Falling Supply and Rising Demand Cause Gold to Soar

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

February gold futures broke $1200 for the first time a little after 4AM New York time. February 2010 is now the major front month contract after the expiration of the December contract on November 30th. Gold futures were up 14% in November, the best monthly performance in ten years. Silver was also up 14%. Gold traded down only three days in November and hit one all-time high after another during that time. While the major U.S. stock indices were also up, gold and silver shined in comparison. Seasonally-weak oil was flat during the month. The trade-weighted U.S. dollar opened November above 76 and closed out below 75, hitting a new yearly low of 74.23 in the interim.

The price rise in gold is caused by a positive supply demand picture both for the physical metal and in the futures trading pits. For the last twenty years there have been three major sources of gold supply and three major destinations of gold demand. The sources for supply have been mining, scrap (also known as recycled gold) and central bank selling. The three majors uses for gold have been for jewelery, investment and industrial (contrary to popular belief, gold has a wide variety of uses in manufacturing, especially in electronics). Complicating the picture has been central bank leasing to miners, big banks and hedge funds that dumped significant amounts of gold on the market in the 1980s and 1990s and was a major factor in holding gold prices down. The unwinding of these positions, Barrick Gold closing out it hedge book is the most recent example, has been creating upward pressure on gold prices for several years now.

There are two major currents in the shift in market supply and demand. Central banks have shifted from the supply side to the demand side and ETFs have caused a major increase in investment demand. Up to mid-decade, central bank selling accounted for 14% of gold market supply, but in the first half of 2009, central banks became net buyers of gold. As supply dried up from central banks a new increase in demand was created by ETFs that buy and store physical gold. There are now eleven of these globally and none existed before 2003. Their gold holdings have gone from zero to 1766.40 tonnes in the last six years. The largest ETF, GLD, is now the sixth biggest holder of gold in the world (between France and China).

Gold mining has provided as little as 60% of market supply in recent decades. So far gold mining output peaked in 2001. It then fell seven years in a row until 2008. The only major producers with increasing output have been China and Russia. This may have more to do with their transitions from a communist to a more capitalistic economic model than with the contents of their gold mines however. South Africa, which was the top gold producer for much of the last 100 years, is experiencing a rapid drop in gold output and it looks like it will fall to fourth place in global rankings this year. It takes approximately ten years to open a new gold mine and gold prices only started rising in 2001 and many remained convinced for some time that the rally wouldn't last. So don't expect any significant increase in mining output until well after 2010. Barrick Gold closing out its large hedge book though is an indication that they believe gold output is likely to continue falling and prices to continue rising.

While high gold prices mean that jewelery demand will fall, the rise in investment demand will more than overwhelm any drop. In a number of developing economies, jewelery and investment demand are not actually distinguishable as is. Purchasing high-caret jewelery is the traditional method of investing in gold. While India has been the number one market for gold demand, China seems to be in the process of overtaking it. There were significant restrictions that limited gold buying by the Chinese until the early 2000s. Gold demand there has been soaring since the restrictions were lifted.

There are a number of major long-term trend changes going on in the gold market and none of them are likely to end soon. There is probably at least another decade before a new equilibrium is established and major shifts start occurring again and drive the price of gold back down. By the time that happens though, the price of gold is going to be much, much higher than it is today.

Disclosure: Long gold and silver.

NEXT: Is the Gold Rally Getting Frothy?

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

In for a Penny, In for a Pound

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

The third quarter GDP figures for Great Britain were released last night and GDP fell 0.4%. I particular liked the headline "UK Still in Recession After Surprise Contraction" announcing the drop. This was the sixth quarter in a row that GDP was down in the UK. So who exactly was surprised by this? Probably just mainstream economists and anyone who reads the drivel published in their reports. One survey indicated that 100% of economic analysts had predicted that British GDP would go up this quarter - and they were all wrong. This is not uncommon. Mainstream economists frequently all ere on the wrong side of a number and are the last to know what is really going on in the economy. There is probably no profession as prone to group think and making errors in its predictions.

Once the GDP numbers were released there was immediate speculation that the Bank of England would increase its quantitative easing (aka money printing) program. The British pound fell by a penny almost immediately. This helped the trade-weighted dollar rally, since the pound is one of its components. The dollar rally was most noticeable when U.S. trading opened however. Gold and silver which reacted bullishly in overnight trading to this potentially inflationary news, dropped straight down after the U.S. markets opened. We have seen this pattern over and over again. A knowledgeable cynic would claim only blatant manipulation of the dollar and the precious metals markets backed by the U.S. government could account for it.

It's only a matter of time though before gold breaks out from its current trading range between $1050 and $1070. Indians spent $2.15 billion buying gold last week during their festival period. Gold sales were 5.7% higher than last years. India has accounted for 20% of global gold demand for many years now. There were a number of reports released by the gold bears in September about how the high price of gold would severely damage gold demand in the subcontinent this fall. It is now clear that that's not going to happen. Gold has traditionally been the way to store wealth in India and this habit goes back at least 2000 years. The Indians have never trusted paper currencies and over time have accumulated massive hoards of the precious metal. This deeply ingrained preference for gold is not going to disappear any time soon.

While Indian demand for gold is likely to remain high, it will probably be overwhelmed at some point by investment demand from ETFs and other sources thanks to the quantitative easing programs in the U.S. and UK. Jewelry has accounted for a majority of gold demand in the past. In India and other developing countries jewelry is purchased as an investment (the gold is frequently almost pure 22 caret as opposed to the diluted 14 caret gold used in jewelry in the U.S.), not as a luxury item as is the case in developed economies. Eventually, Westerners will find that the ancient habits of the East are just as good today as they were long ago.

NEXT: Interest Rates Break Out

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

More Oil Disappears; Gold Investment Demand Skyrockets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

The U.S. government's weekly EIA storage report came out this morning and for a second week in a row there was a big drop in crude supplies. Gasoline in storage dropped even more. The less reliable industry report from the API, released Tuesday evening, showed an even bigger drop of oil on hand. The ever bearish (and wrong) oil industry 'experts' were quick to point out that demand wasn't rising, it's just supply that is falling, as if somehow this doesn't cause prices to rise. One area where demand is unquestionably rising is in gold purchases for investing. According to today's report from the World Gold Council, these more than tripled year over year. As was pointed out in the New York Investing meetup's 'Inflation Investing' class last night, investment demand is the key to future price rises in the precious metals.

While the mainstream media has continually (and inaccurately) trumpeted that there is a glut in oil supply in the last several months and twisted and even misreported recent EIA statistics to show that this was the case, the price of oil has been steadily going up since February 18th. Obviously the smart money and the insiders haven't believed a word of the bearish story on oil that the press has been telling the general public - nor should you. Oil in storage dropped by 2.1 million barrels last week, after a more than 4 million barrel drop the week before. At least this time analysts predicted a drop (of 1.5 million barrels), unlike last week when they predicted a big gain. Gasoline supplies dropped an eye popping 4.3 million barrels this time around. NYMEX oil closed at 60.10 yesterday and almost reached 62 early the morning, which represents a breakout to a new trading range.

A more significant report released this morning was the World Gold Council's supply and demand figures for gold in the first quarter. Investment demand more than tripled from Q1 2008. The current figure of 596 tons is up from 171 tons last year. Investment demand represented almost 60% of all demand for gold in the January to March period - and that percentage is likely to rise substantially in the next few years until it totally overwhelms all other demand categories for gold (jewelry, industrial, and medical). ETF demand by iteself exceeded jewelry demand, historically the biggest source for gold usage, for the first time. Industrial and jewelry demand both had sharp drops, so the overall demand increase for gold went up 'only' 38%. What supposedly prevented a major price rise in gold last quarter was a huge increase in gold supply from scrap (gold holders cashing in their gold). The scrap figures should be taken with a grain of salt however. Analysis of previous big rises in supply from scrap indicate that almost the entire increase came from just one country -India - and nowhere else in the world. This is suspicious to say the least since the rules of economics tend to work the same everywhere.

Gold and its companion silver have yet to start a new rally phase, but should be doing so soon. It's never possible to say exactly when. The new demand figures for the precious metal can only be described as extremely bullish. Oil's current rebound off its lows is well underway and should last minimally at least 5 to 6 more weeks (this is the most conservative estimate). In the best case, it could continue well into the summer. Seasonal factors will eventually cause selling in the fall/winter, but don't expect oil to return to the lows from last winter. It is much more likely oil will be returning to its highs from last summer. You will probably have to wait until 2010 for that though.

NEXT: Dollar Weakens; S&P British Outlook; TED Back From Dead

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.