By Drew Hasselback Never mind the gold bugs and their conspiracy theories

The real questions are about cash flow and operating costs

I’m greatly amused by gold bugs. Publish a single article that makes reference to gold, and I’m soon inundated with mail detailing countless conspiracy theories. Each has the same punchline: The price of gold is nowhere near its “true” level due to a great conspiracy to undermine its value.

I’ve received countless letters and e-mails offering “evidence” of the conspiracy in action. Despite such efforts to enlighten me, I’ve yet to be convinced the gold price is being manipulated through some nefarious plot. Maybe it’s due to an intellectual flaw on my part. Perhaps it’s due to my being brainwashed by the secret cabal directing one of the conspiracies. If gold moves up or down, I think it’s simply the result of good old-fashioned supply and demand for that particular commodity.

Which is not to say that I’ve never thought gold to be a great short-term investment. My point is that while I might like gold sometimes, I don’t necessarily like it all the time. The thing that separates gold bugs from ordinary investors is that gold bugs always believe the gold price is going to rise. A rising gold price means the conspiracy is finally failing and truth is prevailing. A falling gold price means that central bankers and financiers are mucking around behind the scenes to further the anti-gold conspiracy.

Gold bugs view their favourite metal as money, arguably the purest form of money there is. Ordinary investors are content with the intrinsic value that is assigned to gold by the daily fluctuations in the spot market. Gold bugs think the true value is suppressed by the actions of central bankers who overvalue paper money that floats in value on currency markets. 

Let’s talk about why people invest in gold: It’s suggested as a hedge against inflation. The concept works like this. Gold is priced in U.S. dollars. As the value of the U.S. dollar drops, the price of gold tends to rise. Gold’s intrinsic value is supposed to keep the value of the gold steady relative to that dropping U.S. dollar. Now factor in inflation. Let’s say you stuffed $10,000 in your attic. As the years tick on, the face value of that $10,000 remains constant, while the buying power of that $10k decreases. How do you protect yourself? Some would answer that you could have bought $10,000 worth of gold instead. As inflation erodes the value of the currency, gold should offer some protection.

Here’s the problem. Let’s say you bought an ounce of gold back in 1980 when the price reached $873 (U.S.) and inflation was in the double digits. Then gold tumbled, and didn’t surpass that price until a couple of years ago. Even then, if you adjust for inflation, the sum $873 (U.S.) in 1980 dollars is worth about $2,290 (U.S.) in today’s dollars. Considering that it took until December 2009 for gold to poke past $1,200 (U.S.), gold has not offered much protection against inflation over the past few decades.

Shorter term, however, gold has been attractive, rising nearly 40 per cent over the past two years. The ballooning U.S. deficit has caused some to question the value of the U.S. dollar. Some investors have picked up on this as an excuse to gamble on the gold price. Short term, that gamble has paid off.

A lot of the chatter is about how other nations – primarily China – have shifted their U.S. cash reserves to other assets, such as gold. While this has happened, these moves must be put in context. China has more than $2-trillion in U.S. currency reserves. China has about 1,054 tonnes of gold. At $1,200 (U.S.) an ounce, that’s roughly $40-billion worth of bullion – only two per cent or so of those foreign currency reserves. While China has said it intends to boost its bullion holdings over the next few years, an official with the Chinese central bank has warned that China is moving cautiously because the gold price might be in a short-term bubble.

I’m mentioning all this because gold is about to take on new life in the North. Any day now, Agnico-Eagle is expected to start production at the Meadowbank mine in Nunavut. It’s been a while since a new gold mine opened in the North, so the launch will generate some buzz about gold. 

I won’t be too focused on the gold price, however. I’m far more interested in watching whether this new mine will meet its production targets and grade forecasts. The real question for me is whether Meadowbank will generate cash flow based on its operating costs. A mine that generates a healthy return will bolster the case for future mine construction in the North. And that interests me a lot more than a conspiracy theory.

the associate editor of financialpost.com. He was a mining reporter for The Financial Post from 2001 to 2007.