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A Historic Supply Shift That Will Drive Gold Higher and HigherBy
Thursday, September 9, 2010
I've reported many times how the Earth's gold mines have been yielding ever less gold. This is the case even though the price of gold has been soaring over the last decade.
And you have to go back that long to find the peak year of new mine production. This happened in 1999. That year, 83.69 million ounces of new gold came from mines. Back in that year, the price of gold was under $300, hitting a low of $256.
If someone would have predicted in 1999 that in 2010 the price of gold would reach $1,250, they'd have been laughed at. But had they further said that that much higher price would have caused less gold to be mined than had been the case in 1999, they'd have been thought absolutely crazy.
After all, if the price of something soars by 350% ($275 to $1,250) "everyone" knows that more of it will be produced. That's supposed to be basic economics.
And yet, exactly the opposite has happened. Though no one knew it at the time, 1999 marked the peak of global gold production. At least, so far it has.
Last year, 2009, mining production hit 74.46 million ounces. It was a sizable 12.6% increase from the year before. But while it was the largest total in years, it was still not enough to surpass 1999's output.
Besides new mine output, there are two other ways new gold can come onto the market: central banks and scrap gold. Supplies are drying up there as well...
For the last several years, central banks around the world could be counted on to sell a combined 200 tonnes per year. However, this pattern changed drastically last year. We saw central banks accumulate gold for the first time in memory. China, of course, stands ready to buy all domestic production. India famously bought a big piece of the IMF gold. Smaller central banks are buying as well.
If the average investor in the developed nations is still not interested (and says things like, "How can you eat gold?"), central banks are slowly rediscovering the value of having it as a reserve currency.
The second way that gold has come on the market is really the only other way new gold comes on these days. Well, it's actually not "new" gold at all. It is old gold scrap. Scrap gold can be many things, but it is mainly unwanted, broken, or bent gold jewelry. It can also be things as primitive as teeth or as sophisticated as the gold in cell phones and computers.
As the price of gold soared, people with this scrap gold rushed to sell it. The figures tell the story quite dramatically.
In 2008, while new mine production inched up by 1.38%, scrap gold soared by 34%. Scrap sales equaled nearly two-thirds of new mine output. I don't think anything like that had ever been seen before, even at the peak of the gold bull market of the late 1970s.
Adding new mine output and scrap gold together, you get 108.26 million ounces. Looked at that way, it was a new peak of gold coming on the market.
Except, it was foolish to consider the huge rise in scrap gold as an endlessly growing source of new supply. By their nature, there is a limited supply of teeth and rings that people want to part with.
Last year, scrap totals rose again, to the largest total ever: 53.63 million ounces. But while it was another good rise, the percentage increase slowed dramatically. As opposed to 2008's 34% increase, 2009 only saw a 26.75% increase.
Still, though, put new mine output and scrap gold together and you get a total of new gold available to buyers of 128.09 million ounces. On the surface of it, this amount was the highest total of gold ever. But if you look closer over last year's results, you'll notice something else...
New mine production was 74.46 million ounces and scrap was 53.63 million ounces. This meant that scrap equaled about 72% of mine production and over 40% of total new gold available for investors. That was a fresh record, and a huge percentage of new supply now relying on the scrap market.
Can it continue to deliver? The most recent figures, just out from the World Gold Council, are from the first quarter of 2010. Scrap sales for this period were 11.03 million ounces. This represents a huge 43% fall from the first quarter of 2009.
This year's first quarter saw new mine production of 19 million ounces, a 1.37% increase. Putting the two sources together (scrap plus mine) and you get 29.77 million ounces. Of course, it is very "iffy" to extrapolate for 2010 as a whole. However, if we do it, we get 119 million ounces, a 7% fall in total production, and during a year when gold prices will most likely rise.
The supply part of the supply/demand equation for gold has undergone a huge shift since the current bull market began in 2001. New mine production has peaked, central banks are now net buyers, and "scrap" gold supplies may have peaked as well.
I think that gold's startling failure to correct in price after the large run-up from the October 2008 lows of $693 is due in no small part to this changed equation. However you slice it, less gold is coming onto the market.
And demand seems to be growing every day. I sense people who have never bought a gold coin starting to test the waters, people who have not owned any gold ETFs starting to buy. If vast numbers of investors start to have even 5% of their portfolios in gold, this would constitute an explosion in demand.
In conclusion, I see this reduction of supply, coupled with increasing investment demand, supporting the gold bull market for years to come.
Good investing,
Further Reading:
Back in December 2009, gold took a one-month, 10% dive. Longtime readers of Chris Weber, though, didn't bat an eye. As he explained in DailyWealth, gold had soared 27% in three months and "no sprinter can go on forever. He has to rest, to exhale. After that, he can continue his run."
The thing to do in these circumstances is not to panic but to "take advantage of the recent near-10% discount" and buy. Find Chris' full argument here: What to Do If You Haven't Bought Gold.
Market NotesINSURANCE IS GETTING CHEAP AGAIN Insurance is getting cheap again... just ask the "VIX."
The "VIX" is Wall Street's fear gauge. The index tracks the price people are willing to pay for protective stock options, aka "portfolio insurance." When the VIX is high, it indicates traders are willing to pay big for market insurance. When the VIX is low, it indicates traders see blue skies ahead... and aren't worried about hiccups in the asset markets.
During the "flash crash" days of spring, the VIX spiked up to 45, indicating a huge amount of fear in the market. Now that things have quieted down a bit, the VIX is nearing a three-year low. Which brings us to a prediction...
Considering the abysmal U.S. debt situation and our political leaders' willingness to enact every absurd boondoggle and handout that will buy a vote, there aren't many things an investor can be sure of these days.
We can be sure, however, that we'll regularly endure extreme periods of volatility in the coming years. Periods of placid market action and rosy financial headlines will be interrupted with government debt crises, big stock swings, and a wild "flash crash" or two thrown in for flavor. That's why, when crisis insurance goes on sale, you buy some.
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