Breaking Down the Gold Supply Chain
What is the true cost of gold?
Is such a question even adequate to address the realities of pricing? When you buy gold, what exactly are you paying for?
These are all tricky questions, and for a number of reasons:
- First, the cost of gold, as with all commodities, is never fixed--they're subject to fluctuations based on supply and demand.
- Second, the cost of gold, as with most products, depends on what the market is willing to pay for it--buyers and sellers on the commodity level negotiate a favorable price to which both can agree; and that action moves the price of gold.
- Third, when you pay for a gold coin or bar, you are paying not only for a "product" but a share of the entire production "process."
This last point is something that customers often miss.
Paying for a Product and Process
Let's take a grocery item like breakfast cereal. If you were able to buy small quantities of breakfast cereal wholesale, then you would certainly save more money than you would buying the product at your local grocery store, where price is marked up to cover the store's costs and to turn a profit.
But even if you were to buy cereal wholesale, you're buying a product that has a number of its manufacturing costs already embedded into the price. A farmer had to pay various resource and labor costs to grow and harvest the grains. A manufacturer had to pay the farmer in addition to other service providers, manufacturers, and workers to turn the grains into a well-packaged and well-marketed box of cereal.
By the time the manufacturer has determined the price of the cereal per unit, it has to include the cost of production plus a markup in order to generate some margin of profit. In other words, the consumer, whether buying wholesale or not, is paying not only for the final product, but also for a share of the entire process that went into creating that product.
Gold coins and bars are no different from other products when it comes to supply chain costs finding their way into the final price tag.
The Gold Supply Chain
So, what's the process you're paying for when you purchase a gold product? To get a clear picture of all the costs embedded into the final price tag, let's take a look at the entire supply chain from ground to final sale.
1 - Local and National Permits for Gold Exploration
The gold supply chain begins in the physical region where the metal is to be found. Before a miner sets up mining operations, the company needs to obtain a permit from the government.
Mining operations and ownership are regulated by government entities. Regulation extends to various aspects of the operation, including human working conditions, environmental impact, and safety protocols.
Regulations may be specific to a given region or country; or, they may align with international standards and guidance. Each country's regulatory standards will likely have aspects that are specific to that given country with regard to mining, mine ownership, artisanal and large corporate mining operations, land ownership, and mining rights. Regulations may also change according to the political climate and regime.
The cost of obtaining permits to mine gold will vary from country to country. However, it is an expense that will likely find its way to the price of the metal that has yet to be mined.
2 - Mining Operations
Gold can be found in hard rock deposits or alluvial deposits. If a miner is lucky, he or she might find, on average, between one to twenty grams of gold in one ton of ore.
As you might guess, mining is an extensive operation requiring a sizable workforce. Around 7 million people are employed by industrial miners worldwide. But an even greater number--around 100 million people--comprise the "artisanal and small-scale mining industry (ASM). These are smaller independent miners ranging from informal digs to smaller operations.
Artisanal and small-scale mining is an active industry that spans around 80 countries across the globe. It produces 20% of the world's mined gold supply. Depending on the country, ASM and large-scale mining (LSM) may coexist with or compete against one another.
On the ASM side, miners are less equipped, and so they produce less than their LSM counterparts. Yet, the industry plays a significant role in supporting the livelihood of certain local populations. The mining process typically involves digging, transporting, crushing, washing, and filtering gold ore. The sediment is then processed with mercury or other chemicals to yield a gold-chemical amalgam. That product is then sold to local gold traders.
On the LSM side, the process is similar, but large-scale miners have the advantage of machines to crush and mill the rocks to powder or slurry form, and they can use sodium cyanide to yield impure gold.
The cost of production plus the desired premium, both of which vary from miner to miner, will constitute the SPOT PRICE offered to local traders/exporters or to refiners.
So, if a miner sells an ounce of gold at a spot price of $800, and the market price of gold is $1,800, then the miner profits by $1,000.
This process applies to both ASM and LSM miners. Given the scale differences in the workforce, labor resources, and efficiency, you can imagine how the cost or production and premiums will vary according to the miner.
3 - Local Traders and Exporters
The trading process can comprise many different steps and variations. For instance, a small miner can sell small quantities of gold amalgam to a local trader, who then may, in turn, sell it to a larger trader.
Miners may work on a collective basis to bypass the small trader, selling directly to larger traders. A larger trader may opt to smelt the gold if they have the resources, or they may send the gold to a refinery.
And larger miners may have the option to sell their gold directory to smelters.
In each instance, the price of gold will vary depending on who determines the pricing and the original price set by the miner. A reasonable markup estimate is around 2%.
The miner may set the price. So too might the local trader. Local government may also have a hand in setting the price. In short, there can be few to many steps between the miner and the smelter. And within this process, the price of gold may increase depending on the number of steps taken to get the gold from the ground to the smelter.
4 - Transporters
The transportation of gold from mine to smelter can vary widely across ASM and LSM operations. Whether a miner is transporting on foot, by bicycle, truck, or trailer, the cost of labor, energy, insurance, and in a few cases, taxation, will eventually be tacked onto the price--a markup typically ranging around 1.5%.
5 - Smelters and Refineries
Now we reach the midpoint of the gold supply chain. The process leading up to the smelter can be considered the "upstream" process. Everything following it can be called the "downstream" process.
In the smelter process, gold is released through the process of melting the yellow metal and subjecting it to a chemical process to extract the metal in a semi-pure form. The result of this process is dore' gold--a semi-pure alloy of gold and silver.
At this point, the purity will vary, and that's where the refinery comes in. Refineries subject the gold to further treatment in order to bring its purity to 0.999+. Also called "gold blanks," these are the products that are sold to Mints around the world for the purpose of striking gold coins.
The cost of purchasing and producing the gold for the smelter and refinery process will vary. Bars usually see an additional 1.5% increase in price; blanks sold to mints can yield a larger percentage.
6 - Mint
A mint is a facility that produces a country's currency. They produce "legal tender" coins for circulation, and they also produce precious metals coins and bars for collectors and investors.
By the time a mint has produced a gold coin or bar, it can raise the cost of each unit from 5% to 15%, depending on its production cost and assessment of value.
7 - Gold Dealers
At GSI Exchange, our commissions account for costs in restocking, insuring, implementing strict quality checks, and hedging our stored gold (so as to not lose money on our inventory). And that's just the product end of our costs. Like every other business, we also have various administrative costs that have to be taken into account. Quality service relies on a strong team, and we always strive to provide optimal service to our customers.
We do our best to provide competitive pricing as it's in both our and our customer's interest to offer the best quality precious metals products at the best available prices.
The Bottom Line
The price of precious metals will fluctuate on the market side depending on supply and demand. That's just the basic law of economics. But what some customers aren't typically aware of are the costs that go into a precious metals product before it even reaches the market. Hopefully, by now, you have gained a basic understanding of the gold supply chain and the total cost of the process that finds its way into the final price tag.