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Source link: http://archive.mises.org/10461/does-gold-mining-matter/

Does Gold Mining Matter?

August 14, 2009 by

The vast majority of analysts who cover the gold market focus on mine supply as one of the main drivers of gold-price forecasts. I use these examples only to illustrate the ubiquity of this view. However, while analysts need something to analyze — and the mining industry provides many analytical complexities — ultimately, their efforts are wasted. Mine supply has very little influence on the price of gold.

Anyone who agrees that the gold trade is a market would accept the premise that the price depends on supply and demand. Where most analysts go wrong is to analyze gold using what I will call the consumption model. This model counts the current year’s mine production plus scrap (and, in some versions, central-bank sales) as supply, and the current year’s purchases of jewelry, coins, bars, and industrial gold as demand. FULL ARTICLE

{ 14 comments }

2nd Amendment August 14, 2009 at 9:38 am

Tom Barlow even asks, “Are we running out of gold?”

The answer is that dollars are running out of value.

greg August 14, 2009 at 11:38 am

The problem with gold is the high transaction cost on both sides of the trade. The big money is made by the brokers!

This high transaction cost keeps a lid on the velocity of trading which will keep a lid on price movements. Plus the fear that some central banks that are holding reserves will dump them on the market when the price goes up.

Robert Blumen August 14, 2009 at 1:55 pm

greg: “high transaction cost keeps a lid on the velocity of trading which will keep a lid on price movements. ” One of the points I was trying to make is that trading doesn’t have much to do with price movements. The price moves mainly based on changes in the reservation prices on both sides of the market.

Del Lindley August 14, 2009 at 4:07 pm

While I agree with the article’s conclusions, I believe certain parts of the exposition are confusing and others do not emphasize the conclusion that the above ground gold supply dominates gold pricing.

Consider the following excerpt:

“Suppose that, from this new starting point, one gold owner lowered his asking price for one of his ounces below the best offer of the most marginal seller. A trade would then take place between the gold owner and the marginal seller.”

I believe that in these sentences the term “marginal seller” should be replaced by “marginal buyer,” as we cannot know the individual demand curve of the marginal gold seller at any price.

To highlight the point that the gold producers play a minimal role in pricing, I would think that the demand curve shown in Figure 4 would be shifted upwards (or rightwards) so as to intersect the supply curve in the region where the price would be determined by the reservation demand. As it is, it looks like the relatively small amount of gold production (and gold demand) will set the price.

Gil August 15, 2009 at 2:11 am

Is the point of the article is that gold as currency is ‘self-correcting’? That is to say, gold miners may flood the market with gold causing inflation however gold inflation will make mining less profitable thus avoiding gold hyperinflation? Miners then have to wait until there’s significant growth in good & services to cause gold deflation before they can go out and get more gold?

On the other hand, can gold miners just keep getting more gold, period? Gold is being recovered from ever finer quantities of dirt. Far from gold growth being exponential it would in fact taper off as gold miners experience ‘Peak Gold’ – any remaning gold is too expensive to extract thus making the world’s gold supply effectively static.

However, as 2A insinuated and other like to say, that the quantity of money should ideally be fixed. If gold mining has virtually hit its peak then it would make the perfect money as it can longer be inflated. Hence paper money is imperial measurement and gold is a metric form of money.

One problem I have with the article is why gold would hit such high prices that people would want to offload their stash? If gold was heading upwards at such high prices and quickly then this would indicate paper money hyperinflation and no one would be selling gold. If anything they would be hiding it from desperate thieves.

Nick Bradley August 17, 2009 at 8:11 am

What was the point of this article? That market transactions take place at market-clearing prices? Is that news?

If demand is constant, new marginal sellers (miners) would meet the demands of some marginal buyers. As a result, there would be less marginal buyers (satisfied buyers) than there were before miners entered that market — assuming that DEMAND IS CONSTANT.

Essentially, the author is making the argument that satisfied buyers would be replaced by new buyers — that assumes an increase in demand.

Unless you believe that the market has already “priced in” the level of gold mine stocks, an increase in gold production would cause prices to go down if demand stays constant. If this were the case, only the discovery of new mines would cause the price to go down.

It seems to me like this article was little more than a gold bug article extolling gold as a “can’t miss” investment.

Robert Blumen August 17, 2009 at 10:44 am

Nick Bradley: “What was the point of this article?” The main point is that gold mining doesn’t have much influence on the gold price.

“market transactions take place at market-clearing prices? Is that news?” No this is not news. Most of the discussion of the gold price in the financial press looks at the gold market as a market with mines on one side and coin + jewelry buyers on the other side. These analysts attribute movements in the gold price primarily to changes in gold supply. The reason that I chose to write this article is to show that this model leads to an incorrect understanding of price.

For the purposes of this discussion I assume that demand is constant. That is not true in the real world. Both supply and demand change all the time. I used this model to isolate the influence on the price of the holders of existing stocks from that of the miners.

“an increase in gold production would cause prices to go down if demand stays constant.” Yes this is true. The point of my article is that the quantitative significance of mine production on the gold price is small.

“It seems to me like this article was little more than a gold bug article extolling gold as a “can’t miss” investment.” No where in the article does it say what the gold price will be, or that it will go up from current levels, go down, or anything else that could be construed as investment advice.

Robert Blumen August 17, 2009 at 10:52 am

Gil: “Is the point of the article is that gold as currency is ‘self-correcting’?”

Most of the discussion of the gold price in the financial press characterizes the two sides of the gold market as miners and coin + jewelry buyers. My reason for writing this article (and a related piece) is to show that mining has very little impact on the gold price, and that the gold price is primarily determined by the reservation prices of the people who own gold and the reservation prices of the people who own money.

I wasn’t really trying to make any point about gold as currency, since gold is not presently a form of money (see my article on that subject).

“One problem I have with the article is why gold would hit such high prices that people would want to offload their stash? ” The article assumes static preferences for the purpose of making the point that the influence of gold mining on the price is small.

I don’t address the influence on the gold price of an increase in the supply of fiat money, but
I agree with your point here, that if the supply of fiat money increases, then people who own gold would adjust their reservation price upward and owners of fiat money would adjust their buy prices upward.

Nick Bradley August 17, 2009 at 4:45 pm

Robert,

According to the World Gold Council, there has been about 160,000 tons of gold produced in world history and about 2500 tons are produced every year. How much of that 158,000 is actually in existence? Also, I remember seeing a while back that about 1/3rd of gold is used for “fashion jewelry”, industrial, and dental purposes.

What do you think the real supply of tradeable gold is? Very old gold jewelry, coins, and other artifacts trade far above their weight in gold — those will never be traded on the market. Also consider gold in the third world that is not on the market, family heirlooms, wedding rings, industrial supply, dental, etc.

How big is the supply of gold, really? 20 – 30 thousand tons? IF that’s the case, you’re looking at a 10% annual increase in demand to keep prices stable (with a 2500 ton a year production). I think we’ve been getting massive demand growth for gold over the past 10 years, but that will subside.

Robert Blumen August 17, 2009 at 5:59 pm

Nick,

I’m not sure how much gold is “tradable” though I count jewelry as part of the gold supply. In many countries jewelry is an alternative form of holding gold; it can and does come back to the market as scrap.

But when you talk about “massive demand growth to keep the price stable” you are still thinking in terms of the consumption framework.

If the supply of gold is 160,000 tons, then the demand for gold is 160,000 tons. If the supply increases the next year from 163,000 tons then the demand the next year is 163,000 tons. If the supply increases due to increased supply by mines to 170,000 tons then the demand is 170,000 tons. This is not “massive” demand growth. Demand grows in step with supply such that they are always equal. If supply is growing by 1% then demand grows by 1%. I have another article on this here: http://www.lewrockwell.com/blumen/blumen14.html.

Also implied in your comment is that if 3000 tons are mined each year then, 3000 tons of “demand” is required to keep the price stable. But this is not so – the price is mainly determined by the demand to hold gold as against the demand to hold dollars and other fiat currencies when taking into account the entire supply of gold and the entire supply of fiat currency.

Bruce Koerber August 17, 2009 at 7:10 pm

Money and Ethics
Monday, August 17, 2009

Gold Is A Trustworthy Medium Of Exchange.

Since all the gold that was ever mined still exists and is potentially in circulation as a medium of exchange if its highest value is as a medium of exchange, then relatively speaking, the increase in the gold supply – the stock of money – will never be very large.

Apart from the fact that a gold standard prevents governments from inflating, gold should not scare the Friedmanites.

In addition, whatever the stock of money is, that is ideal since prices in a free market are relative. Which means that even if there are many uses for gold in addition to its use as a medium of exchange the relative prices in the economy simply reflect that.

Since trustworthiness is the ‘supreme instrument for the prosperity of the world’ gold is the best means.

Nick Bradley August 17, 2009 at 9:26 pm

Robert

If the supply of total gold increases by 3000 tons, total demand to hold gold must also increase by 3000 tons. That could be a combination to possess gold as a hedge against fiat money, jewelry, or for any other purpose.

Stentor Media October 18, 2010 at 4:58 pm

After reading your blog,in investing, you can’t ignore the effect of human psychology when it comes to gold. Gold has always been a go-to investment during times of fear and uncertainty. From a fundamental perspective, gold is generally viewed as a favorable hedge against inflation. Gold functions as a good store of value against a declining currency.

Prospector November 15, 2011 at 3:18 pm

Do you think the general use market is setting the price of gold, or the Governments? I understand that the largest gold buyers are the Governments in particular countries looking to back their currency with a gold stock pile.

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