either anxious about their portfolios or excited about the new buying opportunity.
So it’s no surprise that the question I’ve been asked most often in the past few months has been, “Where are prices going?”
In the short term, prices cannot be predicted with any real accuracy. But if one takes a longer view, there are factors that can and should be considered. We all know the arguments about inflation and quantitative easing, but let’s take a look at a more basic price driver: the supply of physical gold.
The relationship between supply and demand—the Economics 101 explanation for the price determination of any product—is often overlooked and misunderstood in the precious metals market. The reason for that is the analysis is complicated. It is not strictly based on the physical market: one has to factor in the massive paper market as well.
When supply and demand are considered, particularly in the media, the focus is almost always on demand. When participating in media interviews, I am frequently asked about demand coming from Asia. Rarely am I asked about supply.
That’s a big oversight. Large miners (defined as publicly traded miners with a market cap in excess of $5 billion) account for 30% of annual global gold supply. The statistic is similar for silver. At current prices, the majority of large miners are losing serious money.
The following chart shows the interplay between supply, demand, and prices over the last several quarters.
Large miners are trimming costs, but once SG&A expenses (selling, general, and administrative expenses, including all management salaries, indirect production, marketing, and general corporate expenses) are reduced to the bone, the only way miners can continue to reduce their expenses in a meaningful way is by reducing operations. They will be forced to either shut down or sell mines with the highest operating costs. Those actions will result in a decrease in supply, which should place upward pressure on the price of physical metal.
If prices do not move up on their own with in the next 12 months, we expect that miners will drastically cut production in order to conserve cash.
Many (but not all) of the small to medium-sized miners are sitting on piles of cash and—unlike most large miners—could weather a longer period of suppressed prices. But they won’t be able to make up the shortfall in production. Nor would they want to: they stand to benefit most when prices increase.
Based on our initial research, we believe a long-term basement price for gold is in excess of $1,300 per ounce. This does not take in to account all the other reasons we like to invest in precious metals. This price is strictly based on supply and demand. To be clear, this assumes that demand for physical gold remains relatively constant.
Here’s a chart showing gold demand for the past ten years, excluding ETFs. The chart ends in 2012. So far, demand in 2013 is well above that during the same period in 2012.
Clearly, if demand drops, prices could fall from today’s levels, but that’s where the other demand drivers of precious metals come in. Those demand drivers remain as strong as ever.
1) Western governments and Asia alike continue to debase their currencies. Japan’s efforts to boost exports are starting to work. It won’t stop, and that will force its export-dependent neighbors to respond in kind.
2) Easy money remains the policy of the US, UK, and Asia. We are starting to see a diversion of opinion at the US Fed, but I would argue that the damage has already been done. The stock market is hooked on quantitative easing. Any tapering will impact stock prices and the economy.
3) Yields on US Treasuries are starting to climb, despite the best efforts of the Fed. The cost of servicing the US’s debt rises with each upward tick. Is this a precursor to inflation?
4) And finally, does anyone really believe that the banking system is any stronger today than it was in 2008? It seems we hear about a major new bank scandal every week as of late.
The World Gold Council released its demand figures for the second quarter of 2013 a few months ago. But be sure to dig deeper than the numbers. What you’ll find is that gold ETFs are included in the demand figures. ETFs have seen massive outflows as traders, hedge funds, and institutions pull out—many of them forced to do so due to margin calls.
What I find interesting—and what I’ve known given my vantage point at the Hard Assets Alliance—is that the second quarter saw record demand for gold coins and bars, and demand for jewelry also increased.
Keep an eye on supply in the physical market.
The Hard Assets Alliance website and the SmartMetals Investor are published by Hard Assets Alliance, LLC. Information contained in such publications is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated, and there is no obligation to update any such information.
Any Hard Assets Alliance publication or website and its content and images, as well as all copyright, trademark, and other rights therein, are owned by Hard Assets Alliance, LLC. No portion of any Hard Assets Alliance publication or website may be extracted or reproduced without permission of Hard Assets Alliance, LLC. Nothing contained herein shall be construed as conferring any license or right under any copyright, trademark, or other right of Hard Assets Alliance, LLC. Unauthorized use, reproduction, or rebroadcast of any content of any Hard Assets Alliance publication or website is prohibited and shall be considered an infringement and/or misappropriation of the proprietary rights of Hard Assets Alliance, LLC.
Hard Assets Alliance, LLC reserves the right to cancel any subscription at any time. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Hard Assets Alliance publication or website, any infringement or misappropriation of Hard Assets Alliance, LLC’s proprietary rights, or any other reason determined in the sole discretion of Hard Assets Alliance, LLC.
Affiliate Notice: Hard Assets Alliance has affiliate agreements in place that may include fee sharing. If you have a website or newsletter and would like to be considered for inclusion in the Hard Assets Alliance affiliate program, please contact us. Likewise, from time to time Hard Assets Alliance may engage in affiliate programs offered by other companies, though corporate policy firmly dictates that such agreements will have no influence on any product or service recommendations, nor alter the pricing that would otherwise be available in absence of such an agreement. As always, it is important that you do your own due diligence before transacting any business with any firm, for any product or service.
© 2013 Hard Assets Alliance, LLC.