Long article....
Inelastic Gold Supply
by Jim Willie CB
Jim Willie CB is the editor of the "Hat Trick Letter"
February 7, 2006
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This article attempts to establish the notion that as the gold price rises, the mine production industry will not bring significantly more gold to market. In addition to other obstacles, they will be stymied by hedge book losses, sure to drain valuable funds. They will face large obstacles from rising costs, such as for energy and construction materials. They must overcome labor shortages. In the year 2005, the gold industry has produced a mere 2% more gold than the previous year. The reasons for the shortfall in what might be expected in mine output are many. Abusive hedge practices are one reason in my opinion for the shortfall. More difficult mine venture projects is another. The conclusion is that a much much higher gold price will be required to encourage sufficient supply in order to meet demand and avert shortages. The prospect might spell greater profit for leveraged physical gold and silver investors than stock holders. However, the unhedged mining firms will see staggering gains in their stock price.
SUPPLY & DEMAND
Most people are familiar with the basics of the supply & demand curve. Well, except perhaps economists, who re-invent their craft as they go along, fully sacrificing time-tested principles as they "sell out" and defense their interests. Their self-serving analyses disseminated to the public are routine landscape shrubbery. We are often subjected to questionable economist arguments. One particular story comes to mind, pertaining to the copper market. Supposedly, enormous off-warehouse copper supply (unaccounted for) will drive down the copper price. This has been a Frank Veneroso claim, with details offered on inventory quantities at a few key exchanges. However, where is the factor whereby off-warehouse demand is satisfied off the mainstream copper market? Nowhere. Ever since copper surpassed the $1.00 level, the former advisor to Western central bankers has gone from the argument of inevitable Chinese demand collapse to a new equally shaky argument of excess untracked non-exchange copper inventory. So tons and tons of copper are sequestered quietly, surreptitiously, and managed in such a manner that no customer purchases from these available supplies, even if convenient and nearby, even if official exchange costs can be sidestepped? Nonsense. Whenever a convenient spin is needed on an economic subject, it is alarming how often either supply or demand is ignored, as an oversight (unintended or blatant), or a distortion (accidental or planned) within an argument. Almost a year ago, a colleaugue Greg McCoach in the gold community made a claim as a conference panel member that copper would easily exceed the $2.00 price level. His view was widely dismissed, despite his valid relentless demand side reasoning contrasted against slow arrival of supply due to standard production timelines. Greg was right.
The standard supply & demand theory maintains two notions. As supply increases, the price at which it can be sold declines. As demand rises, the price which it can fetch rises. An equilibrium is reached when demand (D) meets supply (S), so as to clear inventory. Or from the other side, equilibrium is reached when supply meets demand, so as to avoid shortage. The vertical scale is price, the horizontal is quantity in the charts. Where the two curves meet is the equilibrium price dictated by the marketplace.
When shortages exist, as has been the case in both the gold market and the crude oil market, the price mechanism has adjusted to find a higher price to remove that shortage. With crude oil, growing Asian demand led to a gradual ratcheting upward in price. No shortages have been reported or experienced, except for the brief episodes in the wake of the hurricanes in late 2005. The price mechanism works. The phenomenon at work nowadays, a strain to be sure, is that the entire supply (S) curve is moving UPWARD TO THE LEFT, since energy deposits are more depleted with each passing year. With each passing year, less supply is delivered to market at a given fixed price. At the same time, the demand (D) curve is moving DOWNWARD TO THE RIGHT, since developing economies are growing. With each passing year, more demand arrives at the market at a given fixed price.
In the primary mainstream markets, a paradoxical situation seems very evident to mark an extraordinary phenomenon. Gold does not operate under the same rules. My claim is that its demand is inelastic, wherein demand grows as price increases. This is called "gold fever." Also, its supply is inelastic, wherein supply fails to respond properly as price increases. This is the paradox discussed as the article theme.
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