Final thoughts on gold as we enter the festive season…

As gold looks to close out 2013 at its year lows and despondency and despair amongst the bulls is all encompassing, we think the graph below is worth a cursory glance.

It shows that the private sectors in the US are actually starting to build debt again and this is most likely the reason why the Fed tapered its bond buying programme this week. While the growth in US private sector debt is still below is historical average of 8%, some areas like consumer credit are already growing at 6% and it may not be long before all private sector debt is growing strongly. This will allow the Fed to take its foot of the pedal. 

The increase in US Federal debt is not productive; it is just piling on the already huge debt burden which is unlikely to be fully repaid without monetisation. The US debt-to-GDP ratio has been climbing since 1978 which means that the US economy has to take on an increasing amount of debt to produce the same amount of GDP.  However, it is hard to unwind the debt without causing an economic collapse. In September 2008, the economic system stopped functioning as panic over the credit crunch grew. Even a small correction in debt can cause huge damage. Between April and September 2008, total US household debt fell by $61bn, a mere 0.1% of total US debt. 

Gold quite simply cannot possibly be expected to keep up with the fast growth in paper and electronic money floating around the world. You can’t print gold after all. You need to find it, dig it out of the ground, refine it, etc., a hugely expensive and time-consuming process which practically ensures a stable rather than exponentially growing supply. Once investors realise that the central and other banks are in the game indefinitely, gold and silver will lurch higher and faster than anyone anticipates. 

At current gold prices, gold output will almost certainly decline as most producing mines are struggling to make money. The “real” average all-in-cost of gold production is now just under $1,600/oz and with average grades declining the gold price will have to rise above $2,000/oz and stay there to revive production. Lower grade of course means that many gold producing companies are struggling to reach their production targets and break even points. The number of new gold finds is also declining.

To make matters worse for gold consumers, going forward it looks like mine production will decline in the medium term if the price of gold remains at current levels. The fall in the gold price has added to the pressure on gold supply as most gold producers are burning cash at current spot prices. If gold prices remain at current levels for long, more producing mines will be shut and more exploration/development projects abandoned. Unless the gold price rises, production must ultimately decline significantly. As demand is not expected to decline significantly, gold prices have to rise at some stage in the near future. That sets up a helluva supply/demand dynamic and where demand will be unlikely to be met for a number of years as supply diminishes. 

The 2014-16 period could be very positive for gold indeed.