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Analysis of the
economics of gold price formation by the financial media is nearly all wrong. The
majority of articles and research reports obsess about mine supply, as if it mattered
(which it doesn't see 1
and 2).
There are additional pointless discussions about whether the gold industry is
in a phony deficit or surplus (neither).
A variant of this
fallacy is forecasting the gold gold price by
looking at its cost of production. We know as Austrians that costs do not
determine price. While it is true that a positive differential between the
price of gold and the cost of operating current mines results in profits for
gold miners, the market adjustment to eliminate this differential takes place
mostly through a rising cost, rather than a falling price. The mining
industry would surely respond to profit opportunities by producing lower-grade
deposits with a higher cost per ounce, but this will not increase the total
supply of gold by much because marginal costs rise so dramatically with
increasing supply. Even if twice as much gold could
be mined at a cost of $1000/ounce than at a cost of $500/ounce, this would
only increase the growth rate of current supply from 1.5% annually to 3%.
Another bogus
concept is "peak gold". This is meant to be an analogy with peak oil. I am not taking a
position here on peak oil, but the concept of peak oil is not obviously
flawed the way that peak gold is. There is a structural difference between
the gold market and the oil market: all of the gold ever mined still exists,
while most oil is burned shortly after it is extracted. This means that the
price of oil must balance the quantity extracted with the quantity consumed
over a relatively short time frame. In the gold market, the vast majority of
gold supply is already above-ground; the market is dominated by supply and
the demand-to-hold existing stock. Mine supply is a minor factor because it
is small in relation to the existing stock. If mine output were to decline
each year, the total supply of gold would still continue to increase, at a
slower rate, maybe 1%/year instead of 1.5%/year.
I have been pleased
to see in recent weeks two articles expressing a correct understanding of
this issue:
In the Lex Column of the Financial Times titled Peak
Gold?, the unsigned author makes the great point that increasing
demand-to-hold the metal is met through a rising price, rather than
increasing supply :
[peak gold] is
absurd. Rising prices or faltering mines do not equal scarcity. Indeed, even
investment "demand" is mitigated by price as one need only buy a
fourth as much of it as a decade ago to keep actual physical purchases
constant. It is not really demand in the same sense as other finite
commodities because gold is almost always just being held in order that it
might later be sold, to a greater fool, at a profit.
Contrast this with oil. Every year, over
four times as much gold is mined and over twice as much recycled as is
actually needed by industry, while annual crude supply more or less equals
demand for oil. Global oil stockpiles would satisfy just 48 days of crude
demand, while the 163,000 tonnes of gold that the
World Gold Council estimates are above ground would last 375 years, or nearly
3,000 times longer.
Even this figure is hypothetical since if
gold really were to become scarce it would cease to be used in some
applications, with industrial demand shifting instead to other materials,
just as the 1970s price surge led to porcelain's ascendance in dentistry.
Secondly, the always
insightful John Hathaway, in A
Contrarian's Dilemma
The supply of gold
increases at a far slower rate than that of paper money. Each year, the gold
mining industry produces around 2500 metric tonnes
of the metal. This quantity adds a puny 1%or 2% to the above ground supply of
163,000 or so metric tonnes. There is little to
suggest that this grudging pace is likely to change in the foreseeable
future.
Unlike economically sensitive commodities,
to which it is frequently and incorrectly linked, gold does not get used up.
Therefore, traditional supply and demand analysis does little to explain
price movement. It is better to think of gold as a multi trillion dollar
capital market asset. In theory, all of it (at least that which is held as
investment or quasi investment) is potentially for sale at any given time.
Price behavior is best explained by macroeconomic considerations and the
greater investment climate rather than micro economic considerations such as
mine expansions or jewelry consumption.
Robert Blumen
Also
by Robert Blumen
Robert Blumen is an independent software
developer based in San Francisco, California
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