The Supply Of Gold , Mining As Primary Source
As billions of dollars are pumped into the world financial system, the supply of gold is relatively fixed with serious constraints on the capacity to increase supplies much further. Most of the gold in the world has been extracted since ancient times and now miners will face ever diminishing returns in the face of rising costs of exploration and mining.
As investors search for a means of preserving their wealth and purchasing power for the future, it is worth looking at the supply and demand dynamics in the world gold market going forward.
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We need to ask how possible are shocks to the supply side in gold? First let’s look at the three ways in which gold comes into the market. Buy gold online - quickly, safely and at low prices Mine Production To better understand the supply of gold dynamics going forward, consider the trend in gold mining production over recent years. In 2001, world gold mining production was around 2,650 tonnes and since then it has been at best going sideways, and in reality is in a downtrend, with 2007 showing a fall to around 2,450 tonnes. At first you might think that given the rise in the gold price in recent years from its low of $253 in July 1999, following sales by the IMF and a number of world central banks, that there has been a fall in production. This is probably a reflection of the relatively long lead time in the gold industry from exploration, discovery, mine development, extraction and refining and eventual near market availability. During the 1990’s the gold price hardly moved above around $400 an ounce, and given the steadily rising cost of mining a number of gold mining companies cut back on investment, and so very few new discoveries were made during this time. A rise in the rate of gold exploration and so the supply of gold will only come when the price of gold rises sufficiently to cover the high production costs. The changing dynamics mean that while in the past a mining company would only consider developing a resource with potential yield greater than 5 million ounces of gold, today they will look at yields of even 2 million ounces. Costs of extracting gold have increased from around $200 an ounce in 2002 to around $500 an ounce in 2007, and these costs will continue to increase along with energy costs which represents about 50 per cent of total mining costs. Input costs have also risen for various commodities used in mine development and production such as cement, steel and rubber. These higher production costs will inevitably put a floor under the gold price and act as an anchor on the supply of gold. And with rising labour costs and environmental constraints also needing to be factored in, the prevailing view now is that production will decline or at best continue to be flat for years to come. Central Banks In the balance of supply and demand world central banks are net sellers into the gold bullion market every year.
This approach has benefited significantly from Central Bank Gold Agreements (CBGA) made in 1999 and again in 2004 which set out the terms of these Central Bank transactions in an open way which helps predictability and stability going forward. The 2004 agreement between the European Central Bank and 14 other central banks was a renewal of the 1999 arrangement where limits are set on the amount of gold bullion that can be sold. This has now been increased from 400 to 500 tonnes per year over the five years to 2009, to give a total of 2,500 tonnes. A number of the European central banks hold a large portion of their reserves in the form of gold bullion, with Germany the largest holder having to sell 600 tonnes in the five years to 2009. The markets will be watching keenly to see what happens in early 2009, when the present agreement ends. Will a new arrangement be more or less restrictive? What may happen to the gold price if a decision is taken not to require further sales? The IMF has a significant holding of gold and it may seek permission from members to sell a small amount to purchase an endowment and use the income generated to fund its operations. Sales of gold from the official sector would most likely be within the limits already notified to the market and so would be unlikely to have a precipitate effect on the gold price in the near term if at all.
Other related articles: Gold Exchange Traded Fund, Liquid Gold Exposure Investing in gold, protection against inflation Gold in backwardation, attraction of the physical metal Recycled and Scrap Gold The supply of gold from scrap and recycled sources can play a notable role particularly when there have been significant changes in price during periods of volatility and when economic conditions are more difficult.
There is a strong growth industry in recycling gold from microprocessor chips in computer hardware and this is likely to continue as supply bottlenecks appear from primary mining sources. Scrap sources of gold shot up 30 per cent in the first quarter of 2008 as many holders of jewellery, particularly in the emerging markets, sold their holdings and inventories.
Looking forward Slow down in mining production will play a big role in the supply of gold and in its price action over coming months. As more investors and traders see the advantages of using gold to preserve wealth and make profits, the market is likely to see upward price pressure. The weakening of major currencies such as the US dollar, following the huge increase in money supply over recent months, will only add further to an inflationary environment. And with a tightening supply of gold, the metal will continue to attract more interest.
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