Fears on Gold: Declining Supply, Increasing Demand

Gold remains firm as there is increasing nervousness about the global economy and indeed nervousness about the global monetary system, leading to continuing strong investment demand. Gold remains at or near record highs in nearly all major currencies ($914.00, £622.11, €713.06) and looks set to regain its nominal record high of $1,030/oz in the coming weeks. UBS joined Goldman Sachs and Merrill Lynch in drastically increasing their gold price forecasts Thursday. UBS has increased its 2009 average gold price forecast to $1,000 an ounce from $700 as investors seek a safe haven from the financial turmoil.

There is a gradual realization that slashing interest rates to zero and close to zero is not the magic wand, quick fix to our global economic ills. This is especially so as one of the continuing major challenges is the availability of credit and money rather than the price of credit and money.

Banks remain very hesitant to lend and it does not make a huge difference to businesses and employers who need credit whether interest rates are at 0% or at 3%. And now frugal and prudent savers are being punished as they see their savings debased in an unprecedented monetary experiment of massive money printing, quantitative easing and monetization of debt (printing money to buy government bonds).

The Bank of England cut rates to a new record low of 1.5% but experts warned that the cut 'will not help Britain climb out of recession' and some saw the cut as "pointless" with the potential to create inflationary problems and even possibly a sterling crisis.

Understandably, gold's store of value qualities is in demand internationally. Gold's detractors always point out that it does not offer a yield – they are slower at pointing out that very few paper assets today do.

Gold has been proven to preserve wealth throughout history – in all manner of recessions and depressions including stagflation, virulent inflation, hyperinflation and deflation. While the man in the street and the consensus is concerned about deflation, the real medium to long term threat is inflation and investors should be cognizant of this real risk.

While investment demand remains very strong, there are growing fears about the declining supply of gold - the world's mine gold supply has been falling in recent years and it fell to 2,385 tonnes last year, down 3.6 per cent from 2007 (despite the rise in prices in recent years).

The first law of economics is the law of supply and demand. There is a finite amount of gold in the world and thus supply is finite. Fiat money creation is anything but finite and never has so much money been created in the history of the world as has been seen in recent months.

Thus, over the medium to long term, the value of paper currencies will inevitably fall versus the finite, universal currency that is gold.

Comments

[Lawrence J....:]

My problem with gold as an investment is that gold is intrinsically worthless - there is very little demand for it to make things that people need. The use of gold as a store of value, however long-standing the practice may be, is wholly arbitrary. Anyone can decline gold as a medium of exhange at any time. If things really get bad, I expect that the currency of choice will be the bullet.

Feb 08 03:39 PM

[silverwood:]

Good article Mark! You make an excellent arguement of why to be invested in gold. There is a lot of confusion about what gold is. I see it all over SA, but your article goes a long way to help rectify that. Please keep writing these good posts.

Feb 08 03:46 PM

[lance sjogren:]

Yes, if things get bad enough, the currency of choice will be bullets, firearms, wheat, oil, etc.

If things get that bad, however, I think we will be fortunate if we are the ones to die first rather than the survivalists who last a few extra weeks before they die as well, a period of a few weeks that will be a more horrific life than most any of them will ever have lived in their lives.


If we have an economic downturn that falls short of that, gold will likely be a good store of value. It is largely intrinsically worthless, almost as worthless as paper money.

Throughout history, however, it has been valued as a currency. That it would not continue to play that role (assuming something short of a thermonuclear economic scenario), in my view someone should explain why gold will suddenly stop being viewed as money when it has been viewed as money throughout history.

Although it has little intrinsic value, it does have the attributes of being the most physcially permanent of metals in terms of non chemical reactivity, and also its supply is finite, unlike paper money which can be printed ad nauseum.

Feb 08 03:47 PM

[mac.barron:]

Thankfully we are a fair way from the bullet being the Unit of Account. Predictions of blood in the streets and "the living will envy the dead" talk is, IMHO, a tad melodramatic at this point (out in public anyway).

While it is true that you can't plant a gold piece to get crops you can't plant a paper dollar for crops either. Gold is capital "M" Money just because--no matter how counterintuitive it may be.

Moving forward gold will remain popular as it is the classic hedge play. Although its wealth preservation effect is most clearly seen over time as day-to-day market gyrations are canceled out. Gold probably won't make you rich, but it will help to keep you solvent. Given a choice between being wealth and being impoverished I shall choose the former.

Feb 08 06:24 PM

[tb1975:]

Dollars are intrinsically worthless. They are just paper. Gold at least is finite. Value is just a term that represents the consensus worth of something. Right now, everyone agrees the value of gold is $905 an ounce- not worthless.

It doesn't matter what you think it is worth or what I think it is worth. It matters only what the aggregate opinions of the masses think. Throughout history, humankind has agreed that gold is not worthless. Today, as stated above, they think gold is worth $905 an ounce. You can disagree, but that doesn't make it worthless.


On Feb 08 03:39 PM Lawrence Kramer wrote:

> My problem with gold as an investment is that gold is intrinsically
> worthless - there is very little demand for it to make things that
> people need. The use of gold as a store of value, however long-standing
> the practice may be, is wholly arbitrary. Anyone can decline gold
> as a medium of exhange at any time. If things really get bad, I
> expect that the currency of choice will be the bullet.

Feb 08 09:26 PM

[Roger Knights:]

Lawrence Kramer wrote:
"Anyone can decline gold as a medium of exchange at any time."

Sure, but that doesn't matter. Gold needn't be "generally accepted” as a medium of exchange in order for it to function as such, indirectly. All that's needed is a simple conversion to the currently accepted exchange-medium at a local bazaar or weekend flea market or online trading site. As long as even ONE trader says, "In gold I trust," that's sufficient, since, because of him, there will be several who trust it; and because of them, there will be many. Gold's value doesn't rest on a first-order preference of the majority. Thus, it isn’t subject to their whim.

Moreover, because of that independence from its will, the majority believes in gold despite itself. It doesn’t matter if gold has no usefulness or intrinsic value to THEM. Its trust in gold is a secondary, roundabout effect of the trust that the minority has in it. Thus, it’s perverse to say that “anyone can decline gold,” because he’d be a fool to do so. The majority is aware that there will always be buyers for gold, so this gives them ALL confidence in it, even though it butters no parsnips directly.

(I think this detailed analysis of mine is rather ingenious, so anyone may freely quote what I’ve said here.)

Faith in fiat, OTOH, isn't as deeply rooted. For instance, compare the value of a pre-1964 half-dollar silver coin to one of a subsequent year. The former is worth ten times the latter, although their face values are the same. In a hyper-inflationary situation, the former could become worth 20 or 30 times the latter. It doesn't require a majority vote to do this, just the backing of a minority.

"The use of gold as a store of value, however long-standing the practice may be, is wholly arbitrary."

No, it's fiat money that is arbitrary. The majority has voted, in effect, to "make believe" that certain easily created bits of paper are valuable. "Specie" (gold and silver), OTOH, is nature's money. It can't be run off on a printing press and thereby debased. It has to be dug out of the earth.

It doesn't matter if, theoretically speaking, people shouldn't value it because it has no practical usefulness. This objection borders on being a diversion, because a person lacking faith in fiat could buy silver, an industrial metal, rather than gold. It's still "hard money," or “specie,” instead of soft, which is the heart of the matter.

“If things really get bad, I expect that the currency of choice will be the bullet.”

IMO, the everyday medium of exchange wouldn’t be the bullet but the battery—it’s compact and widely useful. But positing such a Mad Max alternative poses a false dilemma. I don’t think there would be a steep cliff down from civilization-as-we-kno... to Total Collapse. Rather, the existing system would get patchy in spots, pieces of it would start functioning poorly, and there'd be dangerous No-Go zones. There'd be a long transition period of semi-chaos before things totally fell apart--if they ever got there, which I doubt. Authority would devolve to neighborhoods and localities. Crime-fighting would devolve to vigilante associations. It wouldn’t be every man for himself—at least, not for long. In such partially functioning localities, gold could still be bartered. Heck, it could be bartered in most No-Go zones.

Feb 08 10:11 PM

[Roger Knights:]

Oops: I should have phrased my third sentence above thusly:
"As long as even ONE trader says, "In gold I trust," that's sufficient. And there won’t be just one, since, because of him, there will be several who trust it; ..."

Feb 08 10:18 PM

[mr freddo:]

We are a long way from the bullet being the currency of choice but it is not out of the question that a breakdown could occur. If an economic event occurs that causes a run on the banks, you could see them closed for an indefinite period. Imagine having to live for several weeks without your bank or your credit cards. While your accounts are frozen, a hyper inflation could wipe out your cash assets. Everyone should get prepared at least by keeping enough food on hand for your family for a few weeks. I'm not saying that it will happen, it's just smart to be prepared.

Feb 09 07:27 AM

[5142152-337:]

Rolex18:

Is there anything else besides PHYSICAL gold? Oh, I know the alternatives, but in reality, they are just pieces of paper that someone you probably wouldn't trust with your weedeateer, is "guaranteeing" your gold is there for you. Hmmm, i think not, my friend. Give me the real thing. I have safes, and guns...and a dog that does not like strangers! Am I wrong, sir?

Feb 09 09:24 AM

[know nothing:]

Calm down, You guy's! Did you all forget that we have a new president, that is going to "CHANGE" things?
You can trust the fiat currency now, Mr Obama won't let the american people down. RIGHT!

Feb 09 10:41 AM

[applesauce:]

Did not see much gold in Mad Max, fuel and bullets were the medium of exchange.


On Feb 08 03:39 PM Lawrence Kramer wrote:

> My problem with gold as an investment is that gold is intrinsically
> worthless - there is very little demand for it to make things that
> people need. The use of gold as a store of value, however long-standing
> the practice may be, is wholly arbitrary. Anyone can decline gold
> as a medium of exhange at any time. If things really get bad, I expect
> that the currency of choice will be the bullet.

Feb 09 12:13 PM

[JudeJin:]

anyone denying the value of gold is too cocksure of themselves. take a look at all the central banks please! they all hold large quantities of gold! you, gold-deniers are smarter and more powerful than the collective wisdom of all the central banks combined?

we don't need the theoretical discussions. just look at the numbers and some hard historical facts.

1969, man landed on the moon. 1970-1979, gold rose more than 10 folds!

gold-deniers are either blind to these hard facts or just plain stupid!

Feb 10 01:33 AM

[JudeJin:]

of course, i'm not saying gold is the only hard assets that is going to skyrocket. all hard assets, such as oil, rare metals, will.

but, by looking at gold, it is very easy to find out that there's very good investment vehicle associated with gold, i.e., gold mines.

crude oil will go up along with gold too. but oil companies do not benefit from oil prices linearly(hope you understand what i mean here).

Feb 10 01:37 AM