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Julian  D. W. Phillips

Julian D. W. Phillips

Global Watch: The Gold Forecaster covers the global gold market. It specializes in Central Bank Sales and details, the Indian Bullion market [supported by a…

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What Will Happen to Gold Supply if Demand is Very High?

Investment demand for gold has never been so high and it is likely to rise still further. Normally when a commodity is in high demand supply is accelerated and holders of that commodity often take profits, thereby increasing supply. Economic history tells us the same, "rising prices and high demand should result in rising supply." When it comes to gold all rules have to be re-written. That's because gold is only part commodity.

Newly Mined Gold

Gold BarsFrom the raising of the finance for a mine, to the start of gold production, takes around five years. That's assuming there is a gold resource available to mine in a gold mining-supportive country of sufficient size to make the mine worthwhile. During the last 15 years of last century, support to such ventures from central banks through bullion banks was so strong that the mines would be loaned the gold they were going to produce. They then sold it forward to the time when the mine would produce and often even further out. This allowed the mine to earn a high gold price [as the price was dropping] and earn the interest on that gold until delivery [Contango]. Then, from production, they repaid the Bullion bank/Central bank the amount of gold they had borrowed. While wise at the time, it did quickly exhaust the easily mined deposits of gold leaving us with a situation today, where good gold deposits are getting increasingly rare and difficult to mine. Add to this the propensity of governments to wait until the mines do really well then hit them with heavy taxation. This is deterring new investment in gold mining. That's where we are now. The result is that from now on, gold mining companies are hard pressed to replace the resources they have exhausted. Consequently, newly mined gold production is set to decline from 2010 onwards, irrespective of what the gold price is.

Central bank sales

From 1985 until 1999 the gold markets sat under the cloud of potential central banks sales. Central banks across the globe encouraged an atmosphere that expected unrestrained gold sales. Naturally the gold price fell from its $850 high down to $275 during that time. Then the "Washington Agreement" was signed which capped European Bank sales at 400 tonnes a year. The gold market breathed a sigh of relief and the gold price turned to the upside. Sales under this agreement and the next [that terminated on September 26th 2009] at first, did reach the ceilings levels that were set, right up until the last two years of the second agreement [where a target of 5oo tonnes a year had been set]. Then they petered out with hardly any sales in the last half of the last year of the Agreement. Since then no significant European central bank sales have taken place [a total of 1 tonne of gold has been sold to date from the inception of the Third Agreement]. It can then reasonably be concluded that central banks sales have dried up. In their place have come central bank purchases of 400 tonnes a year.

The State of the Gold Market now

As we said at the beginning of this article, demand is very high, primarily from investment demand. Both western jewelry and Indian demand have been low until recently. Both of these markets have eventually accepted the current record price levels as being sustainable. Demand from these two sources has now begun to rise again. It's clear that demand is at a high, without the usual froth that accompanies peak demand. So a combination of peak demand and restricted supply leaves only one potential source of supply and a capricious one at that.

Gold Scrap Supply

With no other source of supply markets usually take prices to a level where holders of a commodity sell and take profits, in the belief that such prices are not sustainable and will soon fall. Since gold hit the high of $1,215 for the first time, prices did fall, with many forecasting a low price of $850. This didn't happen. Instead a low of $1,050 was seen, before the gold price began to climb again. During that time and until recently 'weak holders' of gold in India did sell and were the main suppliers of that market, in particular. Now they too have accepted current prices as a new 'floor'.

Most of you will have seen adverts for 'gold parties' [rather like the Tupperware parties] where housewives get together and sell old gold [that's lain in the attic for years]. This has largely run its course now and such supplies are drying out. Once these sellers have sold out, that supply too will dry up too. This source of scrap is not important to the supply side of the gold market.

Gold Bars 2The next potential source of scrap gold is from the current holders of gold, who bought solely to make an eventual profit. Once they believe prices are as high as they will go, they will sell. These can be termed 'weak holders' in the gold market for long-term investors from central banks, to institutions, to individuals hold gold to preserve wealth, in a world where it is threatened. Such investors hold gold simply to be prudent in the face of uncertainty and instability in the financial world. They may only hold a small proportion of their portfolios in gold. But be sure that they won't sell until certainty and stability are likely to return to the financial world. A look at what's going on now in that world tells us that we may see a squadron of pigs circling the White House at the same time?

So what lies ahead for the gold market?

When will more supplies reach the gold market and at what price
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