It's happened before. Though there were no precious metal ETFs in 1980, the demand for physical gold was so great that you literally had to wait in line at a coin shop to buy, with plenty of occasions when you would have been turned away due to lack of inventory. And you'll recall we saw serious shortages, unexpected delays and soaring premiums in late 2008.
Given the fragile state of global affairs and the waiting-in-the-wings crisis for the U.S. dollar, I'll be surprised if we don't see another panic into physical gold. And the question is: Will there be enough metal to go around when the public—95% of which own none—wakes up and wants to buy it?
Contrary to some claims, it isn't because we're about to run out of supply. While global mine production peaked in 1999 at 82.1 million ounces (Moz.) and has trended down since, take a look at the second largest source of supply—scrap. As you would expect, bad economic times and the surge in gold prices have triggered an increase in supplies from that source.
In fact, since 1999, as the price of gold climbed, the scrap supply nearly doubled. (Scrap comes mostly from jewelry, 75% of which derives from India, East/Southeast Asia, and the Middle East.)
So when you examine the total supply of gold coming to the market, it's actually nudged up for three consecutive years, hitting 116.6 Moz. in 2009, a modest 8% increase over 1999. In the greater scheme of things, the total supply of gold to market has changed very little.
So what's the problem?
First, you'd think a higher gold price would lead to rising mine production—but that's not happening. From 1999 through 2009, the average annual gold price rose 248%, yet gold production fell 6.6%.
This means that as gold continues higher, we cannot count on miners producing more yellow metal for us to buy. This concern will become increasingly obvious as more buyers enter the market.
Second, although scrap has more than supplemented the fall in mine production, as I'll show you in a moment, it's still not enough to fully satisfy current demand, let alone any increase in buying.
Meanwhile, the third major source of gold supply is reversing trend. Until last year, central banks around the world had been selling gold, adding a reliable tributary to the flow of metal year after year. This has stopped. As recently as 2007, 17 Moz. came to market from central banks; last year they acquired 7 Moz. The era of central banks as large net gold sellers has likely ended.
The conclusion we can draw from these signals is clear: known gold supply conduits will not deliver any significant new supply in the future. This will have serious repercussions. While it's certainly bullish for the price, I think many investors have overlooked a critical angle:
You can't turn a profit if you can't own it.
Realistically, though, how much more demand can we expect?
One way to estimate this is to compare today's percentage of global assets in gold to the last great bull market.
While gold's share of the global financial landscape has grown since 2001, a whopping 385% leap is needed to equal its 1980 peak.
Certainly some of that percentage could result from a decrease in the value of other assets. For example, residential and commercial real estate values will continue to fall as bad loans are unwound, and stock markets will adjust lower as global economies slow from cutbacks in government spending. But the gap is so enormous that investment in gold could easily increase significantly before this bull market is over.
Another way to measure potential future demand for gold is to look at today's investment and coin demand compared to the last bull market. The following chart first looks at what portion investment in gold comprises of the total uses for gold (i.e., including jewelry and industrial uses). Then we look at the percentage coin buying represents today vs. the peak in 1979. The point is to see if we've already reached high investment levels in gold similar to the last bull market peak—or if there's room for more.
When investment demand for gold (physical metal, ETFs, bank buying, etc.) peaked in 1979, it represented 54% of all uses for gold that year, a far cry from last year's 32%. Of course, this is just arithmetic; lower jewelry demand could make investment demand look bigger as a share of total demand. But this data makes clear that an increase in investors wanting more gold could rise dramatically.
The picture is more striking when we look at coin demand. Coin buyers represented 36% of all gold investments in 1979; today it's barely 14%. Coin demand would have to grow by 157% to match the last bull market peak. Yes, gold ETFs have and will continue to replace some of the demand for physical metal, but this shows there remains tremendous room for growth for investors wanting more gold coins.
Based on this data, I believe that despite the strong demand for gold investments we see today, it can go much, much higher in the coming years.
Here are some examples of coin demand straining current supply that you may find surprising:
- The Rand Refinery in South Africa, the world's largest, forecasts it'll sell 1 million Krugerrands this year. Sounds like a lot—until you consider that from 1974 to 1984, they sold 2.6 Moz./year. And that was when the world's population was roughly 35% lower than today.
- The U.S. Mint has had difficulty meeting heightened demand when annual sales are only slightly above historical averages.
- So far this year, gold production in China is up 5%, but demand for physical gold is up 30%.
- During two tense weeks of the Greek crisis in April/May, the Austrian Mint, one of the world's five largest, sold a quarter-million ounces, an amount that exceeded all of first-quarter sales. And Pro-Aurum, one of Europe's largest online precious metals traders, had to temporarily suspend sales due to a backlog of orders and insufficient supply. If Greek-style sovereign debt fears spread to other nations—something looking all but assured—rolling bullion shortages could resurface.
So my question is this: if the dollar is collapsing and gold is screaming to $5,000 an ounce, will you feel like you own enough?
Better get some now while you still can.
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Gold, Get it While You Can