, debt saw a marked increase as the administrations provided fiscal stimulus in response to the global financial crisis and the COVID-19 pandemic. As we begin to recover from COVID-19, what might debt growth look like going forward?

U.S. Public Debt Projections

As of September 30, 2020, the end of the federal government’s fiscal year, debt had reached $21 trillion. According to estimates from the Congressional Budget Office, it’s projected to rise steadily in the future.

 2021P2022P2023P2024P2025P2026P2027P2028P2029P2030P
U.S. Public Debt21.9T23.3T24.5T25.7T26.8T27.9T29.0T30.4T31.8T33.5T
Debt-to-GDP ratio104.4%105.6%106.7%107.1%107.2%106.7%106.3%106.8%107.4%108.9%

By 2030, debt will have risen by over $12 trillion from 2020 levels and the debt-to-GDP ratio will be almost 109%.

It’s worth noting that debt will likely grow substantially regardless of who is elected in the 2020 U.S. election. Central estimates by the Committee for a Responsible Federal Budget show debt rising by $5 trillion under Trump and $5.6 trillion under Biden through 2030. These estimates exclude any COVID-19 relief policies.

What Could This Mean for Investors?

As the U.S. Federal Reserve creates more money to finance rising government debt, inflation could eventually be pushed higher. This could affect the value of the U.S. dollar.

On the flip side, gold and silver have a limited supply and coin production has decreased over the last three presidential terms. Both can act as an inflation hedge, while playing a role in wealth preservation.

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