Forget mining and
central banks. Here's the single most important gold supply issue today...
SO IT WAS TOUGH yet
again to meet any gold "bears" at the London Bullion Market
Association's annual conference last week, this year hosted in Berlin's Hotel
Adlon, writes Adrian Ash at BullionVault.
The bullish arguments you know already no doubt. Low-to-zero
Western interest rates...plus a growing clamor to buy gold amongst Chinese
households (the Middle Kingdom's demographics are more bullish still, as
Turner showed)...make a compelling case for rising gold investment demand,
even without the risk of government-bond defaults, rising inflation or
continued losses on "mainstream" financial assets.
The Berlin conference had plenty more to say on those
stories too, as we'll see below (and as you can see on the slides now freely published
on the LBMA's
website). But first, what of supply?
Well, all the gold ever produced in history came from a
mine, as Paul Burton of GFMS World Analyst
reminded the conference. But in the last decade, gold mining has failed so spectacularly
to meet the surge in demand, he could only question its "relevance" to
the market's net outlook. Dollar gold prices quadrupled from
2000 to 2009, another speaker noted, yet annual mine output rose just 1%. And allowing
for the intervening slide in output, said Burton, gold mining output is now so
price inelastic, it took eight years of rising prices to produce any meaningful
blip in output (2009's year-on-year increase of 7%).
Further output gains look unlikely, Burton went on, thanks
to the gold mining
sector's "production lag" – both because of an "exploration
lag" (new investment only turned higher in 2003) and because new
discoveries of 1-million ounce deposits have collapsed regardless. The five
years to 2009 saw record-high levels of exploration spending, perhaps totaling
the previous 12 years added together (at least on BullionVault's skew-eyed reading of
Burton's chart from the conference floor. See what you make of it on page 9 here). Yet
all told, GFMS's best forecast is now for annual gold mining production to
decline by 13% between 2012 and 2019.
That other constant drip-drip of gold supply – the
"official sector" of central banks and outfits like the International
Monetary Fund (IMF) – also looks irrelevant for now, as Burton's GFMS colleague
showed in his speech. European states are now holding, not selling their
reserves, but emerging markets (for now) remain mere ankle-biters compared to
the weight of private investment or jewelry demand each year. So net-net, said
the GFMS chairman, central bank activity looks "neutral", despite the
bullish picture for emerging-market demand he also laid out. More notably, and
"something we haven't seen before", private-sector investment
holdings now outweigh central-bank gold reserves overall. Making investor
sentiment a key plank of any longer-term forecast.
Even without the end of central-bank sales, however, or the
failure of mine output to rise, "The single most important gold supply
issue is scrap," as John Reade of Paulson Europe said in his conference
summary. Re-selling unwanted jewelry "has gone mainstream" noted Jeffrey Rhodes,
CEO of INTL Commodities DMCC, becoming "socially acceptable" in a way
that using pawnbrokers to raise cash never was. Throw in gold coins, dental
bridges, bonding wire from microchips and any other supply "not from a
primary [ie mining] source", and scrap gold matched more than one fifth of
global gold mine output last year, up from just 7% a decade ago. Turkey has
overtaken India as the No.1 source of scrap gold supplies (217 tonnes in 2009,
equal to almost a tenth of world mining supply), but the most dramatic change
has come in the developed West, where "sophisticated electronic assay
equipment has seen the captain's ball at your local golf club replaced with
gold buying parties," as Rhodes said.
Since 2005 alone, US scrap supply has more than doubled
according to data from GFMS Gold Survey, taking United States' re-sales from fifth
to second position worldwide in 2009 with 124 tonnes. Italy's re-sale market
moved from seventh to sixth with a tripling to 78 tonnes of scrap, and the UK
& Ireland have leapt 1505% from virtually nothing a decade ago to nearly 60
tonnes in 2009, bagging the world No.6 slot in the first-half of this year.
Throw in Germany and France, and four European nations make the top 10 scrap
supply nations by growth since 2000. In the first six months of this year,
scrap supplies from each of the US, Italy and UK & Ireland had all outpaced
India (the former No.1, remember), enabling scrap to become the "only
credible counter to investment buying." But should these massive supplies
of scrap in fact be overwhelming investment pressure on prices?
Since "investment buyers and scrap sellers are driven
by the same motivation of price expectations" as Rhodes reminded the LBMA
conference, this price-elastic source of supply could threaten "a perfect
storm of selling once sentiment changes," he believes. But first, that
would require higher prices again, because (for now) even scrap-gold merchants
have turned bullish, he reported, capping flows to refineries in anticipation
of stronger gains ahead. And second (and more critically given the source of
the last few years' real jump in scrap supplies), "Is the drawer
empty?" as Paulson Europe's John Reade
wondered in his quick-fire recap before the conference adjourned.
Cash-strapped households, remember, can only sell their
unwanted gold bracelets once. How high would prices need to go before more
cherished pieces could be sent to the smelters? Apply the same question to
private gold investments in fact (ETF holdings have proven notably
"sticky", if not yet as "long-term means forever" as gold
coins), and you get to the nub of the "bubble or boom?" debate.
Because at some point, according to pretty much every speaker, the circumstances
now boosting global investment demand will recede – and with them, therefore,
the gold price will fall back as well. As we've already seen (in Part I),
the bubblicious frenzy needed to mark the top of spike remains plainly absent.
Leaving only the circumstances behind this current boom to consider.
"The current bull market has much deeper roots than the
credit crisis," the LBMA was reminded by former Blackrock head of natural
Birch (now a farmer). Pointing to gold's nadir of 1999, "continuous
disinvestment" was needed to keep prices down, and when Europe's big
central banks agreed to cap their sales that September, it marked the start of
this rise. Roll on 11 years and 350%, however, and "Just because gold's a
safe haven doesn't mean it's a cheap safe haven," Birch warned Berlin.
Which raises the question of cost and utility for new buyers today.
"I think people long gold should not be concerned
reading this slide," said John Reade in his summary, pointing to slide 14
of William White's opening
keynote speech. Chairman of the OECD's Economic & Development Review
Committee, White had prefaced his 20 minutes of gloom-and-doom (salted with
uncertainty, fear and doubt) by saying that the OECD itself would certainly
disagree with everything he was about to say. Reade reminded the delegates that
White's copyrighted sales-line should be "Scaring investors since
2003," as he accurately picked the shape of the bubble well ahead of
schedule, and hasn't been proven wrong yet.
"Investors should be positioning for 'tail
events'," White concluded. "But which ones?" Somewhere between
deflation, slow growth, de-coupling of Asia from the West, or a lurch into
rapid hyperinflation or a new series of bubbles fed by ultra-loose monetary
policy, "Is there room for gold in a world like this?" asked the former
Bank for International Settlements forecaster.
"The answer has got to be yes. But quite what
role...well, that's for you to decide!"
A handful of private investors have begun to make that
decision, as Wolfgang
Wrzesniok-Rossbach of the Heraeus refinery showed in detail. But the real
weight of money – the institutional mandates caring for your insurance and
pension savings – has scarcely bothered to buy gold 'til now, a point made at
length by both Shayne McGuire and Graham Birch on Monday morning. Across in
Asia, "People don't need convincing on gold," said David Gornall of
Natixis, noting that 81% of global "bar hoarding" demand comes from
Asia, with buying amongst the "traditional buy-side countries" such
as India and Thailand – as well as the fast-growing world No.2 for gold demand,
China – continuing to grow despite record-high gold prices.
Even there, "the emergence of retail physical gold investors has resulted
in structural changes in distribution, product and buying behavior," as
Sunil Kashyap, managing director of Bank of Nova Scotia-ScotiaMocatta
explained. Yet all told (and absent the "bubble" idea which the
conference demolished time and again), what looks like a new paradigm might in
fact mean more a return to old patterns – globally – of gold buying and
hoarding...with a little "mobilization" thrown in by the scrap market
when times get tough.
India and Turkey, after all, have long been both top buyers
and scrap suppliers to the international gold market. Rising investment demand
here in the "rich West" (which, to repeat, remains well off a
"bubble" today) represents a simpler, unleveraged way of retaining
your savings than most Western households have grown used to. But gold was a
core chunk of private wealth holdings not so long ago, back before the
debt-fuelled boom we've enjoyed since WWII began – a boom which must now end
with "rebalancing" between the world's debtors and creditors, as George Magnus of
UBS made plain Monday morning. The kind of dislocation required won't be much
fun for either, which again looks good for gold demand, if not necessarily
All told today – and seeing the world's fastest-growing
economies continue to buy and hold ever more gold as their wealth increases –
maybe US and European savers are only just getting back to the future. Either
way, that "bubble in gold" doesn't exist. Not by a long way just yet.
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