Ever since the beginning of gold’s bull market, this metal’s economic balance has come under intense scrutiny. Demand has been on the rise as more and more investors have embraced gold as a store of wealth. And the supply chain has done its best to meet this growing demand.
However considering gold’s sharply rising price over the last decade, it is clear that this market has been experiencing a major structural imbalance. And the supply side of the equation has proven to be a fascinatingly volatile realm, making it quite difficult to set the scale.
Interestingly this supply volatility is somewhat of a new phenomenon, as the major supply sources of mine production, recycling, and central-bank sales had been relatively consistent and reliable in feeding demand for many years. But for a variety of reasons, this just isn’t the case anymore.
One big factor that has radically altered supply’s cadence is an actual loss of one of its major sources. Just in the last couple years gold supply from central-bank sales has completely dried up. In fact, the CBs have since become substantial net buyers of the metal. According to metals-research consultancy GFMS, in 2011 CBs loaded their coffers with 440 metric tons of gold (~10% of total annual supply).
It is no doubt entertaining watching the CBs implement radical changes in their fiscal strategies. And while it is wise of them to buy gold rather than foolishly sell it like they had been doing for so many years, this shift has resulted in a big impact on the global supply chain. For nearly 20 years leading to 2007 CB sales averaged between 400mt to 500mt per year, a consist and reliable supply source that was the equivalent of up to 20% of global gold supply. This source is now gone!
Gold’s second-largest source of supply, recycling, has also seen its fair share of volatility over the course of this bull. For many years recycling was consistently good for about a quarter of global supply. But thanks to higher gold prices coinciding with a brutal global recession, this supply source has seen a huge boost over the last four years.
In 2009 recycling exceeded 1500mt (nearly 40% of global supply) for the first time ever, and it has been above this level for three years running. But though this surge has partly counteracted the loss of CB supply, recycling volume has been trending down over the last couple years. Interestingly this downward trend has many folks scratching their heads considering gold’s record highs, but it does make sense considering the timing of the big 2008 and 2009 recycling surges that brought us to these levels.
Sadly much of the recycling during these surges was desperation retail selling, the hawking of gold jewelry in order to keep food on the table during hard economic times. And since it doesn’t take very long for this type of recycling to reach a point of exhaustion, as most people who needed to sell in this fashion have done so by now, these 1500mt+ levels are likely short lived. In 2011 recycling was down by 2%, and I would expect it to keep trending down towards normal levels in the years to come.
So with central-bank sales now extinct, recycling in a downtrend, and gold demand still at record levels, gold’s final source of supply has a lot of weight on its shoulders. And with mine production typically accounting for about two-thirds of total global supply, thankfully it is used to bearing such a burden. But as you can see in the chart below, even this primary supply source comes with its fair share of volatility.
In the several years preceding and in the early years of gold’s bull, mine production was consistently generating annual output of at least 2500mt. But by the time 2004 rolled around, this supply source started taking a dive. And over a span of five years global mine production had fallen by a staggering 12.7%. At 2008’s low point of 2260mt, the world’s mines were producing 10.6m ounces less than they were in 2003.
Next page: Understanding the downtrend