Gold: Global Supply Outlook

Gold Investment demand is surging. But what about gold supplies...?

NEVER BEFORE has Gold Investment demand been so high, writes Julian Phillips at GoldForecaster, and it is likely to rise still further.

Normally, when a commodity is in high demand, supply is accelerated and holders of that commodity often take profits, thereby increasing supply as well. 

Economic history tells us the same.  Rising prices and high demand should result in rising supply.  But when it comes to gold, all rules have to be re-written.  That’s because gold is only part commodity. 

It typically takes around five years from the raising of finance for a mine to the start of Gold Mining production. That’s assuming there is a gold resource available to mine in a gold-mining supportive country of sufficient size to make the mine worthwhile. During the last 15 years of last century, support to such ventures from central banks through bullion banks was so strong that the mines would be loaned the gold they were going to produce. They then sold it forward to the time when the mine would produce and often even further out.

This allowed the mine to earn a higher Gold Price (as the price was dropping) and earn interest on that gold until delivery. Then, from production, they repaid the bullion bank (and thus the central bank source) the amount of gold they had borrowed.

While wise at the time, it did quickly exhaust the easily mined deposits of gold, leaving us with a situation today where good gold deposits are getting increasingly rare and difficult to mine. Add to this the propensity of governments to wait until the mines do really well then hit them with heavy taxation. This is deterring new investment in Gold Mining.

The result is that from now on, gold mining companies will be hard pressed to replace the resources they have exhausted. Consequently, newly mined gold production is set to decline from 2010 onwards, irrespective of what the gold price is.

As for central bank sales, from 1985 until 1999 the gold markets sat under the cloud of potential “official sector” sales. Central banks across the globe encouraged an atmosphere that expected unrestrained gold sales. Naturally the Gold Price fell, down from its $850 high of Jan. 1980 to $275 in mid-1999.

Then the “Washington Agreement” was signed, capping European sales at 400 tonnes a year. The gold market breathed a sigh of relief and the Gold Price finally turned up. Sales under this agreement and the next (which ended and was then renewed on 26 Sept. 2009) did at first reach the ceilings levels that were set, right up until the last two years of the second agreement. Amid the global financial crisis, however, they then petered out, with hardly any sales in the last half of the last year of the Agreement.

Since then, no significant European central bank sales have taken place. A total of 1 tonne of gold has been sold to date from the inception of the Third Agreement, nine months ago. It can then reasonably be concluded that European central banks sales have dried up. In their place have come Asian central-bank purchases of 400 tonnes a year.

As we said at the beginning of this article, private Gold Investment demand is now very high. Both Western jewelry and Indian demand had been low until recently, but both of these markets have eventually accepted the current record price levels as being sustainable. Demand from these two sources has now begun to rise again, and it’s clear that today's strong global gold demand comes without the usual froth that accompanies peak demand. This combination of peak demand and restricted supply leaves only one potential source of supply – and a capricious one at that – gold scrap supply.

With no other source of supply, markets usually take prices to a level where holders of a commodity sell and take profits, in the belief that such prices are not sustainable and will soon fall. Since gold hit the high of $1215 for the first time, prices did fall, with many forecasting a low price of $850 an ounce.

This didn’t happen, however. Instead, a low of $1050 was seen, before the Gold Price began to climb again. During that time (and until recently), apparently ‘weak holders’ of gold in India did sell, and were the main suppliers of that market, in particular. Now they too have accepted current prices as a new ‘floor’. 

Most Western consumers have now seen or heard of adverts for ‘gold parties’, rather like the Tupperware parties of the 1960s and '70s, where housewives now get together and sell old, unwanted gold jewelry that’s lain in dressing-table drawers for years. The initial surge of scrap supply from this relatively new source has largely run its course, however, and such supplies are drying up. Once these sellers have sold out, that supply too will dry up too. This source of scrap is not important to the supply side of the gold market. 

The next potential source of scrap gold is from the current Gold Investment holders, those people who bought solely to make an eventual profit. Once they believe prices are as high as they will go, they will sell. These can be termed ‘weak holders’ in the gold market, for long-term investors from central banks, to institutions, to individuals hold gold to preserve wealth, in a world where it is threatened. Such investors hold gold simply to be prudent in the face of uncertainty and instability in the financial world. They may only hold a small proportion of their portfolios in gold. But be sure that they won’t sell until certainty and stability are likely to return to the financial world.

A look at what’s going on now in that world tells us that we may see a squadron of pigs circling the White House at the same time.

Looking to Buy Gold today...?