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[O]n the whole, no commodities are so little exposed
[as gold and silver] to causes of variation. They fluctuate less than almost
any other things in their cost of production. And from their durability, the total quantity in existence is at all times so great in proportion to the annual
supply, that the effect on value even of a change in the cost of
production is not sudden;
a very long time being required to diminish materially the quantity in existence, and even
to increase it greatly not being a rapid process. Gold and silver, therefore, are more fit
than any other commodity to be the subject of engagements
for receiving or paying a given quantity
at some distant period.
John Stuart Mill, Principles of Political Economy (1848)
And God created the two precious metals, gold and silver, to
serve as the measure of value of all commodities. They are also generally used by men as a store or treasure.
For although other goods are sometimes stored it is
only with the intention
of acquiring gold or silver.
For other goods are subject to the fluctuations of the market,
from which they [gold and silver] are
immune.
Ibn Khaldun, Al Muquaddimah
(circa 1379)
For most commodities, supply and production are almost synonymous. In a given year,
the amount available is about equivalent to the amount produced. The difference is accomodated by warehouse
inventories of some sort, which
are typically a small
fraction of the annual production. At the same time, buyers of the commodity typically use it up within a short period of time,
for example by literally consuming it in regards to foodstuffs or incorporating it in manufactured products or construction in the case of metals or other commodities. Thus, we can see
that these commodities' price is heavily influenced
by supply and demand. If annual production is high or low, then of course supply is high or low,
with some variation accomodated by increasing or decreasing warehouse
inventories. Demand is rather constant, as the end users
have a constant need for the commodity
to continue their businesses. Factors
such as wars or economic cycles may cause immediate effects on demand; these are not spread out into the out-years.
Let's take, as an example, copper.
In 2010, the world production of copper was about 16.2 million
tons.
http://minerals.usgs.gov/minerals/pubs/commod...-2011-coppe.pdf
However, known
inventories of copper were
only about 645,000 tons. This includes
major exchanges, not privately held
supplies, but I would guess
this is most of it.
To state the obvious, 645,000
tons is a lot less than 16,200,000 tons. It is only about 4% of world
production. In other words,
most of the copper produced in any year goes directly
into copper uses, with little ending
up in long-term storage.
Production and usage (consumption) are about the same. Often, this copper is
not quite "consumed"
because it is usually in a condition that allows scrap
recovery and recycling. However, it is
no longer in some sort of pure bulk
format.
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http://www.investmenttools.com/futures/
Unlike copper, which is produced
continuously, foodstuffs typically have a harvest season. After the harvest, it is necessary
to store the product until
the next harvest season. So, inventories are higher,
in terms of a percentage
of annual production. But, they
are still not that high.
Here, we can see that
grain inventories typically fluctuate
around 15% of world production. This is lower than
you might think, because some regions have multiple crops and the southern hemisphere is harvesting while the northern hemisphere is planting.
What about gold? The situation with
gold is the other way around. Inventories are enormously larger than annual production -- about
fifty times larger! So, we have copper, in which inventories are 4% of annual
supply, and gold in which
inventories are around 5,000% of annual supply. Big difference. You can see why
certain supply issues that
might be a big deal for copper would be totally
irrelevant for gold. For example,
if world copper production were
to fall 20% because of a revolution in Zambia or the
Congo, that might drive prices much higher.
However, if world gold production were to decline (or increase) by 20%, it would have almost no effect on the availabile "supply" of gold.
Here, we can see that
world gold production for 2010 was about 2,250
tons, or about 72 million troy oz. Note that this has been dropping in recent years, oddly enough given the increase in price.
OK, how much gold is there in the world? The USGS
estimates that about 85%
of all the gold ever mined
since the beginning of
time is still in human possession. This is about
5.0 billion ounces today.
Think of a big
5.0-billion-ounce pile of gold bars, coins, and jewellery.
Annual production of 72m oz. is
only about 1.4% of available
supply.
How about "consumption"? Obviously, if 85% of all the gold ever
mined is still with us in bullion or jewelry form, then most
of the annual production is
not consumed, in the sense
that copper or corn is consumed, but rather formed into jewellery and bullion products, adding a little bit to that big pile. Here are the stats from the World Gold Council:
We see here
that jewellery accounted for 2,017 tons of gold use in
2010. Technology accounted
for 466 tons. Coins, bars, ETFs and other forms of bullion were another 2,483 tons. Much of the "supply"
was from recycling. This is industrial recycling, and also your "cash for
gold" schemes where old jewellery is smelted down to raw bullion.
However, it turns out that jewellery is essentially a "bullion product" itself in most of the world. We are accustomed to having gold jewelry that costs much more than the value of the contained
bullion. The gold necklace
from Tiffany's costs $1,000, but has only $150
of gold. The rest is the blue box. However, this is not the case in most of the world, particularly
Asia, where most of this jewellery is fabricated and sold. In Asia, the cost of the jewellry is only
about 2% higher than the
value of the bullion contained.
In other words, jewellry is also
a "bullion product"
not much different than Krugerrand coins, which, by the way, also sell for about a 2% fabrication premuim, just like jewellery
in Asia. I would also put things like gold teeth in the jewellery category, as there is no utilitarian
reason to make crowns out
of gold.
In Asia, jewellery is not used, as it is in the U.S., as primarily a decorative item. It
is used as money! One of
the largest users of gold
jewellery in the world is
India. Imagine you are an
Indian farmer:
This is a graph of the
exchange rate between the Indian
rupee and the USD over the past
forty years. As you can see,
the rupee was a junk currency
for many years, steadily sinking in value against the dollar, from 10:1 to
50:1. This followed the 1970s, when
of course all currencies declined
in value. If you were an Indian farmer, how would you preserve
your wealth? In a bank account? There might not even be a bank where
you live. In banknotes? I
don't think so. Stocks and bonds? Not an Indian
farmer. You can see the very real need for something -- anything -- to serve as a store of monetary
value, and what better than the best of them all, gold
bullion. (Note that India's long period of currency decline ended around 2002, which, not-so-coincidentally, also marks the start of India's great resurgence from a perennial basket case
and charity poster child
to emerging market superpower. Can you see why I say
that the Magic
Formula is Low
Taxes and Stable Money?)
So, we see that the true industrial uses of gold are in the technology
category. This is gold plating on electronic
components, that sort of thing.
It is only 466 tons per year, which is
only about 17% of annual bullion production. Even this, however, is often not consumed permanently but is retrieved again as scrap recovery, ending up in the
"recycled gold" category
some years down the road.
In the case of copper, annual
"consumption" for industrial
purposes is about 100% of
supply, which is nearly synonymous
with annual production. However, in the case of gold, there
is only about 15m oz. of industrial "demand"
per year, while available "supply" is 5.0 billion ounces -- 333x greater! And, as I mentioned, a
lot of that industrial demand is actually
satisfied by recycling.
Now you can see why
gold is not subject to
"supply and demand"
issues like all other commodities.
Nathan Lewis
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