Understanding Gold

As some of our readers may know, a few weeks ago, Standard Chartered published a research report entitled 'In Gold We Trust' that was subsequently widely disseminated via Zerohedge and/or Scribd (you can download it here). Well, for one thing, they pinched the title from Erstebank, which has  published a widely read series of gold reports sporting the same title and has just released the fifth report so entitled. The series is written by a good friend of ours, Ronald Stoeferle, who is something of an exception among gold analysts employed by mainstream financial institutions. What makes him different is that he actually understands gold.


While there are some notable of exceptions, many mainstream analysts to this day fail to properly analyze gold. This is in fact demonstrated by the above mentioned Standard Bank report. To be sure, that report is still useful to people interested in gold, in that it provides a wealth of statistics on current and projected mine production, as well as details on the prospects of a number of gold mining companies that should be of interest to investors. Its main failing is that similar to many such reports we have come across over the years, it asserts that 'falling  mine production will likely drive up the price of gold'.

That is an error Ronald would happily never succumb to.

As we pointed out in several previous articles, such as 'Some Thoughts on Gold –  part 1 and part 2 and 'Precious Metals- an Update' (scroll to 'Fundamental Drivers of the Gold Market' in this one for a detailed look on what drives the gold price), the annual  production of gold mines currently amounts to approximately 1.5% of the total stock of gold. The large above ground stock of gold makes the metal unsuitable to an analytical approach that is similar to that employed in analyzing industrial commodities.

As a rule, in industrial commodities a fairly small above ground stock is held compared to the annual flow of production. If for instance the copper market were to suffer a 400,000 ton shortfall in production in a given year relative to demand, then that would be likely to have a very significant effect on copper's price. Almost 20 million tons of copper are currently produced and demanded annually. The warehouse stocks of copper currently held at the London Metals Exchange (LME), one of the largest repositories of copper inventories in the world, stand at a mere 465,000 tons (there are even larger inventories in China, but the LME is still a very important player in copper trading and storage).


LME copper warehouse stock levels over the past month – click for higher resolution.



A somewhat dated chart of global copper production. In 2002, it amounted to roughly 15 million tons – in 2011 it is estimated to reach 19.7 million tons –  700,000 tons more than were produced in 2010 – click for higher resolution.


It is clear that a 400,000 ton production shortfall would suffice to reduce the LME's stocks of copper to an insignificant level. Obviously, copper users would have every reason to worry about supply and prices would be driven higher accordingly. In 2010, the deficit between the primary (mine) supply and demand of copper was estimated to have been just 250,000 tons (see this pdf from the International Copper Study Group) – and copper's price rose from $3.40 per pound to $4.40 per pound during the year. 

Now imagine what would happen if gold production were to decline by a very large amount next year, say e.g. by 10%, from roughly 2,600 tons to 2,340 tons. According to the the analysis by Standard Chartered, this would have a significant effect on the gold price. But why should it? There are an estimated 165,000 tons of gold held above ground. Some estimates say the amount is even larger (there is considerable uncertainty as to the total amount of gold that was produced before detailed statistics on global production were gathered), but let us for now hew to this widely accepted number. 2,600 tons represent just 1.57% of this total, while 2,340 tons would represent 1.42%. Obviously, given that there is a stock of 165,000 tons of gold available, it will hardly matter whether 260 tons (0.157% of the total stock) more or less are produced in a given year. It is precisely because of this large stock-to-flow ratio that gold is useful as a money commodity (this is not the only reason of course, but it is an extremely important factor).

Hence an analysis of gold that treats gold as though it were an industrial commodity will always miss the mark. Gold must be analyzed as though it were money, a point Ronald makes early on in his latest report.

We hereby offer Ronald's latest missive – the fifth  'In Gold We Trust' report – to our readers for download (download link further below). As always, it is an excellent and highly recommended read.

Gold has regained a great deal of the stature it lost during the 1980 to 2000 bear market after rallying for almost 11 years, but it is still the one investment asset that quite a few people 'love to hate'. We think that many people will reconsider this stance in coming years – and the sooner, the better it will be for them. Gold has once again become an indispensable tool for investment portfolio diversification – and unless there is a dramatic change in the policies governments and central banks have embarked on, it may well become a life-saver for the hard-earned savings of a great many people.

If you are interested in a thorough, well-written and most importantly, correct analysis of gold, then this report is for you.


Download: In Gold We Trust (pdf), by Ronald Stoeferle from Erstebank


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One Response to “In Gold We Trust”

  • billmasi:

    Thank you. That was clear and to the point – and will, from now on, effect how I look at world gold production figures as a (non) driver of price.

    Appreciate the lesson.

    Bill M

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