In this article I will attempt to explain part of the recent decline in the price of precious metals. I believe that a gradual accumulation of these metals, traped by utilization, can cause a global shortage. It is not until an alternative is found that the price declines. I hope to illustrate the resumption of a long term trend that has been briefly interrupted. I will use some historical comparisons for context, as there are some similarities to current events.
The other night I watched A Big History on H2 with my 10 year old daughter, learned that the Spanish Empire's wealth during the 15th and 16th centuries did not come from the gold discovered in South America. They extracted far more silver from the region. It was silver that formed the basis of their economic might.
At that time, much like today, China was an economic super power. They produced a vast array of goods that were valuable to the West and demanded payment in silver. The West produced very little that China wanted and because of this China ended up with too large a concentration of silver globally. What I mean is there was a shortage of silver in the West. Currency was minted out of pure silver, so this was seen as a bad thing. The English managed to get Chinese merchants to accept chests of opium instead of silver. That created about 4 million junkies, destabilized the region and started the Opium War. Four million junkies may not sound like a lot by modern metrics, but global populations were much, much smaller then.
I can hear you asking the question, "So what does this have to do with gold?" I promise I will get to that answer as soon as is possible, but before that we have to take a look at some more recent history.
Just as silver replaced gold as a primary form of coinage, copper replaced silver. In modern times aluminum has replaced copper in many aspects. There are even a few currencies that have replaced copper with aluminum for minting coins.
Portugal, Brazil, Cape Verde, Mozambique, Angola, Guinea-Bissau. St. Thomas & Prince, Italy, Spain, Egypt, Morocco, Tunisia, Botswana, Ethiopia, Yemen, Afghanistan, India, Nepal, Myanmar/Burma, Cambodia, Vietnam (and French Indochina), Philippines, Argentina, Uruguay, Suriname, Cuba, Costa Rica, Belize, Japan, China and many more.
At different times large amounts of these metals have been tied up in currency causing a shortage. When that shortage occurred, they chose the next most abundant metal to replace it and relieve the shortage. The other alternative that was widely adopted was the introduction of paper money. These shortages were also caused by technological development. As we developed new uses for these metals we could no longer afford to tie up the resource as currency.
The Sky High Price of Gold.
In recent years we have seen record appreciation in the price of gold and silver. Many analysts have said this was caused by a combination of the flight to safety and the easy money polices of the central banks.
If that were true, how could we have had the precipitous sell off in Gold and silver at the same time that the central banks increased easing?
In order to help put this into some perspective and develop a constant, I would now like to look at both the S&P 500 (SPY) and gold . We will look at each of them in turn starting from the period before the financial collapse and before easy money policy.
This year we have managed to achieve a series of all time highs in the SPY. I did start to wonder how much higher we were than the all time high prior to the collapse. I am choosing to think of that increase as the amount attributable to fiscal stimulus. As we can see that is approximately 17%-18%, if there is any correlation to fiscal policy and gold price you would expect a similar movement in gold. Now take a look at gold, from around the same time period,
At the recent low, we can also see 17-18% appreciation over a similar time period. So for the sake of simplicity I am choosing to use this as a base line. I would argue that it is this 17.5% increase that represents the easy money policies of central banks. I am suggesting that gold is now at a level where it should be supported by those policies and normal demand.
We should now consider what led to the oversized gain and more recent decline in the price of gold and silver. Some of the gain can be attributed to market over reaction. Some of the decline can be attributed to a correction. We cannot expect this phenomenon to explain all of the movement.
I believe that we ended up with a concentration of metals similar to that of China in the 15th Century. Many will be quick to blame China once more as we have all heard of large stores of commodities. I have another possibility for you to consider.
A Technological Concentration of Precious Metals.
The illustration below gives us a rough idea of just how much gold, silver and other metals are contained in a single iPhone. It is not just iPhones, almost every electronic device we have contains small amounts of these metals.
The uptrend in the price of gold and silver started long before Quantitative Easing. Although the amount in each individual phone is relatively small, we have a lot more of them in existence each year. Take a look around your house or office and try to remember what it looked like 20 years ago. The late 90s were a crucial time period when, for the first time, people had more than one cell phone. A work phone/pager and a personal phone became standard. We have also had the advent of the family plan and our kids all have phones too. It has been estimated that next year there will be more mobile phones on earth than people. When you start adding it up, it is quite a concentration of these metals. We still have not taken iPods, tablets, flat screen televisions, laptops or computers into account. These are just a few examples and there are many more including your car.
Could this accumulation in technology really account for such a drastic price change?
I believe that it has been one of the main causes of price appreciation over the last few decades. I also believe that it is one of the main reasons for the recent decline in price.
When gold was nearing record highs, our televisions were bombarded with advertisements about recycling gold. Sometime around 2009 the "We will give you cash for old gold," jewelry ads started. More recently companies like Apple (AAPL) started buyback programs. They were encouraging you to send in your old iPhone when buying the latest generation. The modern tech junkie desperate to get their hands on the latest model was happy to oblige. For the first time since the tech concentration started a concerted effort was made to reclaim some of these metals. The importance of this is simple - there is more gold in one ton of iPhones than there is in a ton of ore.
EPA data from "Municipal Solid Waste in the United States, 2011 Facts and Figures," May 2013
You will notice a 5% increase in recycling from 2010-11. The largest increase in any single year. Five percent of an even larger sea of electronics. These are also just the US figures - e-recycling is on the increase globally and was covered in an article by Jay Greene, of CNET, last year.
There is more silver in phones than there is gold, almost 10 times as much. If recycling was having an effect on the gold price we would expect a similar, perhaps larger, effect to be visible in silver price.
From the chart we can see similar declines in silver also. Although the effect is not ten-fold it is certainly a much larger decline. Obviously there are many other factors at work in both of these markets, but the correlation between the events and price is striking. I do not feel we can totally discount the theory that recycling electronics has contributed to the price decline of some metals in recent years.
The concentration of metals stored up in disused technology has contributed to price appreciation in the last few decades. More recently easy money policies and speculation drove the price in gold and silver to record highs. From those highs a concerted effort to obtain gold and silver by recycling helped to shake the speculative froth out of the market. That led to the somewhat sudden decline in price over the last year or so. It would appear that gold has now put in a bottom very similar to the one we saw in the S&P in early 2010.
The time frame was more compressed for the S&P, but it managed to rally higher from a lower low. In both cases the intraday low of the prior low was within a couple of cents of the final lowest low. This is not reflected in the closing price. It is also much clearer if you look back at the SLV/GLD chart. The double bottom is clearly defined over the last six months when looking at the price of silver.
It is this bottom, and the comparable 17% increase in gold and equities, that leads me to believe we have reached a point of equilibrium. A balance between the easy money policies of the central banks, increasing demand, reasonable levels of speculation and organized programs in recycling.
Going forward we should expect stead appreciation in price for both gold and silver. This is justified by a more stable economy in the US and Europe. In emerging economies, consumer expectations will lead to an even greater concentration of these metals in technology based devices. This is a continuation of the long-term tech trend and could last for up to another decade.
Further action by central banks could upset the equilibrium. If, for example, the Fed was now to increase purchases again, I would expect gold to act in a normal manner resulting in higher prices. Tapering has been built into the current price and so incremental changes will have little effect on price. Were the Fed to suddenly pull out of QE altogether, you would see a sudden reaction in the market and a lower gold price.
Over the next 12 to 18 months, a weaker dollar will also help to support gold price.
I am aware that this article will be too general for many. I have attempted to illustrate a concept for the longer term that is not well covered. I would urge you to remember that I am not just talking about cell phones. The amount of precious metal in cell phones globally is still a small percentage of the overall market. The point I am trying to illustrate is that every single time you come in contact with any electronic device you are touching gold and silver.
Additional disclosure: This article is for informational purposes only. You should seek professional advice before making any investment.