Gold And The Potential Dollar Endgame Part 1 and 2
Submitted by Tyler Durden on 11/09/2012 19:32 -0500Authored by Dan Flynn and Joe Yasinski of Gold Bullion International,Part 1 of 3: What supply and demand? It’s all stock to flow these days.Reading our title has us convinced that somewhere our college economics professors are hanging their heads in shame with all of those x and y graphs scribbled to no avail. Economists the world over can take comfort that the laws of supply and demand still largely rule the marketplace. However, we believe there is a noted exception for a yellow, largely useless metal. A metal that just happens to have shaped the world’s monetary systems for the last several thousand years. Gold’s “supply” traditionally defined as global mining production is virtually meaningless in determining its’ price. How can this be? Analysts pontificate that global supply dynamics are integral in forecasting future metal prices. We can only attribute this to the fact that these analysts still myopically cling to the view of gold as a commodity.Gold, even when viewed as a commodity, is unique in that it is not consumed. As there is little cost effective industrial application for the yellow metal, little to no “natural” industrial demand exists. Virtually every ounce ever mined from the earth is still above ground, either in a vault or a safe or an earring. An estimated 170,000 metric tons sits above ground, hoarded and unambiguously owned. Given that the annual supply of mined gold is approximately 2,500 metric tons, how is it gold not priced close to zero? After all, there is a 65 year overhang in supply! Despite all that we know of supply and demand dynamics and economic ‘law’, gold’s price is within striking distance of its’ all-time-high – in every currency on the planet.A major contributing factor to gold’s price is that the vast majority of the stock of physical gold is held in very strong hands. It is largely held privately by very wealthy families or by governments and their central banks. This gold lies very still, some of it not changing owners or locations for decades, if not centuries. These giant holders have little need to ever sell, holding gold as a long term store of wealth or as a central banking reserve asset. Gold naturally appeals to these super-savers because of gold’s history as the ultimate store of value and lack of counterparty. Sure you can buy real estate, art, or classic cars- and the extremely wealthy do. But beyond illiquidity and subjective risk, these assets can become cost centers in themselves with maintenance, storage, insurance, etc. Gold is universally recognized as a wealth asset but is also infinitely divisible, portable, and highly liquid. Gold’s value has been established over a millennia and is ultimately the asset that denominates or values all others.Rather than supply in the traditional sense, what drives the gold price is the percentage of the existing stock (170,000 tons) that is available for sale on any given day. The percentage of available inventory for purchase is the “flow.” Divide the flow into the stock and you get the STF ratio. A low STF ratio indicates a very high percentage of the existing physical stock is available for sale and a very high number means owners prefer to hoard physical metal rather than exchange it for dollars. So for example, if every ounce of gold was put up for sale tomorrow, the STF ratio would go to one and the price would plummet, likely to near zero. But, what if instead of everyone selling their gold tomorrow, all existing physical owners of gold decided to keep it instead? Could this even happen? Doesn’t conventional wisdom and ‘economic law’ tell us that as the price of gold goes up, there are fewer buyers able to purchase and more sellers willing to dishoard?In our opinion, conventional wisdom simply doesn’t apply here. Gold, in our opinion is what is often referred to as a Giffen good. A Giffen good is one that actually sees a spike in demand as its price rises. Conversely, demand drops along with price. While the concept of a Giffen good is well known, the number of examples in the real world are slim and usually limited to localized commodity markets in extremis. A golden, glaring exception is the massive example playing out before our very eyes. In typical Giffen behavior, gold was scorned and dishoarded by individuals as well as central banks as the price hovered in the low 100’s. Fast forward to today and gold demand is at to or close to all time highs, even as the price sets new records in currencies around the world.
http://www.zerohedge.com/news/2012-11-09/gold-and-potential-dollar-endgame
Part 2 of 3: “Paper Gold, what is it really good for?”In our first installment of this series we explored the concept of stock to flow in the gold markets being the key driver of supply/demand dynamics, and ultimately its price. To briefly summarize the STF concept, the “stock” of existing gold is the total amount ever mined and the “flow” is the amount of physical gold available for purchase on any given day. Obviously the more flow, the more for sale and presumably, the lower the price. Today we are going to explore the paper markets and, importantly, to what degree they distort upwardly the “flow” of the physical gold market. We believe the very existence of paper gold creates the illusion of physical gold flow that does not and physically cannot exist.After all, if flow determines price – and if paper flow simulates physical metal movement to a degree much larger than is possible – doesn’t it then suggest that paper flow creates an artificially low price? If the physical metal does not actually flow along with paper representations of flow, then isn’t it true that the current stock to flow ratio may already be much higher than previously imagined?When we talk about “paper” markets, we are broadly referring to derivative markets; forwards, swaps, and in the case of gold, unallocated gold accounts as well. Derivative markets for commodities were developed to smooth the wild price swings caused by supply gluts or unexpected shortages. The first modern exchange for rice dates back early 18th century Japan. By 1848, the Chicago Board of Trade was formed, originally clearing trade of forward contracts on corn. Consumed commodities tend to exhibit tight supply/demand dynamics so it is easy to understand the necessity for such ‘paper’ markets for legitimate hedging purposes. As discussed in part one, gold is not consumed and given the existing stock and annual mine production – there is an approximate 65 year ‘overhang’ of new mining supply. Can you imagine the need of Cargill to hedge the cost of corn if a non-perishable, 6 decade supply sat in their warehouse? With a relatively massive existing stock of gold, there is no potential supply shock to hedge against – and the need for a large derivative gold market seems completely illogical. It follows that as the derivative market for most commodities developed over the last 3 centuries, the gold market remained “physical only”. Whether for settlement of international trade or otherwise, there was no need for ‘paper gold’ as the marketplace for and the flow of physical gold bullion was robust.http://www.zerohedge.com/news/2012-11-30/gold-and-potential-dollar-endgame-part-2-paper-gold-what-it-good
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