Gold Supply Graphs and Analysis: Why the Price is Setup to Keep Climbing in 2011

Here's a nice piece of analysis from Jeff Clark, who breaks down the supply situation for gold, and makes a compelling case that gold should keep climbing higher in the years ahead.  Jeff draws some interesting comparisons with the peak of gold's last bull market as well, to show that we potentially have a lot of room left to run.
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Gold, Get It While You Can
By Jeff Clark, BIG GOLD

We've got it easy right now. Click or call, and you can quickly and conveniently own a gold coin or bar. But if global concerns cause another panic or the dollar breaks down, you could find yourself standing in a line at the local coin shop or getting a busy signal. Simply, for reasons I’ll discuss here, you may find it very difficult to get your hands on physical gold when that time comes.

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?

Answer: No.

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 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 million ounces 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 million ounces came to market from central banks; last year they acquired 7 million ounces. 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:

If more and more people want to buy gold and the supply doesn’t increase, what happens to your ability to get it?

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 millionounces per 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.

While all this is bullish for the price of gold, it’s alarming what it suggests might happen to the availability of physical gold.

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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At the just-concluded Casey’s Gold & Resource Summit, dozens of resource experts and seasoned investment pros talked about gold and gold investments as an integral part of any crisis-proof portfolio. Listen to the in-depth advice of John Hathaway… Eric Sprott… Richard Russell… Doug Casey… Ross Beaty… Rick Rule… including their top stock picks of the year. Learn more here.

Ed. Note: I am a Casey Research subscriber and affiliate.

Breakdown of World Supply and Demand for Gold

Out of the entire commodity sector, gold has the greatest tendency to disconnect from its underlying supply and demand fundamentals. Still, though, the fundamentals act as a rubber band on its price - when supply overtakes demand, prices will eventually fall.

And of course, the opposite is also true. Thus, gold bulls are keeping an eye on this year's supply/demand situation, to see if this is the year that demand overtakes supply.

Seasoned commodity investors know that when this happens - look out! Prices can really do moonshots, because prices for commodities occur at the margins - and when there's nothing at the margin, it's a bidding war for what's left.

Here's guest author Doug Hornig diving into the fundamentals for gold this year...

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Supply Side Economics –
How Is Gold Going to Fare This Year?

by Doug Hornig, Casey’s Gold & Resource Report

Gold started the summer doldrums looking strong and has retreated since, but what are its prospects for the rest of the year and beyond? That will largely be determined by the interplay between supply and demand; let’s take a look at the supply side.

Reports of dwindling supply are accurate in some areas; however, the story is not that simple. Unlike most metals that are consumed in industrial use, most of the gold ever mined is still around. Gold is forever. Thus newly mined, refined, and fabricated gold is not all that’s entering the marketplace; there are multiple ways of meeting demand. Here’s a look at each.

Breaking Rocks

Imagine that you could turn back the calendar to late 1848, as word was beginning to spread about the gold discovery at John Sutter’s sawmill on the South Fork of the American River in Coloma, California. Would you have loved gold enough to be one of the 49ers who responded to its siren song?

Those were heady times. The Golden State – though it wouldn’t officially receive its apt nickname until 1968 – had a seemingly endless supply of yellow metal, much of it just lying in remote creek beds, waiting to be scooped up. The French Ravine in Sierra County yielded single nuggets of 426 oz. in 1851 and 532 oz. in 1855. By 1869, the record was a monstrous 1,893-ounce specimen from the Monumental Mine in the Sierra City district.

The days of fabulous discoveries are not entirely gone. As recently as 1980, Kevin Hillier, a lucky Aussie following beeps from a metal detector, dug up a nugget that tipped the scales at 876 troy ounces. And in Ruby, Alaska, in 1998, bulldozer operator Barry Clay was stunned to see a 294-ounce nugget roll off the dirt pile ahead of his blade.

Modern commercial producers, though, aren’t looking for fist-sized nuggets, or even the fingernail-sized flakes that many 49ers hoped to find at the bottoms of their pans. Today, a major gold strike might grade out at 5 grams per ton of rock, and economical recovery is routinely done at significantly lower levels.

The easy-to-get stuff is largely gone. With demand rising, miners are struggling to produce ever more gold from ever-lower grades of ore. And they’re falling behind.

The CPM Group’s 2009 Gold Yearbook, one of the bibles of the industry, notes that world gold production peaked in 2001, after increases in 14 of the 15 prior years (despite a vicious bear market). Production increased only fractionally in 2001, to 82.1 million ounces, and has declined in five of the seven years since. And substantially so, with 2008 production coming in at only 74.6 million ounces, a more than 9% drop.

There are a number of simple reasons for the production decline. The older, more productive mines are playing out; newer mines tend to be lower grade; fresh mega-discoveries have become rare; cost of extraction has soared; environmental regulations are more stringent; and greedy governments demand a growing slice of the revenue pie.

South Africa has been particularly hard hit. After ruling the roost for nearly a century, it dropped to second place in production, behind China, in 2007; and into third, behind the U.S., last year. South African output topped out in 1970, at 32 million ounces, and has since fallen off more than 75%. Some miners now must burrow two miles underground to bring up something usable, and the country appears about played out.

Though the U.S. does hold the #2 spot, at 7.6 million ounces in 2008, it too has experienced a long slide. From the 1998 peak of 11.9 million ounces, it’s fallen every year but one, for a 36% overall decline.

There are some bright spots. Russia, still mostly unexploited, continues slowly but steadily ramping up production, delivering 5.9 million ounces to market in 2008. And China’s industry is growing by leaps and bounds. It captured world leadership in 2007 and cemented that position last year, with production of just over 9 million ounces.

In addition, there are some very large, well-defined deposits waiting to come on line. Kinross/Barrick’s Cerro Casale project in Chile, with 23 million ounces of gold reserves, is scheduled for a 2012 commencement; Barrick’s Pueblo Viejo in the Dominican Republic (20.4 million ounces) is slated for 2011; Newmont’s Boddington Expansion (13 million ounces) is targeted for the third quarter of this year.

But other elephant-sized discoveries are problem-laden. NovaGold/Barrick’s Donlin Creek project in Alaska (30 million ounces) is so remote it may never be economical; Barrick’s Pascua Lama on the Chile/Argentina border (18 million ounces) has been beset by anti-mining NGOs; and Las Cristinas in Venezuela (16.9 million ounces) probably will be developed only if Hugo Chavez is in the mood.

Considering the present state of the industry and the limited opportunities for developing new mines, we think it likely that gold production will fail to meet consumption for years to come. Either the price must rise to mute demand, or the shortfall must be made up from elsewhere.

The Gnomes of Zurich (and Beijing, and…)

For the past two decades, central banks have been dishoarding their gold at a pretty decent clip and have been a major source of the metal hitting the market.

Before 1999, each central bank was free to sell whatever amount it cared to. But in that year, the 15 largest European central banks (excepting only Britain) adopted a Central Bank Gold Agreement (CBGA). Although not a signatory, the U.S. sponsored the CBGA – allegedly to promote stability in the gold market – and adheres to it on an informal basis.

Under the five-year terms of the agreement, participating central banks are limited to selling an aggregate total of 500 metric tons (or 16.1 million ounces, if you think retail) of gold in any given year. The current CBGA period expires this September, but the agreement is widely expected to be renewed.

Since 2005, the trend has been notably down, with a particularly steep drop-off from 2007 to 2008. Among CBGA banks, 2007 sales were right at the limit, 15.9 million ounces, but that plunged nearly two-thirds, to 5.8 million ounces, in ’08. And the CPM Group estimates that 2009 will see another CBGA sales decline, to about 5 million ounces.

Central banks not only show increasing reluctance to part with their gold, some are now net buyers. Russia led the way in this department, adding nearly 2 million ounces to its holdings in 2008.

Then there is China. That country has made a lot of noise lately about its waning confidence in the long-term value of its forex holdings, primarily U.S. dollars, and has been aggressively trading them for tangible assets. Many analysts believed that the buying spree would likely include gold, but no one could say for sure. China’s internal financial affairs are rather less than transparent to outsiders.

However, the conjecture is now confirmed. In April, the People’s Bank of China stunned the markets by announcing that over the past six years, it had been quietly adding 14.6 million ounces to its reserves.

China’s announcement had little immediate effect. But considering China’s elevated position in the world economic pecking order, other governments are sure to take notice and follow its example.

How Much for the SOB’s Wedding Ring?

The supply source that’s taken the biggest leap forward in recent times is the recycling business. So-called “scrap gold” includes rings from failed marriages, earrings with missing mates, out-of-fashion bling – and anything else that’s been gathering dust in the jewelry box. Old electronics, too. A ton of discarded cell phones will yield 150 grams of gold, 30 times what a miner gets from an average ton of ore.

People are hip to the rising gold price, and they’re parting with their unwanted baubles en masse. It’s big business. TV ads soliciting scrap abound, including one during the Super Bowl; Internet recyclers have proliferated; and in some suburban neighborhoods, gold has replaced Tupperware as the focal point for social gatherings.

The flood of scrap has hardly been insignificant. CPM reports that it rose an estimated 18.9% in 2008, to 38.5 million ounces, following a 23.3% jump in ’07. Scrap sellers are bringing to market more than half as much gold as all the world’s miners.

The CPM Group does predict that the trend in scrap will start slowing, but still forecasts a rise of perhaps 5% this year, to 40.5 million ounces.

CPM gives two reasons for the projected slowdown. First, so much has already been melted down that sellers may be reaching the point where they will want to hang on to whatever’s left. And second, refineries are running at capacity and have little further capability for turning earrings into ingots.

As long as the price of gold remains high and economic distress continues, people who are hurting will keep swapping metal for dollars. And tons of scrap, melted down and released back to consumers, definitely serve as a drag on the gold price.

How much scrap will be recycled in the next few years is unknown, and so the effect on the market remains to be seen. The safest assumption is that this year will be much like the last, with gold’s ascent comparably retarded -- meaning, not much.

Conclusion

While the market will be well supplied with new gold in 2009, whether it will exceed or lag consumption is the $64,000 question. Both jewelry and industrial consumption are on the wane, leaving investment demand as the driver. It is heavy and getting heavier, as more and more people come to believe in the wisdom of having some physical metal in their possession. Or at least investing in a paper proxy such as the SPDR Gold Trust, which in a few short years has risen from nothing to the sixth largest gold owner in the world.

Gold is increasingly viewed by investors as what it’s been throughout history: a safe-haven asset whose value can be counted on in hard times. Thus we recommend to our subscribers to keep one-third of their portfolio in physical gold. But the real money is made in gold-related investments, such as royalty companies and medium to large gold producers with millions of ounces under their belt. Our current favorite is such a slam-dunk winner that we call it “48 Karat Gold.” Click here to read our report.