Are We Facing a Global Gold Supply Shortage?

By MoneyShow.com  DEC 12, 2012 3:07 PM

Make sure your personal gold reserves are in place before a gold supply crunch becomes a reality.

 


A number of market analysts and gold-industry insiders are warning about a possible gold supply shortage.

Barrick Gold (NYSE:ABX) CEO Jamie Sokalsky recently stated that since gold production is inelastic (i.e., insensitive to price changes), there will be a very limited increase in supply from gold producers, even during sharp increases in the gold price. Rick Rule, a billionaire and avid gold investor, pointed out that while we're seeing spectacular demand, a number of issues will make supply very tight in the future, especially among retailers.

The issues facing gold miners are well known: depletion of existing mines, lower grades, and fewer new discoveries—especially big and rich ones. Further, miners face increased calls for nationalization, demands from workers for higher pay or from local communities for better infrastructure, and—of course—environmental concerns.

Many mining company representatives say it's getting harder to not only find large deposits, but to get those deposits into production. Some estimate it now takes twice as long as to go from discovery to production versus a decade ago.

These warnings aren't always taken seriously, especially by those who see that mine production has been growing. At first glance, they're correct—but only if you look at the short-term picture.

The following chart shows that global mine production has indeed been rising since 2008. From 2009 through 2011, output rose an average of 3.9% per year. However, we know that a good chunk of this increase is due to China, and upon excluding its output, you can see how it alters the global picture.


Click to enlarge

What's important about China's production is that unlike most other countries, it doesn't reach the world market, since China doesn't export gold.

Further, while some point to the growth in production since 2008, output is still 12.8% below the year 2000 level. And there are reasons to believe the gap between global mine production vs. mine production excluding China could widen.

MarketWatch reports that China's Ministry of Industry and Information Technology has said that China wants domestic gold production to reach 14.5 million ounces by 2015, an increase of approximately 25% over last year's levels. Given that what's produced in the country stays in the country (where there is escalating domestic consumption), a "widening of the fundamental market shortage," as per the MarketWatch article, seems almost certain.

Since global production is lower without China's production included, we decided to examine total supply (mine production plus scrap), backing out Chinese production and adjusting for Chinese gold imports. How much gold is left for the rest of the world after the Chinese take what they want? The contrast surprised even us.

Total gold supply has been growing since 2006, reaching a record of 120 million ounces in 2011. However, as you likely know, China's consumption is second only to India's—and could soon reach No. 1.

China's gold imports from Hong Kong have soared, hitting a record 13.5 million ounces last year, with 16.5 million ounces imported through August of this year. Upon adjusting for China's imports, gold supply for countries outside China has actually been falling since 2009!

That's Not All
Another trend to take in to account is China's growing interest in natural resources—basic materials, energy, and others. What gets underreported, however, is that the Chinese are also purchasing gold mines. Here is a list of Chinese gold-mining acquisitions over the last year:

The facts can't be denied: China is on the hunt for gold deposits and mines. These gold-focused deals will add more ounces to the country's pool of gold assets. Just the three most recent acquisitions (Focus Minerals, Norton Gold Fields, and Inter-Citic Minerals) contain 12.5 million ounces of gold resources.

As the Chinese have publicly stated before, acquiring large amounts of gold on the open market would almost certainly drive prices higher, as well as trigger greater volatility. One way to get around that is to purchase deposits that either are or will be producing the precious metal, allowing them to accumulate the gold before it hits the international market—and at cheaper prices than spot.

In spite of the gargantuan quantity flowing through Hong Kong, it's entirely possible that we are underestimating China's demand. In light of all this, it seems clear that concerns about future supply are real.

What to Expect
There are some clear implications for us investors:

Our advice is simple: make sure your personal gold reserves are in place before a gold supply crunch becomes reality. And for leverage on the likely resulting mania, build a portfolio of the best of the best gold stocks.

Editor's Note: This article was written by Jeff Clark of Casey Research.

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