"Forget mining and central banks. Here's the single most important gold supply issue today..."

IT WAS TOUGH once again to meet any gold "bears" at the London Bullion Market Association's annual conference this year.

The bullish arguments you know already no doubt. Low-to-zero Western interest rates...plus a growing clamor to buy gold amongst Chinese households (the Middle Kingdom's demographics are more bullish still, as Mitsubishi's Matthew Turner showed)...make a compelling case for rising gold investment demand, even without the risk of government-bond defaults, rising inflation or continued losses on "mainstream" financial assets.

The Berlin conference had plenty more to say on those stories too, as we'll see below (and as you can see on the slides now freely published on the LBMA's website). But first, what of supply?

Well, all the gold ever produced in history came from a mine, as Paul Burton of GFMS World Analyst reminded the conference. But in the last decade, gold mining has failed so spectacularly to meet the surge in demand, he could only question its "relevance" to the market's net outlook. Dollar gold prices quadrupled from 2000 to 2009, another speaker noted, yet annual mine output rose just 1%. And allowing for the intervening slide in output, said Burton, gold mining output is now so price inelastic, it took eight years of rising prices to produce any meaningful blip in output (2009's year-on-year increase of 7%).

Further output gains look unlikely, Burton went on, thanks to the gold mining sector's "production lag" - both because of an "exploration lag" (new investment only turned higher in 2003) and because new discoveries of 1-million ounce deposits have collapsed regardless. The five years to 2009 saw record-high levels of exploration spending, perhaps totaling the previous 12 years added together (at least on BullionVault's skew-eyed reading of Burton's chart from the conference floor. See what you make of it on page 9 here). Yet all told, GFMS's best forecast is now for annual gold mining production to decline by 13% between 2012 and 2019.

That other constant drip-drip of gold supply - the "official sector" of central banks and outfits like the International Monetary Fund (IMF) - also looks irrelevant for now, as Burton's GFMS colleague Philip Klapwijk showed in his speech. European states are now holding, not selling their reserves, but emerging markets (for now) remain mere ankle-biters compared to the weight of private investment or jewelry demand each year. So net-net, said the GFMS chairman, central bank activity looks "neutral", despite the bullish picture for emerging-market demand he also laid out. More notably, and "something we haven't seen before", private-sector investment holdings now outweigh central-bank gold reserves overall. Making investor sentiment a key plank of any longer-term forecast.

Even without the end of central-bank sales, however, or the failure of mine output to rise, "The single most important gold supply issue is scrap," as John Reade of Paulson Europe said in his conference summary. Re-selling unwanted jewelry "has gone mainstream" noted Jeffrey Rhodes, CEO of INTL Commodities DMCC, becoming "socially acceptable" in a way that using pawnbrokers to raise cash never was. Throw in gold coins, dental bridges, bonding wire from microchips and any other supply "not from a primary [ie mining] source", and scrap gold matched more than one fifth of global gold mine output last year, up from just 7% a decade ago. Turkey has overtaken India as the No.1 source of scrap gold supplies (217 tonnes in 2009, equal to almost a tenth of world mining supply), but the most dramatic change has come in the developed West, where "sophisticated electronic assay equipment has seen the captain's ball at your local golf club replaced with gold buying parties," as Rhodes said.

Since 2005 alone, US scrap supply has more than doubled according to data from GFMS Gold Survey, taking United States' re-sales from fifth to second position worldwide in 2009 with 124 tonnes. Italy's re-sale market moved from seventh to sixth with a tripling to 78 tonnes of scrap, and the UK & Ireland have leapt 1505% from virtually nothing a decade ago to nearly 60 tonnes in 2009, bagging the world No.6 slot in the first-half of this year. Throw in Germany and France, and four European nations make the top 10 scrap supply nations by growth since 2000. In the first six months of this year, scrap supplies from each of the US, Italy and UK & Ireland had all outpaced India (the former No.1, remember), enabling scrap to become the "only credible counter to investment buying." But should these massive supplies of scrap in fact be overwhelming investment pressure on prices?

Since "investment buyers and scrap sellers are driven by the same motivation of price expectations" as Rhodes reminded the LBMA conference, this price-elastic source of supply could threaten "a perfect storm of selling once sentiment changes," he believes. But first, that would require higher prices again, because (for now) even scrap-gold merchants have turned bullish, he reported, capping flows to refineries in anticipation of stronger gains ahead. And second (and more critically given the source of the last few years' real jump in scrap supplies), "Is the drawer empty?" as Paulson Europe's John Reade wondered in his quick-fire recap before the conference adjourned.

Cash-strapped households, remember, can only sell their unwanted gold bracelets once. How high would prices need to go before more cherished pieces could be sent to the smelters? Apply the same question to private gold investments in fact (ETF holdings have proven notably "sticky", if not yet as "long-term means forever" as gold coins), and you get to the nub of the "bubble or boom?" debate. Because at some point, according to pretty much every speaker, the circumstances now boosting global investment demand will recede - and with them, therefore, the gold price will fall back as well. As we've already seen (in Part I), the bubblicious frenzy needed to mark the top of spike remains plainly absent. Leaving only the circumstances behind this current boom to consider.

"The current bull market has much deeper roots than the credit crisis," the LBMA was reminded by former Blackrock head of natural resources Graham Birch (now a farmer). Pointing to gold's nadir of 1999, "continuous disinvestment" was needed to keep prices down, and when Europe's big central banks agreed to cap their sales that September, it marked the start of this rise. Roll on 11 years and 350%, however, and "Just because gold's a safe haven doesn't mean it's a cheap safe haven," Birch warned Berlin. Which raises the question of cost and utility for new buyers today.

"I think people long gold should not be concerned reading this slide," said John Reade in his summary, pointing to slide 14 of William White's opening keynote speech. Chairman of the OECD's Economic & Development Review Committee, White had prefaced his 20 minutes of gloom-and-doom (salted with uncertainty, fear and doubt) by saying that the OECD itself would certainly disagree with everything he was about to say. Reade reminded the delegates that White's copyrighted sales-line should be "Scaring investors since 2003," as he accurately picked the shape of the bubble well ahead of schedule, and hasn't been proven wrong yet.

"Investors should be positioning for 'tail events'," White concluded. "But which ones?" Somewhere between deflation, slow growth, de-coupling of Asia from the West, or a lurch into rapid hyperinflation or a new series of bubbles fed by ultra-loose monetary policy, "Is there room for gold in a world like this?" asked the former Bank for International Settlements forecaster.

"The answer has got to be yes. But quite what role...well, that's for you to decide!"

A handful of private investors have begun to make that decision, as Wolfgang Wrzesniok-Rossbach of the Heraeus refinery showed in detail. But the real weight of money - the institutional mandates caring for your insurance and pension savings - has scarcely bothered to buy gold 'til now, a point made at length by both Shayne McGuire and Graham Birch on Monday morning. Across in Asia, "People don't need convincing on gold," said David Gornall of Natixis, noting that 81% of global "bar hoarding" demand comes from Asia, with buying amongst the "traditional buy-side countries" such as India and Thailand - as well as the fast-growing world No.2 for gold demand, China - continuing to grow despite record-high gold prices. Even there, "the emergence of retail physical gold investors has resulted in structural changes in distribution, product and buying behavior," as Sunil Kashyap, managing director of Bank of Nova Scotia-ScotiaMocatta explained. Yet all told (and absent the "bubble" idea which the conference demolished time and again), what looks like a new paradigm might in fact mean more a return to old patterns - globally - of gold buying and hoarding...with a little "mobilization" thrown in by the scrap market when times get tough.

India and Turkey, after all, have long been both top buyers and scrap suppliers to the international gold market. Rising investment demand here in the "rich West" (which, to repeat, remains well off a "bubble" today) represents a simpler, unleveraged way of retaining your savings than most Western households have grown used to. But gold was a core chunk of private wealth holdings not so long ago, back before the debt-fuelled boom we've enjoyed since WWII began - a boom which must now end with "rebalancing" between the world's debtors and creditors, as George Magnus of UBS made plain Monday morning. The kind of dislocation required won't be much fun for either, which again looks good for gold demand, if not necessarily prices.

All told today - and seeing the world's fastest-growing economies continue to buy and hold ever more gold as their wealth increases - maybe US and European savers are only just getting back to the future. Either way, that "bubble in gold" doesn't exist. Not by a long way just yet.