by ScruffyWe have been speculating for years on exactly what would change and make the price of gold take off. The discussion below regards the value of gold even though it is nominally measured by its exchange rate in fiat currencies. Unfortunately today the world is accustomed to measuring the price of gold by the fiat spewing forth from every CB on the globe. Individual currency exchange rates will vary in relation to each other, but the fundamental pressure of supply versus demand is valid regardless of which currency we use. I will repeat the current day basic conundrum that the value of an ounce of gold is an ounce of gold and is independent of the currency exchange rate.
The purpose of this missive is to provide a snapshot of the fundamentals that are today shaping the precious metals markets for the near future.
On the supply side of the equation we see hard evidence of shrinking supply of new mined gold. This condition is not likely to change in the near future. Some of the reasons include:
- The artificially suppressed price for both gold and silver resulted in years of shrinking exploration. Thus mine production had been at the expense of reserves and resources.
- Increasing costs have caused many miners to "high grade" for years. This means they have been focusing on the most available, lease expensive gold to mine.
- Mining lower grades will slow production independent of the depletion of reserves. This condition can only be remedied by intense exploration to find rich new ore bodies. This is unlikely and recent trends are for smaller ore bodies and poorer grades in newly discovered areas.
- The time from discovery to production has been estimated at 7 years and that time is increasing. The increases are socio-political in terms of environmental restrictions and political red tape associated with issuing new permits. The trend is bad!
- Energy costs have been rising faster than the price of gold and silver. This has resulted in some producing mines having been shut down even as the prices of the metals have been going up. This trend will continue as energy prices rise and extraction costs increase. Energy costs increase both the cost to develop a new mine and the operating costs of all mines.
- There is a shortage of new mining equipment. The future here is unclear, but for example tires for the large trucks are in short supply and demand is increasing globally. Some old tires have been removed from refuse piles and refitted to machinery just to keep the machines in operation.
Also on the supply side we see a definite change in the willingness of central banks to be bullied into selling and or leasing their gold reserves. It is well documented that the supply deficit of gold has been offset by central bank leasing and sales. Recall that just the hint of transparency and setting a ceiling communicated by the so called Washington agreement caused an immediate and violent rise in gold in 1999. What is happening now is that the agreement has been extended at a slightly higher level and there are indication of some CBs not willing to sell/lease their allotments.
It is a fact, gold supply is shrinking.
On the demand side we have even more good news for real money types. We now have indications that a growing list of nations will not only cease sales or leasing of their gold, but will increase their gold reserves. This is good fundamentally, but the political implications are tremendous. For years England and the US have been able to bully the CBs of the world to sell gold and hold pretty toilet paper as reserves. This is a major change in both the present demand fundamental and the future trend! A list of nations that have indicated that they would or may increase their gold reserves includes:
- South Africa
- S, Korea
- Saudi Arabia
In addition the selling by the Bank of England has now been recognized for the grossly stupid, political manipulation of gold that it was. This is unlikely to happen again and there is speculation that they may want some of the gold that they sold back.
Speaking of wanting their gold back, we have all heard that someday those that "leased" their gold will want that gold returned. Though the details of who, how much, and when are hidden because of the high degree of honesty with which they operate, it is getting ever more likely that this has already started and may accelerate. If the estimates of 12,000 to 16,000 tonnes of gold were leased there is NO WAY that all of that gold can ever be returned without the price of gold being driven an order of magnitude higher. There will definitely be some of that gold that must be returned adding to demand, but soon the failed leasing scheme will also be changed and become a demand factor rather than a supply factor.
Some nations are moving toward a gold (or cold backed) currency for settling nation to nation accounts. This would have the effect of increasing demand to park it in the mechanism of exchange. Either gold would have to be readily available for transfer, or gold would have to be stored and receipts would have to be exchanged. Either way this gold would need to come from current supplies increasing demand. As the nations who participated in this type of exchange would most likely strengthen their economies and currencies, they would need more gold and would attract other nations who would then see the fiscal benefits of honest money.
In more and more parts of the world investor demand is increasing even though the price of gold is increasing. India, China, Turkey, Japan, Venezuela, Thailand, S Korea, … in almost every nation except the US and the old European consortium, the people are recognizing the fiat fraud and buying gold at theses heavily depressed prices.
Even in the US, gold bugs who were, and still are considered somewhat misguided, are being recognized as having been right all along. The media is not yet committed to the truth, but the truth of honest money is just now being recognized by more and more people in the industrialized countries. The fatuous cheerleading and manipulated government statistics are starting to be questioned and recognized for what they are.
This is leading to investment demand by the people who are getting it and institutions that are drawn to opportunity.. Soon we may se the people in the traditionally industrialized nations waking up to honest money. When this happens the demand will explode temporarily. I say temporarily because those industrialized nations fiat currency are way over valued and as soon as the average guy recognizes it and wants to trade his pretty green paper for honest money the price will rapidly move higher and higher until he cannot afford to buy much is any.
Undoubtedly demand is increasing even as we see prices rise to new highs.
What we have is the best of both sides of the equation; increasing demand and falling supply. Technical issues will cause an erratic movement on a daily and weekly basis, but over the long run the fundamentals will move gold higher.
January 10, 2006
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