Why Gold Is Likely to Keep Moving Higher

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Great forces, mostly benevolent, are at work in the gold market. Demand, as reported copiously by the mainstream financial press, continues to grow steadily on a global basis. It is on the supply side of the equation, however, where we now find the strongest arguments for resumption of the bull market. To come to the point, fundamental trends suggest that the gold market may be moving from a period of general scarcity to outright shortages.

Occasionally I like to take a close look at gold's fundamentals -- a gut check of sorts. It helps me get a deeper sense of what is driving the market. From scarcity to shortages, the past is prologue...

I cannot remember a time when the fundamentals have lined up more favorably for gold. The factors which have driven the price up over 75% over the past few years remain in place and in fact seem to be intensifying. The past, in this respect, could very well serve as prologue. Great forces, mostly benevolent, are at work in the gold market. Demand, as reported copiously by the mainstream financial press, continues to grow steadily on a global basis. It is on the supply side of the equation, however, where we now find the strongest arguments for resumption of the bull market. To come to the point, fundamental trends suggest that the gold market may be moving from a period of general scarcity to outright shortages. Unless some formidable source for gold is suddenly found, the period of shortages could come to full flower as early as 2008.

. . .And forced covering of their forward sales

The steadily rising gold price has encouraged some mining companies (and forced others) to buy back their previous forward sales -- a process called dehedging. Though some analysts in the industry perennially predict the dehedging will slow, it has instead accelerated and become a major factor on the demand side of the gold balance sheet. In 2005, the mines dehedged 86 tonnes of metal. By 2007 that figure had grown to 400 tonnes -- a 465% increase.

When a mining company dehedges, it reverses its previous role as a seller in the fundamentals' equation and instead enters the market as a buyer. The effect on the supply-demand chart has been dramatic. What was once supply which acted to hold down the price has now become demand and an impetus to the price. This role reversal has contributed significantly to gold's steady rise over the past several years.

...Have you ever asked yourself how much of the gold mined actually makes it to the open market? One would think that all the gold mined makes it to market. However, like much in the gold market, the answer to that question is more complicated than it appears on the surface.

Few people know, for example that China, which became the top gold producer in the world this past year, is a net importer of gold. (Annually, it produces about 275 tonnes and consumes about 325 tonnes.) In short, the biggest market for Chinese gold is the Chinese people themselves, and the demand is large enough to consume everything China produces.

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