No high premiums for suggested gold miner cartel

Yesterday The Gold Report published an interview titled Miners Should Launch a Gold Cartel or Risk Losing Everything, Advises Stephan Bogner.

In it Stephan suggests that "mining companies should collectively refrain from selling into the market at spot prices but should instead find buyers themselves, as there are definitely investors worldwide—especially from Asia, as well as the Middle and Far East—that would pay high premiums on the spot price to get their hands on physical bullion."

I think this suggestion is simplistic in a number of ways. Firstly, while premiums can develop in certain geographical markets from time to time due to various factors (see this interview with Al Korelin where I explain the impact of restricted Chinese import licenses and quotas) in no market is anyone paying $1900 an ounce - "high premiums" at best means tens of dollars, not hundreds of dollars (see this William Kaye interview). The fact is that Chinese demand exploded in April because the price dropped, and a lower price is the miner's problem.

Secondly, the gross premiums being quoted are not necessarily what the bullion banks are getting. In that William Kaye interview, he says that "senior members in China’s government, probably in the State Council, basically decided that they were sick and tired of the premiums that the Chinese people were having to pay over the London price for gold", which accords to what we heard, but William gets it wrong when he says that "they (Chinese officials) recognize that the bullion banks, at the expense of the population and the jewelers, have been making arbitrage profits". The real story is that it is the limited number of licensed Chinese importers who have the upper hand over the bullion banks, who compete to supply (and extend credit) to the importers, so a good part of the premiums were going to the importers, not the bullion banks. So miners would not get all of the reported high premiums.

Thirdly, the actual gross premiums paid by importers are just that - gross. From that you have to take off the costs of selling, which would include management time spent by each mining company finding and negotiating with each buyer, shipment costs to refiners, fabrication costs, shipment costs from refiner to buyer, and in most cases of the main distributor/importers, the cost of interest in funding the sale as these business often want 180 day payment terms or consignment stocks. The end result is that the reported gross premiums end up as a much smaller profit.

The idea of miners finding buyers themselves is like saying farmers should deal directly with individual supermarkets. There is a reason industries like milk (and gold) have processors who aggregate volumes, and distributors who manage sale to many retail outlets. It is just more efficient than producers trying to deal directly with every buyer. Gold distributor/importers for example, prefer to deal in tonnes at a time as that keeps shipment costs between countries down.

The only way it could work is if a group of miners got together and pooled their output and negotiated with a refinery for fabrication and distributors for sales at a scale that made sense. But then that organisation is just doing what bullion banks do. In addition it would need to raise capital from investors to fund the gold tied up until they eventually got paid, and miners are having problems raising money. There is also credit risk associated with who you are selling to, if they don't pay. These are not skill sets many mine managers have.

I'm not trying to dissuade miners from forming such groups - it doesn't make a difference to the Perth Mint, for example, whether we deal with a bullion bank or a miner group. Just pointing out that there is no easy money in these "high premiums" that are seen from time to time. Gold distribution is a competitive business and the marginal profit earned is not going to solve miners' current financial problems, which require prices hundreds of dollars higher, not tens of dollars.

The only way gold miners can really impact price at the margin is to withhold supply. Stephan suggests this, saying that miners "should use gold and silver as the functional currency for the industry ... look for ways to bank their gold as cash assets or take out gold loans, not dollar loans. They should buy physical gold and silver and store it outside the banking system. When they require cash, they can sell part of their holdings." David Baker, of Baker Steel Capital Managers, has been talking about miners holding gold on their balance sheet and gold dividends as well. Perth Mint fully supports such initiatives (see this Korab Resources announcement for example).

However, the problem with the idea of holding gold is that at this time the most miners are strapped for cash and don't have the ability to not sell and simply hold gold in the quantities necessary to impact the price.

I don't know what the solution is to gold miner's current problem, but suggesting that there is some pot of easy high premium gold waiting for producers just creates a false hope.