Wednesday, February 08, 2012

Late Night Thoughts on Gold Scarcity - Nearer Than You Might Think

8 February 2012Link
Back in 2003, I read every article on gold and gold investing I could find. Now I only read those that I think will introduce me to truly new ideas, or that are composed by authors whom I regard as considerably wiser than their peers.

Jeff Clark, a partner of Doug Casey, is one of the writers whom I trust to make me stretch my thinking a little bit further. Jeff has again succeeded, in his new article, "A New Reason Gold Stocks Will Soar."

Anyone who is economically minded thinks in terms of market rule #1: Prices are set by the balance of supply and demand. Here's what we don't often think about. Human population is rising more rapidly than the rate of gold production, while at the same time, most nations in the world are engaged in a process of "competitive currency devaluation."

Human population has increased 15% since 2000, while annual new gold supply has fallen 4.2%. The rate of printing of new money by most world powers has been running 5-10% per year since 2000, and the US has increased its (more rapidly devaluing) money supply at this torrid pace since 1960.

Let me walk you through a scenario that is not that difficult to imagine.

1. Let's say that at some point, a market shock pushes up treasury yields (effective interest rates) for the major powers (the US, Britain and the European Nations, Japan, and perhaps China). The Europeans have already shown us that even at rates in the 7% range, countries such as Italy and Spain are unlikely to be able to repay their debts (interest rates on debt will grow more rapidly than government revenues). At 7% interest, the US would be paying $1 trillion per year to service its world record-setting debt load.

2. As Mr. Clark points out, the market capitalizations of Apple Computer and Exxon Mobil are each larger than the combined valuations of every gold mining company in the world. China alone (mostly its private citizens) bought slightly over half of all of the world's new gold supply (3.3 million ounces) in the month of November 2011. And the $47 billion of gold investments held by global pension funds represents only 0.15% of their total holdings (an amount almost too small to be detectable). If that infinitesimal number were doubled, gold and gold stocks would still represent only 0.3% of institutional investments. That is, a doubling of institutional gold investments would still leave pension funds holding an amount of gold investments too small to mention or think about, but it would add $47 billion of demand to the (tiny) global gold market.

3. Mr. Clark is thus presenting a different kind of supply and demand argument. Consider only two factors. A doubling of Chinese demand (it's possible, the Chinese are massive savers) OR (not AND) a doubling of institutional demand (bringing institutional gold-related assets from 0.15% to 0.3% of total holdings) would effectively remove ALL new gold supply from the markets.

What would this mean for the average investor?

Think about it. We're not talking about rising prices in the face of increased demand. We're talking about NO SUPPLY in response to only marginally increased demand. Gold bullion, gold coins, gold certificates. It doesn't matter. Physical gold would rapidly become unavailable to the ordinary saver/investor AT ANY PRICE.

At this point, you might be asking, "Gold is mostly held in storage. It has only minor industrial and economic uses. Who would care?"

Here's the problem with the "who cares" argument. As we discussed earlier, even a minor spike in interest rates (say to 7%) would create a financial crisis in almost every major national economy. That is, our government leaders would have to pare back government services to a drastic degree (unlikely to be popular: consider the present situation in Greece being replicated in every major nation in the world), or to pay their mounting debts by inflating and devaluing their currencies (a step that they have already taken). At some point, currency devaluation causes citizens - particularly savers - to lose confidence in the currency itself, and thus to seek alternative stores of value.

Now you'll understand why gold has been the world's "reserve currency" for thousands of years. Imagine holding your wealth in barrels of oil in your back yard. it poses storage problems. Gold is the most effective and time-honoured store of value, particularly during a period of loss of confidence in "printed money." That is, when there is a growing sense that "nothing" has or holds value, then the demand for reliable stores of value increases. And as we've established, a massive surge in gold demand would not be needed to unbalance the market. In fact, a minor and incremental increase in gold buying is all that it would take to "clear the market," leaving no more gold available at all for sale to the average consumer.

In conclusion, I'm not asking you to imagine a world where gold is "expensive," perhaps much more so than today. I'm asking you to imagine a world in which gold is simply NO LONGER AVAILABLE to the average citizen saver at any price.

Read Jeff Clark's article here for more details and analysis.