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The
Chinese mining sector is currently producing 340 tonnes
a year and rising. No doubt there is every encouragement from the State for
this figure to rise. We believe that no matter how high it rises, little
if any of that supply will reach the world’s ‘open’ market
in London. Even global gold production is not likely to rise
significantly from the current level of around 2,500 tonnes.
Therein lies a development that, in itself, will
change global gold market dynamics.
Newly
mined gold supplies
The easily mined gold of the past has been thoroughly exploited,
although there may well be the occasional discovery of massive deposits in
places like Mongolia or other distant regions of the world. The usual future
picture will be of discoveries in politically explosive or hostile nations
that contain less than 5 million ounces. Deposits of 1 million ounces will be
developed, whereas before they were thought of as far too small and like
their larger brothers, development will take 5 years or so still, before they
come into production. Infrastructure development will be an integral part of
the picture. With rising prices almost matched by rising costs, there is
little incentive to mine gold in nations that will add heavy royalty taxes to
these costs or even to nationalize them. The prospect of much higher prices
has not led to feverish mining developments, nor will it.
What is even better for the gold price is the reality that new
discoveries are unlikely to be made in the developed world, except for
Canada. The discoveries that will be made will be in places like Russia or
China or Mongolia or Eritrea, where governments have every interest in
developing them. In short, gold mining companies may well be able to replace
depleted reserves but are unlikely to be able to make global gold production
rise to any significant extent.
Not
for public distribution!
We are of the opinion that newly mined supplies in countries such as Russia
or China will be bought into that government’s reserves and not find
their way into the global market centered in London. Even mines in Mongolia
or Africa, owned by Chinese companies will divert their supply to the
government of the company that owns them.
Supplies into London will come from countries other than those buying
their own production into their reserves. We do expect that more and more
nations [such as in South America], will buy their own production in the
future, further depleting supplies to the ‘open market’.
This complicates matters because it will lead to virtually no rise in
supplies to the main physical markets of the developed world or even to a
fall in ‘open’ market supplies. With London as the foremost of
these markets, we can expect the gold price to reflect the falling supply
from countries not buying their own production [like South Africa]. For
instance, if global supply, overall stands at 2,500 tonnes
and China and Russia take off all their local production, supply to the
‘open’ market will fall to [340 plus 210] 1,950. The net result
will be that the gold price will be based on a supply 22% lower than total
global supply. This present day reality defines the power of central bank
buying over the gold market and the gold price. There is no fighting over
price, no competition between government and the ‘open’ market.
Central banks will simply instruct local producers to sell their gold to them
at market related prices.
How
important to central banks is Gold?
As the value of currencies drop, gold will rise in importance in
national gold and foreign exchange reserves and become not just an important
reserve asset but a vital reserve asset. It is becoming the one
national asset that rises above any other foreign paper asset in terms of
reliability of value. Central banks, in turning either holders or buyers of
gold, have become an active encouragement to other central banks with small
gold reserves to acquire more. In fact, as government sales of gold have
ceased and central banks are, at worst, only holders of gold, central bank
gold buying has spread to the four corners of the globe already. The surplus
earning nations are leading the way in buying gold as they find that the
growing surpluses they acquire must be held in assets that can ride out the
developed world debt crises that are worsening at the moment. We expect the
number of central banks that buy gold will increase whether they are in gold
producing nations or not.
Better
than partial Confiscation
By diverting gold into reserves from local production, a central bank
achieves the same result as a partial gold confiscation would have done. The
difference is that there is a willing seller in the gold miners. The
advantage over an act of the direct confiscation of citizen’s gold is
that it allows citizens to continue to acquire gold in the open market while
the central banks remain unseen buyers. Central banks are showing that they
want the total national stock of gold [official plus private] to rise as high
as markets will allow. Following this route, any price rises are then not
seen as caused by central banks, but by an unfettered market where higher
prices are accepted across the world. The ongoing buying by the global retail
sector adds to the ‘national’ quantity of gold owned. In the
event of a dire currency crisis or danger to the global markets such a gold
buying structure still leaves the option of confiscation of its
citizen’s gold in hand. This adds a new dimension to the concept of
gold confiscation and puts it firmly on the map.
Central
Bank buying in the ‘open’ market
The difficulty for a central bank, in a nation that does not produce
gold, is that it will have to go into the ‘open market’ and
compete with retail buyers for the gold it wants, that still does find its
way to market. This must be done carefully, because any sign of central bank
buying gold in the market and the price of gold runs ahead. However, the
central banks have learned this is so and are far wiser buyers now. For
instance, Russia has announced that it will acquire at least 100 tonnes a year of gold for its reserves in the future. The
market knows this and has accepted it. The next stage is to be an effective
buyer of gold. At the end of the day price is irrelevant. So Russia need only
inform its dealer that it would like to see the offer of gold above
certain quantities.
 Being
price-unrelated, such a position cannot be activated unless there is a
showing of gold by the dealer in good quantities. Often this happens as the
gold price is driven down by selling in the States by an ETF. Then the
central bank’s dealer takes the offer to the bank and an instant deal
is struck and the gold leaves the market, without prices rising. Only when
other, usually retail buyers, trying to produce gold in quantity, drive
prices higher in the hope that there are sellers out there waiting for higher
prices, will prices jump. The central bank is unlikely to make prices move
either way. When looking at the monthly amounts Russia has bought it shows a
considerable variation as it follows this way of dealing.
What
will this do to gold prices in the future and how high will they rise?
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Julian D. W. Phillips
Gold/Silver
Forecaster – Global Watch
GoldForecaster.com
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