Gold miners have had a terrible year. As a barometer of sector health, the Market Vectors Gold Miners ETF (NYSEARCA:GDX) has declined 18.6% year to date, excluding dividend and over the past five years the ETF has declined 59.4%. And it seems as if things are only going to get worse for the sector as the price of gold collapses and costs continue to rise.

Gold Miners: Barrick Gold’s credit default swaps jump to 199 bps

Barrick Gold Corporation (NYSE:ABX) (TSE:ABX) the sector’s largest player in terms of production, recently saw the price of its credit default swaps jump to 199 bps, close to a 2014 high of 206, making the company’s debt the second most expensive to insure among Canadian companies. Standard and Poor’s has threatened to downgrade the major producers, including Barrick, to ‘junk’ if the price of gold falls below $1,100/oz — now a very real possibility.

The miners themselves are not to blame. The cost of gold production has skyrocketed over the past decade and the price of gold has not been able to keep up. For example, during 2001 the all-in-sustaining cost to produce one ounce of gold stood at an average of $350. By 2007 the average AISC of production had reached $717/oz, rising further to $1,100/oz by 2009. For many producers, the cost of production exceeded $1,300/oz during 2013.

Gold Miners AISC of production

Even the market’s largest producers still have stubbornly high costs. Barrick Gold reported an AISC of $834/oz during the third quarter and is now guiding for a full-year AISC of between $880 and $920/oz. Meanwhile, Goldcorp Inc. (NYSE:GG) (TSE:G) reported an ASIC of $1,066/oz during the third quarter. Full-year guidance is for between $950 and $1,000 per gold ounce. Newmont Mining Corp (NYSE:NEM) is guiding for a full-year AISC of $1,020 to $1,080/oz.

Pricing pressure within the gold mining industry can be traced to one thing; cost inflation. While the cost to produce gold has increased over the years, the price of gold, which is influenced more by supply and demand factors, has stagnated.

However, popular belief dictates that the price of gold should rise in line with inflation. Although it seems as if this is not the case.

Gold Miners: Price of gold does track CPI

A study entitled On the Economic Determinants of the Gold-Inflation Relation published earlier this year appears to show that there is no cointegration between gold and the consumer price index (CPI) if the volatile period of the early 1980s is excluded from the data. The data studied spanned the period between 1985 and 2012. This result does run contrary to some studies, such as Worthington and Pahlavani (2007), Wang et al. (2011) and Beckmann and Czudaj (2013), which show that the price of gold does track CPI. On the other hand, studies by Blose, 2010; Baur, 2011; Erb and Harvey, 2013 support the opposite view. It should be noted that the Erb and Harvey (2013) study only studies data over a period of one year.

Still, the study looks at 319 data points between January of 1985 and June of 2012, comparing both the CPI as noted by the Federal Reserve Bank of St. Louis Fred database and gold prices are the average monthly London PM fix sourced from the World Gold Council. All in all, the paper finds that the data studied supports the argument that the cointegration relationship between the gold price and the CPI disappears in data after 1985.

As previous studies before it have done, the above study contradicts previous data conclusions adding yet more confusion to the fundamentals of the gold price. Nevertheless, this data does provide some interesting food for thought.

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