Investor Demand Drives Gold Scarcity and Price

Friday, a good friend showed me his insightful analysis of gold in an email. His email goes something like this:

“It is interesting to see that global investment demand is now larger than jewelry demand. I have said for a long time that the investment sector will have a HUGE effect on the price of gold, since only about 2,700 tons are produce each year, which translates to 0.0126 oz/person/yr. If only 1% of the people buy gold globally, then the number is 1.26 oz/person/year, which is not much. Then consider that the 2,700 tons produced each year is already spoken for. So where will the gold come from when investors want to buy it? The answer is that there will not be much of it to go around. May be only another 500 tons per year will float out of hoards into investor's hands. So instead of 2,700 tons, only 500 tons are available, which is about 0.00233 oz/person/year. Again, if 1% of the population is to buy gold, they can get only 0.233 oz/person/year. That is very interesting. It seems like the price of gold has a HUGE sensitivity to investor demand.”

After reading the email, I did a little digging to verify my friend’s analysis and this is what I found:

Ton	2006	2007	2008	Avg.
Supply
Total mine supply (incl. net producer hedging)	2,075	2,034	2,057	2,055
Central bank sales	365	484	246	365
Old gold scrap	1,129	958	1,215	1,101
Total supply	3,569	3,476	3,518	3,521
Demand
Fabrication (Jewelry, industrial, dental)	2,748	2,866	2,621	2,745
Investment	676	685	1,184	848
Total demand	3,424	3,551	3,805	3,593

Data Source: World Gold Council

So my friend’s production number is a little off, but his total supply tonnage is almost spot on. As the table shows, fabrication demand outstripped mine supply in each of the past three years. After using central banks supply and scrap for fabrication, there is really very little left for investors. And as you can imagine, and confirmed by data, gold investment has been on the rise. With so little gold left for a growing herd of eager investors, is there any wonder why gold spiked 60% between 2006 and 2009?

Naturally, when investors cannot find enough gold to buy, they will look for substitutes. Historically, one of the substitutes had been silver, and this time should be no different. Borrowing my friend’s analysis and using it on silver, I found another interesting result. Using data from GFMS, total supply exceeded fabrication demand of 833 million ounce by 50 million ounce in 2008. In other words, there was 50 million ounce available for investment. Again, if 1% of the world population buys silver for investment, each buyer would have been able to buy only 0.75 oz last year!

For decades, precious metals received no respect from investors. As there was little investor demand, producers were geared to satisfy fabricators only. But the world changed. As anyone who regularly visits this site knows, precious metal investment is gaining momentum; and producers are not prepared for it. There would not have been enough to go around absent ‘leakage’ from existing hoards.

How long can this leakage continue? Central banks are almost entirely out of silver. Their gold reserves stand at 35,000 tons. If they continue their sale rate of 400 tons a year, that gold will last under 9 years, a long time. But do we expect central banks to hold no gold and silver? And what if investor interest accelerates? Inflows into precious metal ETFs are rising. Or what if central banks reverse their position and start buying back gold to shore up currencies? What if there is a currency crisis and the global community demand the IMF to create a new reserve currency backed by gold?

These are far-fetched scenarios, but they are not improbable. Remember black swan? At a time like this, the upside for gold and silver far outweighs the downside.

Disclosure: Long positions in GLD and SLV; no positions in IAU or GDX.

Comments

[Roger Knights:]

Good article. I think a turnaround in central bank behavior, especially China's, is the black swan in the living room. However, the math or facts in the following are wrong:

"Their gold reserves stand at 35,000 tons. If they continue their sale rate of 400 tons a year, that gold will last under 9 years"

Jun 28 07:52 AM

[texpat:]

35K tons at 400 tons a year would stretch to 90 years. But over half of those 35K tons has been leased (and sold), never to return. Few central banks want to sell any more gold, which is why the Chinese recently had to get it from the IMF.

Jun 28 08:57 AM

[ray in soli...:]

How much Gold is tied up in ETF's

The big rise in gold started about the same time that several ETF's on gold began trading. The ETF buys gold as people invest in the ETF and then stores it in a bank vault. This gold is taken off the market until people sell the ETF and more gold is available. this is a large scale hording of gold as people invest in the ETF and take gold off the market. I thought I saw a report that said over 40% of the worlds available gold is tied up in ETF's.ETF's are great when they hold a basket of stocks, but when they hold only one commodity and take a large share off the market, they tend to skew price in their favor.

Jun 28 03:33 PM

[376602:]

Finance Minister Harry Brown, and most recently President Obama and the US CONGRESS, sold the Metal from the "Central Bank". GBP "The Pound" came under pressure after no European Central Banks joined the Bank of England's in sale. "In Obama We Trust".

Question: Then how goes the USD?



On Jun 28 08:57 AM texpat wrote:

> 35K tons at 400 tons a year would stretch to 90 years. But over half
> of those 35K tons has been leased (and sold), never to return. Few
> central banks want to sell any more gold, which is why the Chinese
> recently had to get it from the IMF.

Jun 28 05:29 PM

[376602:]

Good Digging! Can you disclose the Sources?

Commodities are priced at the "margins" of supply and demand.

US Journalists and Politicians are famous for blaming the capital markets' innovators (M. Rich, M. Milliken, Enron, AIG), or the free market, never the Party or Political Donations that lead to the Government Agencies missteps..

Margins have non-linear and social dynamcis, put more simply:
2006 / 4.2% surplus
2007 / 2.2% shortfall
2008 / 7.5% shortfall

Jun 28 06:12 PM

[capt Brian:]

And with all that, gold is down again here Sunday night $3 and was down to 934, and it will probably continue to go down, as Obamma has got all the answers, Pelosi has the best interest of the USA at heart, and Frank is gonna marry a nice female, and give up boys.

and I am a mongoose...

wheeze

Jun 28 06:47 PM

[376602:]

iTulips - Ka-poom theory.... whiplash.


On Jun 28 06:47 PM capt Brian wrote:

> And with all that, gold is down again here Sunday night $3 and was
> down to 934, and it will probably continue to go down, as Obamma
> has got all the answers, Pelosi has the best interest of the USA
> at heart, and Frank is gonna marry a nice female, and give up boys.
>
>
> and I am a mongoose...
>
> wheeze

Jun 29 12:47 AM

[Stephen Yu:]

I apologize for the math error. The total central bank gold reserve is 35,000 ton according to World Gold Council. At 400 ton sale a year, the reserve should last about 90 years!


On Jun 28 07:52 AM Roger Knights wrote:

> Good article. I think a turnaround in central bank behavior, especially
> China's, is the black swan in the living room. However, the math
> or facts in the following are wrong:
>
> "Their gold reserves stand at 35,000 tons. If they continue their
> sale rate of 400 tons a year, that gold will last under 9 years"

Jun 29 11:30 AM

[Stephen Yu:]

Gold data is from World Gold Council. Silver data is from GFMS.


On Jun 28 06:12 PM 376602 wrote:

> Good Digging! Can you disclose the Sources?
>
> Commodities are priced at the "margins" of supply and demand. <br/>
>
> US Journalists and Politicians are famous for blaming the capital
> markets' innovators (M. Rich, M. Milliken, Enron, AIG), or the free
> market, never the Party or Political Donations that lead to the Government
> Agencies missteps..
>
> Margins have non-linear and social dynamcis, put more simply:
> 2006 / 4.2% surplus
> 2007 / 2.2% shortfall
> 2008 / 7.5% shortfall

Jun 29 05:34 PM