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New Shine Behind 25-Year High for Gold: Changes From Ground to Market

Technology and Strong Demand
Alter Its Odd Economics;
Inside a Secret Vault
Trading In Jewelry for Cash
By E.S. BROWNING
April 12, 2006; Page A1

After gold soared above $500 an ounce a few months ago, tub after plastic tub of gold jewelry from the Middle East and India began arriving at Darren Morcombe's refinery in southern Switzerland. In a part of the world where gold jewelry is as much an investment as an adornment, consumers and jewelers had decided the shiny bracelets, necklaces and belts -- many never worn -- were suddenly too valuable to keep.

As prices skyrocket for one of the oldest forms of money, the rules of normal economics don't apply. Fears about inflation, terrorism and a possible dollar decline are driving gold's price up. But production is down, because mining companies cut back capital investment during a 1990s price slump.


Some central banks, the biggest gold investors, sold when the price was low, and now a few are buying when the price is high. The jewelry industry buys the bulk of each year's output, but price today is driven more than ever by a much smaller slice of the market -- professional investors -- whose appetite lately has soared. After years of being squeezed, gold miners are making fortunes, while refiners and gold bankers are getting pinched.

The price, in retreat for almost two decades after peaking at $847 in 1980, has more than doubled in the past five years, closing yesterday in New York at $595.20 a troy ounce, near a 25-year high. Purchases by investors jumped more than 25% by weight in 2005 alone.

Gold is the only major commodity that isn't produced primarily to be consumed in the economy -- like iron, copper, pork bellies or oranges -- but simply to be owned and admired. It is too heavy, soft and rare to have many practical uses outside of electronics and dentistry. Yet it is one of the earth's most prized objects, valued mostly because it is considered valuable.

A look at gold's circuitous journey from the ground to refiner to bank vault to jewelry store -- and sometimes back again -- shows how the ancient world of gold is being shaken up by both markets and technology.

The Gold Chain

At the start of the gold chain stand people like Joel Lenz. He runs two Nevada gold mines for Newmont Mining Corp., the biggest U.S.-based gold producer. Mr. Lenz works, lives and serves on a local school board in the mile-high desert of Nevada, where the bulk of U.S. gold is unearthed.


As recently as the 1970s, 70% of the world's gold was taken from South Africa's deep underground mines. South Africa remains the world's largest producer, but its output in tons now is one-third of what it was, and it represents 12% of the world's expanded production. Australia and the U.S. follow with 10% each, China 9%, Peru 8% and Russia and Indonesia 7% each, according to London-based researcher GFMS Ltd.

The gold mined in most parts of the world, including at Mr. Lenz's Lone Tree Mine, differs significantly from the stuff that lured prospectors west 150 years ago. Visible sources of gold -- gleaming mountainside veins or nuggets and powder lying in riverbeds -- are becoming rarer. The Lone Tree Mine is an open pit two miles long and almost 1,000 feet deep, a monstrous gash that some day will be turned into a large lake. The gold Mr. Lenz removes from it consists of microscopic particles laced through earth and rock.

"I've been here for 14 years," says Mark Evatz, who supervises Lone Tree Mine's digging and transport, "and I have never seen an ounce of gold that I have mined."

To find the gold, modern-day prospectors like Newmont's Wayne Trudel pore over old drilling reports, set up computer models and theorize about which mineral formations are likely to contain fine gold particles. The process can take years, at a cost of $19 per ounce of discovery. The geologists drill out samples from various strata and examine them under microscopes. The results are plotted on three-dimensional computerized maps that outline twisting underground gold veins. As the price of gold rises, the areas on the maps considered worth mining expand.


At Lone Tree, each ounce of gold is sprinkled through 75 tons of rock and soil. Miners use Global Positioning System consoles to make sure they are digging in the right spot -- since ore-rich rock looks little different from other rock. The gold is separated from rock and other metals through a variety of technologies that employ heat, pressure, cyanide and charcoal.

In all, Lone Tree produces about 600 ounces of gold a day, in the form of a damp, cake-like sludge that is 50% to 75% gold and also includes silver and other metals.

World gold production peaked at 2,621 metric tons in 2001 -- just as the price was falling below $260. As prices finally rose, output actually fell. Last year, less than 2,500 tons was produced. The reason: Opening or expanding mines can take a decade of exploring, investing and seeking environmental approvals, and shell-shocked companies cut such spending heavily during the long price decline. Some were slow to invest again when prices started climbing.

Fearing further price declines, many mining companies in the 1990s made matters worse by contracting with large banks to sell future production in advance, at then-current prices. To pay the miners, the banks borrowed gold from central bank reserves, sold it and replaced it later with the mines' output. That flooded the market with gold, depressing the price. Newmont shunned such hedging and quickly boosted capital spending when prices rose, but the cutbacks forced people to leave the high desert in search of work.

With Lone Tree running out of ore and its jobs now slated to disappear, Mr. Lenz spent months in 2003 helping persuade Newmont to reopen the nearby Phoenix Mine. It had produced gold and copper off and on since the 1860s, and its best ore was long gone. Newmont figures it can make money from the mine if gold sells for $340 or more an ounce, and it agreed in late 2003 to reopen it after gold crossed that price threshold.

Environmental Concerns

To keep the pit from flooding, Lone Tree pumps out 45,000 gallons of water a minute, lowering the water table in an already dry area. Environmentalists say that mercury emitted when gold is separated from other metals turns up in fish, wildlife and water supplies. Nevada regulations adopted this year require gold miners to use advanced technologies to control mercury emissions, formalizing a voluntary program. Critics say the rules don't solve the problem.

Gold miners have been accused of more severe environmental damage in developing countries. In February Newmont agreed to pay Indonesia $30 million to terminate a civil lawsuit charging it with causing disease by polluting a bay with arsenic and mercury. Newmont officials face a separate criminal action over the same alleged pollution, which the company denies.

When the miners at Lone Tree in Nevada are done producing gold sludge, gun-toting guards cart it off in armored trucks. The delivery schedule is kept secret even from senior mine executives.

The sludge is delivered to a Newmont plant in another mining town, Carlin, about an hour away. Technicians run an electrical current through the sludge, separating out more base metals. The gold is formed into 100-pound "buttons" shaped like Hershey's kisses, now finally gold-colored but tinged with red, green or black (depending on how much copper, silver or nickel remains).


A Valcambi worker pulls a metal bar containing gold out of a chemical bath as part of the refining process.
About three times a week, when 2,000 ounces to 4,000 ounces have accumulated, workers melt the buttons into 55-pound to 60-pound bars. The bars, between 60% and 95% gold, are known as "doré," a French word meaning "gilded" or "golden."

The gold now heads toward the world of jewelry and high finance, via a refinery, where the doré bars become almost pure gold. There's an independent refinery nearby, in Utah, but Newmont sends its Nevada doré by commercial airliner (no one will say from what airports) to Valcambi SA, the Swiss plant where Mr. Morcombe is chairman, because the mining company has a major stake in that refinery.

Although high gold prices make mining quite profitable, other parts of the business have become jammed with competition and margins are tight. Some countries maintain refineries for nationalistic reasons, a bit like airlines, and the excess capacity is now keeping refining charges well under a dollar an ounce. Swiss banks, which helped make Switzerland a gold-refining center after World War II, have been pulling back, including Valcambi's former owner Credit Suisse.

At Mr. Morcombe's refinery, in Balerna, just north of the Italian border, the high price of gold is affecting business. Recycled jewelry is still pouring in the door, while gold demand from jewelers is falling since the high prices make it tough for them to turn a profit.

Doré bars from mining operations continue to arrive. They are melted and formed into thin rectangular plates that then can be slotted into a bath of chemicals in a nearby room. Another electric current is passed through, separating the gold from other metals. Depending on its initial composition, the doré can go through that and similar processes several times until it reaches a high level of purity -- from 99.5% to 99.99%. Before long, at a new higher-tech wing, the refinery plans to produce gold as pure as 99.9999% (a rare level known as six nines).

Once refined, gold heads to manufacturers, investors or retailers.

Jewelers use more than 70% of gold supplies every year. Italy long was the leading jewelry maker. Lately, lower-cost Turkey has taken a lot of business from Italy, and even-lower-cost India is taking some of Turkey's business. The world's biggest jewelry retail chain is Wal-Mart Stores Inc. But as a nation, India is the world's largest gold-jewelry buyer.

In India and elsewhere in Asia, gold jewelry is used for dowries and major gifts. When people have extra savings, they buy jewelry, which can be sold either in times of need or when prices soar.

"We are selling old gold because the price is high," said Hemani Shah, a customer recently in a Mumbai shop. "During the monsoons when the market goes down, we'll buy."

Gold also is used in electronics because it is a fabulous conductor. It is present in virtually all computers. Gold's use in dentistry has been falling for years, but last year alone Americans and Canadians had a total of 34 million teeth repaired or replaced with fillings, caps, bridges, crowns and other dental appliances containing gold, according to Dentsply International Inc., a dental supply company. World-wide, dentistry eats up nearly 70 metric tons of gold a year, says GFMS, the research group. All these business uses account for another 15% of yearly gold supplies.

Most of the remaining gold -- 12% to 15% -- goes to private or government investors. Much of that ends up as large rectangular bars weighing 27 pounds or 28 pounds each, the mainstays of government and commercial bank vaults.

When times are good, gold seems a waste of money compared with more modern investments, such as the stocks of fast-growing companies. In troubled times, such as during the recent bear market and following the 2001 terrorist attacks, broader groups of investors stash part of their nest eggs in safer places -- and gold is often seen as such a haven. Some bearish investors, called gold bugs, tend to stick with the metal through thick and thin.

Wild Card

One wild card in the gold market is the world's central banks, which, because of gold's traditional role as a store of value, long have been the largest gold hoarders. They still own about 19% of the world's gold, according to GFMS. European central banks, however, have been selling gold for years. Central bank sales mounted in the late 1990s, as gold prices fell to multiyear lows. Now, faced with criticism that they sold too cheaply, some central bankers are thought to be buying again, including those of Russia and some Middle Eastern oil countries -- reflecting the temptation even among experienced financiers to sell low and buy high.

The U.S. went off the gold standard under President Nixon, but it still has by far the world's largest gold reserves at more than 8,000 metric tons, valued at about $153 billion. The U.S. hasn't sold significant amounts since the Carter administration, putting off any debate about the proper role of gold in backing a currency.

A pair of exchange-traded gold funds created in 2004 and 2005 are helping to drive investor interest in the metal. These funds, which are set up like mutual funds and trade on stock exchanges, allow institutional investors and even individuals an easy way to bet on gold. As more money flows into the funds -- which total about $7.3 billion today -- more gold must be purchased to back them.

The gold from those funds, like much of the world's investment gold, is stored mainly in London, where nine secretive bullion banks finance the trade. Financial institutions that own shares in the funds occasionally ask to see the gold backing their investments, but the two banks holding the funds' gold, HSBC Bank and Bank of Nova Scotia, have a policy of refusing such requests. Investors must take the word of auditors that it actually exists.

J.P. Morgan Securities in London, an arm of U.S. banking group J.P. Morgan Chase, is another of the nine banks. It occasionally allows visitors. Gold comes and goes from its vault with surprising frequency, moving among miners, refiners, jewelers and investors.

It often arrives at freezing temperatures after riding in a plane's hold. The gold is fork-lifted into a cavernous vault the size of a basketball court, deep below the ground. Stacked on mundane wooden pallets are billions of dollars in gleaming gold bars.

Even amid all this accumulated wealth, competition has eroded profit margins.

On a recent morning, the phone rang at the desk of Peter Smith, who helps run the gold business at J.P. Morgan. A bank in Dubai needed 600 bars, each 99.9% pure and weighing 10 tolas (an Indian measure). Sitting in front of a computer with three screens, Mr. Smith phoned a Swiss refiner and found his client some bars. The price he quoted included a refiner's markup of 50 cents an ounce, including shipping. The 2,250-ounce order totaled well over $1 million. The bank's cut was five cents an ounce -- or just $112.