Gold Shortage

Shortage is a sad state in which something needed cannot be obtained in sufficient amounts. Demand exceeds supply. Shortages were very common in the communist economies, as prices were controlled by governments and couldn’t rise to clear the market. Fortunately, in a free market without government interventions in the price mechanism, shortages occur rather seldom and are temporary.

Shortage is a sad state in which something needed cannot be obtained in sufficient amounts. Demand exceeds supply. Shortages were very common in the communist economies, as prices were controlled by governments and couldn’t rise to clear the market. Fortunately, in a free market without government interventions in the price mechanism, shortages occur rather seldom and are temporary.

Shortage of Gold Is Coming – Or Not

Despite these economic basics, some analysts fear the allegedly coming shortage of gold. They paint apocalyptic visions of people waiting in queues and trying to buy gold at all costs, with no single gram of gold available in the market. Sounds scary, right? Of course, it does, as the aim of these sellers of fear is to prompt you to buy gold. Fear and passion are among the most successful selling techniques. But remember, fear is the path to the dark side. Fear leads to anger. Anger leads to wrong investment decisions and hate. Hate and wrong investment decisions lead to losses and suffering.

Gold Shortage and Peak Gold

The idea of gold shortage is strictly connected with the concept of peak gold. Since we – of course! – have already gone beyond peak gold, the mining industry is headed for a dramatic supply shortage.

The only problem is that mining production did not enter a terminal decline. Instead, as one can see in the chart below, an upward trend started again in 2008. Hence, the gold bull’s hopes of peak gold and the upcoming gold shortage seem to be exaggerated.

Chart 1: Mining production (blue line, right axis, in tons), total supply (green line, right axis, in tons), and the price of gold (yellow line, left axis, annual average, in $) from 1997 (2002) to 2016.

Many analysts don’t appreciate properly the power of the marvelous price mechanism. The scarcity of any commodity, including gold, would increase its price, encouraging new discoveries and production. Simultaneously, a higher price would dishearten some potential buyers, reducing the shortage and bringing the market closer to equilibrium.

Gold Shortage and Manipulation

Many people believe that the gold market is heavily manipulated. The Fed’s use of gold leasing and naked short selling of the precious metal on Comex led to the growing shortage of physical gold supply, at least in relation to the paper claims on gold. In other words, the belief is that the central banks and the corrupted financial system created more paper gold claims than there is bullion to satisfy them. There is simply not enough gold to back all the paper claims on the yellow metal. When people finally realize what is going on and the paper gold market collapses, the price of gold will skyrocket.

However, the claims about the disconnection between paper gold prices and physical demand are unfounded and result from ignoring the way the futures market works. The lack of physical delivery in the gold futures market is nothing strange, as the majority of transactions in the futures market (not only gold) are without physical delivery and are cancelled out by entering a covering position, because it is a much more convenient way of settling the contract and gaining exposure to the price movements.

Conclusions

What does it mean for the investors? Don’t listen to the so-called experts who have been calling “gold shortage” for years. Given the enormous gold holdings in the world, it’s actually hard to imagine a lasting shortage of the yellow metal. Indeed, gold usually remains in contango, not in backwardation, which implies that there is no supply shortage. Thus, forget this idea. Taking decisions based on false premises is the shortest way to suffer losses.