10/05/2012

Rising gold prices, a supply and demand issue?

Are the ever increasing gold prices a function of reduced supply, increasing demand, or both?

Increasing fears of inflation due to global stimulus, and the emergence of the middle class in countries like China and India has shifted the demand curve for gold to the right. As gold prices continue to rise, gold miners seek to increase their supply to meet the current market demand. Gold miners are attempting to shift the supply curve to the right, while keeping prices high and extraction cost low.
As stated in the article, gold supply isn't keeping pace with demand. This ultimately led to a spike in the price of gold. So how high will gold prices go? Is gold still a viable long-term investment? Will prices come crashing down as global recession fears ease?

In my opinion, an investment in gold represents the ultimate "fool's trade." In the investment industry this means that the price of gold can only go higher if the next buyer is willing to pay more than the prior buyer. Gold pays no income and has very little industrial uses. The current price of gold isn't indicative of its true value. The metal is definitely overbought, and I suspect that this bubble will eventually pop leaving many to wonder what happened to their so called safe investment.

9 comments:

Dave Tufte said...

Michael: 100/100 ... but stick to the facts ... gold prices are not ever rising.

Your last paragraph is pretty good. There is not a good track record for gold investments.

Having said that, gold is extremely useful in an investment portfolio. Because it tends to have a very low (and sometimes even negative) correlation with stocks, adding gold to a portfolio is a great way to reduce risk through diversification.

Da Boy said...

While Michael makes some very interesting points regarding gold, I do not agree with the 'fool's market' analysis. I think that since there is not a true substitute for gold, speaking overall in terms of investing, jewelry and technology, and there is a finite supply of gold, I see this as the reason that gold prices continue to rise. As we begin to deplete the mines in current production, if there are not new mines discovered to increase the supply, the price of gold will continue to rise, demand will continue to thrive as the population of the planet increases and world economies continue to grow. Gold is now and has always been a status symbol, if nothing else. I don't see an end to the 'bubble' that Michael referred to in his post.

Dave Tufte said...

Da Boy: 50/50.

There is a problem with saying "finite supply of gold". The word finite doesn't mean we're close to finding it all. And yet most people who say that about resources are making precisely that point.

In this case, neither me nor Da Boy knows whether we've found 90% or 0.90% of the finite supply of gold. But, there it is later in the paragraph "if there are not new mines discovered". The key word there is "if".

Owen said...

Gold has been in high demand for almost all of history. In history, the possession of gold was a sign of power and wealth; the more you had the more powerful you were. You could buy armies with gold and anything else you wanted. It hasn't changed, gold will always be in high demand, and the demand for gold is embedded in most cultures. So buying gold is definitely not a foolish thing to do, if the world economy crashed gold will still be there. If you look at the Dow 80 years ago, a bunch of those companies are not even around anymore, they were hugely successful and powerful companies of their time, that have been replace with newer tech. But gold is still gold and will always be gold.

madhatter said...

Da Boy and Michael both are looking at gold from the wrong direction. When the Federal Reserve issues more 'dollars' used to chase a fixed number of commodities in the market, prices appear to rise. In fact, what we are seeing is a devaluation of the currency. If we were to examine the dollar price of oil compared to the gold price of oil, everything comes into focus. In 1972 when Nixon took the US off of the Gold Standard, oil was $2 per barrel and gold was $35 per ounce. An ounce of gold would have bought 17.5 barrels of oil. Today oil is approximately $92 per barrel and gold is $1760 per ounce. This ratio shows an ounce of gold will buy 19 barrels of oil. This one example shows gold as more stable and a better store of wealth than the continuously growing supply of Federal Reserve Notes that is neither stable nor a secure store of wealth. Investor's don't trade dollars for gold to increase wealth, they do it in an effort to maintain buying power, their true wealth.

Dillin said...

In my opinion, gold is currently a bubble. The only reason people are buying gold right now is to hedge against a weak currency. If you look at who is buying gold right now, it is people that are afraid that the U.S. dollar is going collapse. They think that if the world economy goes away they will be able to trade in the gold currency. They fact that they are buying on fear shows that gold is artificially inflated. As soon as the political winds shift, most “gold investors” will be dropping their gold and buying assets like stocks, bonds or real estate. The sad fact is that most people that buy gold buy paper that tells them they have an ownership in gold. If the world economy did end, they would no longer have claim to that gold. Why have gun sales and food storage sales increased by the same amount as gold? The answer is because people are afraid of the near future. Gold is absolutely a bubble.

Dave Tufte said...

Owen: 47/50, madhatter 50/50, Dillin 50/50.

I think all of you ought to read up on your basic finance :)

Owen: you're making an argument that gold is a good buy historically because the value of some blue chip stocks went down.

madhatter and Dillin: you are making a similar argument but using dollars instead of stocks.

But: 1) all 3 points are implicitly agreeing with my point that gold is good for diversification (but I'm not sure that you're making that connection :), and 2) all 3 points are missing the fact that people who invest too much in gold have been repeatedly burned through history (which is the flip side of the argument that diversification is the key in the long run).

Julia said...

I agree with Michael that gold prices will be always rising. Even when the market value goes down, the value of gold will always be high.Gold demand is rising faster than supply.Being from Russia,we have an extremely active recycling markets. Recycled gold supply will depend on gold price and cost. Supply has been growing slowly in the past few years in Russia, but jewellery demand will depend on economic growth. Russian companies changed its strategies of buying all gold from small independent mines to keep prices high to being “the gold supplier of choice”.

Dave Tufte said...

Julia: 44/50 for a spelling error, and for a singular/plural disagreement.

Hmmm. I wonder if you're confusing nominal and real prices Julia? Yes, in nominal terms the price of gold is generally always rising. But in real terms, this market is characterized by occasional bubbles where some people make a lot of money and get out, and some people don't get out and end up losing a lot of money. But on average, there is no long-term reason for gold to be part of an investment portfolio based on its return alone (there are good reasons to hold a small amount, say 5% of your portfolio, for diversification purposes).

As to the demand for jewelry, yes it's there, but it is small relative to overall gold production.