January 31, 2015

A recent article at Mineweb discusses the latest gold-market analysis of Gold Fields Mineral Services (GFMS). As far as past or likely future gold price movements are concerned, every sentence in this article is either completely wrong or completely irrelevant.

The GFMS analysis discussed in the article follows the typical, wrongheaded pattern of adding up the flows between different parts of the market and using these flows to estimate supply and demand. It’s the same mistake I’ve addressed many times in the past, most recently in a 26th January blog post. The mistake is largely based on the misconception that current mine production constitutes the supply side of the equation, rather than just a small increment to an existing aboveground inventory.

If you start with a totally wrong premise, you will probably end up with a ludicrous conclusion. In this case the ludicrous conclusion is that gold supply is currently greater than gold demand.

In a market that clears (such as the gold market), supply can never be greater than demand and demand can never be greater than supply. Supply and demand must always be equal, with the price constantly changing to whatever it needs to be to maintain the balance.

Claiming that the supply of gold exceeds the demand for gold would be like claiming that the supply of dollars exceeded the demand for dollars. Such claims create the impression that there is a pile of gold or dollars somewhere that nobody wants or owns, because current demand has already been fully satisfied by the rest of the supply. The reality is that all gold and all dollars are always held/owned by someone, with the price (or purchasing power) adjusting to keep the supply equal to the demand.

From a supply-demand perspective, the only significant difference between gold and the US$ is that the supply of dollars regularly changes a lot (by 8% or more) from one year to the next, whereas the annual rate of change in the total aboveground gold supply is always around 1.6%. The reason, of course, is that considerable real resources (labour, materials and energy) must be employed to increase the aboveground gold supply, whereas the supply of dollars can be increased at no cost at the whim of central and commercial bankers.

That’s why I care about changes in US$ supply and do not care about changes in gold-mine production.

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