Special Report Part III: The Supply Crisis in Gold: Where Has All the Bullion Gone?

By John Manfreda

Editor's Note: On January 23rd, we started painting a picture for you regarding the current troubled gold and silver mining industry and the opportunity it presents to you. That first alert in a five-part series was painted with a broad brushstroke.

With the remaining alerts in this series, we provide you the finer details of supply and demand for both gold and silver.

Given the following...

1. Strong and strengthening demand
2. Severely stressed supply
3. Unprecedented monetary expansion
4. Artificially low interest rates
5. Prices for gold and silver at or below all-in costs of production

... you don't need to wait for all five alerts to recognize now is a prudent time to acquire both gold and silver for wealth insurance and profit.

-- Rich Checkan

This is the third article in which I examine the various aspects of supply and demand for gold, to help you clarify your buy, sell or hold decisions. Here, I take a deeper look into the three major factors affecting supply.

The 3 factors shrinking the supply of gold are not intrinsic to the actual value of gold. Gold is in low supply because:

1. Mines are shutting down or consolidating
2. Scrap gold is off the market as holders wait for prices to rise
3. China, a big buyer, is taking its gold off the world market

We are experiencing a very unusual phenomenon: Steady to rising demand (a link to Part II is at the bottom of this article), dwindling supply, but no price surge. Why is this happening? The cause, rather than the effect, of the limited supply is because the recent price history of gold is falling from record highs.

Let me explain.

With agricultural commodities, a fall in supply is usually the result of direct factors, such as a natural disaster like weather or infestation. Demand stays steady and prices rise in the face of the scarcity.

This is not the case with gold today. Supply is low because the mining industry is forced to slow down, or shut down, in the face of the price decrease. There is no point in mining when the cost of production is higher than the price of the gold coming out of the ground.

Similarly, consumers and refiners see no point in selling scrap gold until prices rise once again.

In a recent article by ASI's President and COO, Rich Checkan, the four outcomes when prices are at, or lower than, the cost of production are:

1. Smaller, weaker companies will go out of business.
2. Others, with some strength, will be acquired by bigger operations and the industry will consolidate.
3. Strong companies will use their reserves to stay in business and stop or cut mining operations until prices correct.
4. Companies with limited cash reserves may choose to sell future production at today's lower prices just to generate enough cash flow to weather the short-term market weakness. At the same time, they will cut wherever they can...exploration, production, staff.

Any of the above, and all of which are already happening, will decrease supply.

The $1,200 Threshold

The World Gold Council sites $1,200 per ounce as the threshold below which the all-in cost of production is greater than the price of gold. This is the point at which production cutbacks occur and supply decreases. The price point is confirmed by Reuter's data that shows the average industry cost of production as $1,200 per ounce.

The World Gold Council estimates that 30% of the gold mining industry is rendered unprofitable if the price of gold falls below that figure. This explains the legion of bankruptcies, consolidations, closings and suspensions in the mining industry.

To cite just a few:

• Barrick Gold has planned to sell, close or curb production in 12 of its 27 mines, that's 44% of their mines.
• Kinross gold has reduced its capital and exploration budgets by roughly 30 million dollars.
• Yamana Gold has cut production forecasts.
• The historic Prumiummon Gold mine near Marysville has closed the majority of its mining operations since June of 2013.
• Newmont Mining has put its Conga project in Peru on hold.
• Anglo American dropped plans to push ahead with the Pebble copper-gold mine in Alaska.
• Colossus minerals went into bankruptcy in 2013.
• Goldcorp cut its reserve estimates by 15%.
• Barrick Gold has just recently cut its reserves by 26%

It is worth noting that new mines take as long as two decades to develop.

A pullback in mining today has a long-term effect that could show up as a serious supply issue over the next 20 Years. Nat Rudarakanchana, writing for the International Business Times, quoted World Gold Council Managing Director William Rhind:

"There's a real cost of getting it out of the ground. And that cost has to be accounted for. That's not to say that prices can't fall below the marginal cost of production... It's just to say there is sensitivity there...to the price."

Scrap and recycled gold supply is now at a five-year low.

Above ground gold supplies are also atrophied. Scrap or recycled gold supply fell to a five-year low in 2013, according to Juan Carlos Artigas, the World Gold Council's investment research director.

Several factors account for this. In bear markets, consumers tend to hold onto their precious metals. This is a serious blow to supply as scrap from consumer jewelry and decorative items account for one in every three ounces of the global gold supply. Consequently, refiners handled 4% less gold in 2013 than in 2012, and the least since 2008, according to TD Securities.

It's not just consumers holding onto their gold. Retailers (who buy gold) and middlemen (who sell to refiners) are also hoarding their inventory.

Businesses in the famed New York City 46th Street jewelry district are feeling the effects. (As quoted in Used Gold Supply Heads for '08 Low as Sellers Balk: Commodities, Bloomberg Personal Finance, Joe Richter and Debarati Roy, May 14, 2013):

"Nobody is selling right now, and it's survival of the fittest... If you bought at $1,700, how can you sell at the moment? Everybody's presuming it's going to go back up." David Nektal of 46th St. Buyers.

Leah David of Leah David Fine, a Manhattan jeweler similarly said: "Since very few people want to sell anything, jewelers like me will have no choice but to sell our own inventory or the new jewelry as scrap."

All of this signals a wise strategy: Long term buyers, with a goal to Keep What's Yours, are buying low at this stage and then adding through dollar cost averaging to hedge a short term price dip.
Put in other terms: Do what China is doing.

It is impossible to focus on the dwindling supply of gold without looking at the demand for gold in China. As you watch the Bloomberg report at the end of my article, you will get a chilling sense of how gold is moving from West to East, literally. The commentator describes empty vaults in London and the hoarding of gold in China. The Chinese are hoarding gold, limiting worldwide availability, and substantially effecting supply.

The Chinese economy is complex - growing in some sectors and failing in others. It is clear the Chinese are interested in freeing themselves from the dollar.

We have said many times, ASI's thinking and Chinese economic policy have one thing in common. Both agree the U.S dollar is of uncertain stability and potentially diminishing buying power. Protection comes from gold.

With all the changes in the economic climate in the United States and abroad, nothing has really changed about the ASI philosophy.

ASI has always seen the need to diversify across currencies, across countries and across assets. Gold is the oldest currency, easily stored abroad, and comprises an excellent alternative asset class to balance the volatility of securities.

The fundamental benefits of gold remain unchanged.

With the above insights in mind, call ASI at 877-340-0790, or send me an email, so you can,

• appropriately add to your core portfolio of long-term holdings,
• rebalance your portfolio,
• improve your asset allocation, and
• buy precious metals at current prices in anticipation of a price rise.

My next article on Silver Demand will be published on Tuesday, March 4th.

Here are the links to the first two articles:

Part I - Inside the Troubled Mining Industry
Part II - Gold Outlook 2014 - 'Mining' Profits from the Demand for Gold
Bloomberg Video Report - What's happening to all the gold?