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"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.
Adrian Ash
Head of
Research
Bullionvault.com
You can also Receive your first gram of Gold free by opening an account
with Bullion Vault : Click here.
City correspondent for The Daily Reckoning in London, Adrian Ash is
head of research at BullionVault.com – giving you direct access to investment
gold, vaulted in Zurich, on $3 spreads and 0.8% dealing fees.
Please Note: This article is
to inform your thinking, not lead it. Only you can decide the best place for
your money, and any decision you make will put your money at risk.
Information or data included here may have already been overtaken by events
– and must be verified elsewhere – should you choose to act on
it.
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