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Gold Has Two Fundamentals Going for It

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There’s been a lot of focus on inflation and interest rates and how they will impact the gold market in the coming months. But gold has two fundamentals going for it that aren’t getting nearly the same kind of attention.

Simple supply and demand. 

An article recently published in Investment News noted that growing demand for the yellow metal in emerging markets, coupled with a limited capacity for new production, bode well for gold moving forward.

The jewelry market makes up roughly two-thirds of the demand for gold, and much of that comes from emerging markets such as India and China. State Street Global Advisors head of gold strategy George Milling-Stanley said, “We’re seeing that economic growth is fastest in the parts of the world that like gold the most.”

In December, World Gold Council chief market strategist John Reade said he expects gold to shine in 2018. One of the reasons he focused on was economic growth in India and China, the world’s leading consumers of gold.

Our research shows that continued economic growth underpins gold demand. As incomes rise, demand for gold jewelry and gold-containing technology, such as smartphones and tablets, rises. Income growth also spurs savings, helping increase demand for gold bars and coins.”

According to the 2018 World Economic League Table, India will leapfrog France and England in 2018 to become the world’s fifth largest economy in dollar terms. The report also predicted China will overtake the US as the world’s biggest economy in 2032.

China and India rank as the number one and two gold consuming countries in the world. It stands to reason that strong economic growth and rising income in these Asian nations will boost demand for gold.

On the other side of the coin, gold mine production is falling off. Milling-Stanley told Investment News said he expects that trend to continue.

While mining companies would like to see growth in new production, they are barely seeing enough to sustain current production. Production peaked in 2014, and it’s likely to decline for the foreseeable future.”

Global gold production plateaued in 2017, and Chinese output hit a record low. Global mine production rose by just a paltry 5.7 tons in 2017, according to data compiled by the World Gold Council. That represented the smallest increase since 2008.

Investment News pointed out that mining companies can’t just snap their fingers and ramp up output as demand increases.

It can take years to identify a new mine site, get clearances to open the mine and begin production. And recently, new gold discoveries have been rare.”

According to SRSrocco, the world’s largest gold mining company forecasts declining production over the next two years. Barrick Gold’s 2017 yearend report predicted production will decrease from 5.3 million ounces in 2017 to 4.7 million ounces in 2018. The 2019 forecast is even lower – 4.4 million ounces.

SRSrocco put together a graph tracking production for the top-four gold producers (Barrick, Newmont, AngloGold & Goldcorp) since 2011, including forecasts for the next two years. You will note a pretty consistent downward trend.

If these forecasts hold, we are looking at a 23% drop in output over less than a decade.

Gold mining companies have not been investing in exploration or developing new mines. Capital expenditures for the big four dropped 75% between 2012 and 2016, falling from $14.3 billion to $3.6 billion. There was increased spending to $4.5 billion last year, but it was still half of what it was in 2011.

And there is also the possibility that the world has reached or is close to “peak gold.” That’s the point where the amount of gold mined out of the earth will begin to shrink every year, rather than increase, as it has done pretty consistently since the 1970s. During the Denver Gold Forum last September, the World Gold Council chairman said he thinks the world may have already reached that point. There are certainly signs pointing in that direction. As we reported in January, South Africa could run out of gold within four decades. Analysts say that at current production levels, South Africa has only 39 years of accessible gold reserves remaining.

Of course, technology advances and new discoveries make predicting peak gold an imprecise science, but plateauing production numbers do lend some credibility to those predicting declining output in the future. At the least, it seems pretty certain based on forecasts by biggest mining companies that we are looking at lower output numbers over the next few years.

When we look at the future of gold, it’s easy to get caught up in the latest geopolitical turmoil or the most recent policy pronouncement by the Federal Reserve. Of course, these events in the news cycle are important. But investors should never lose sight of the most basic fundamentals – supply and demand. The gold industry may well be entering a long-term — and possibly irreversible — period of less available gold. As mining companies find it more difficult to pull gold out of the earth, it will mean less gold for refiners to produce for the consumer market. Remember, gold gets its value from its scarcity.

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