I remember in early 2009 how difficult it was to buy gold at a decent premium and get it delivered in less than six weeks.
It wasn’t what any of us expected. “There’s plenty of above-ground gold to go around” and “global production is on the rise” were common buzz phrases of the day.
But the reality was anything but common. It was a scary time and many investors were turning to gold. The problem was that so many investors wanted to buy that premiums went through the roof. And delivery times—assuming the product you wanted was even available—were measured in weeks and months instead of days.
One dealer told me that he was so frustrated that he had difficulty sleeping at night. There just wasn’t enough physical metal available to fill his orders.
This setup kick-started one of gold’s biggest bull runs in modern history. The price more than doubled over the next three years.
It’s that reality—too much demand and too little supply—that looks poised to repeat. It’s a driver for gold that most market analysts overlook and is one that could push the gold price much higher…
To get some perspective, here’s the value of the total annual gold supply compared to the market cap of some widely held stocks.
At $1,200 gold, just one company from our list—Disney—has a market cap equal to a full year’s supply of gold. Exxon Mobil, even after a steep fall in its stock price, is more than twice as large. Apple Computer is more than three times bigger.
This will become a real problem—or a big opportunity—when big money starts to move into this tiny sector.
And there’s no bigger “big money” than pension funds…
Shayne McGuire is head of global research at the Teacher Retirement System of Texas. In his book Hard Money: Taking Gold to a Higher Investment Level, he states that the typical pension fund holds about 0.15% of its assets in gold and another 0.15% in gold mining stocks, for a total of 0.30% devoted to the sector.
Global pension assets are currently valued at approximately $35.4 trillion. So a 0.30% allocation to gold would equal $106.2 billion.
Here’s my question: what if pension fund managers get nervous about the growing volatility in stock markets, or slowing global growth, or the contagion of negative interest rates, or an escalation in the currency wars and decide to double their exposure to the gold industry? That’s still just 0.6% of assets, hardly a diversification killer.
Well, here’s what they could buy with that $106 billion.
That puny increase in exposure could buy every single company in the XAU (Philadelphia Gold/Silver Sector), every share of GLD (SPDR Gold Shares ETF), every share of GDX (Market Vectors Gold Miners ETF), and every share of GDXJ (Market Vectors Junior Gold Miners ETF).
Or, as Grant Williams points out in his excellent video, they could commit another $25 billion and buy every major gold producer in the world.
And don’t forget this is only one class of institutional investor. Hedge funds manage at least $2.8 trillion, sovereign wealth funds over $7 trillion, and insurance companies at least $25 trillion. Then there’s mutual funds, ETFs, private equity funds, private wealth funds—and throw in millions of retail investors like you and me and we're looking in the rear view mirror at $50 trillion.
If stocks enter a bear market, real estate peters out, or fixed income becomes not so fixed, the natural question then becomes: where will all this gold come from?
That’s a good question because even though the above-ground supply of gold is a whopping 171,000 tonnes (6.1 billion ounces), only a small portion of that is, or can be, available in investment form. We’re not going to melt down church statues or rob graves looking for gold crowns to mint more gold Eagles. That’s the mistake analysts make. They quote above ground gold supply when it’s not all available.
And the issue isn’t just that some of the above ground supply isn’t available; it’s that supply is simultaneously falling.
Here’s one place where that fact is alarmingly evident. The center of the gold market is London, and the Bank of England holds a lot of gold. But look what’s happened to holdings everywhere else.
This is what the gold portion of that portfolio looks like.
In just four years, global vault holdings outside of London have fallen by two-thirds.
That drop is the direct result of persistent demand for physical metal (which is starkly different than demand for paper products). Regardless of the tiresome drone from gold cynics and virtually constant negative press coverage, global investors have relentlessly snapped up every ounce they can get their hands on.
What about Asia—couldn’t we source some gold from China’s hoard?
No, because they’re not selling, they’re buying. In fact, Chinese investors just set a record for the amount of gold they’ve withdrawn from their exchange (where they trade more in physical metal than paper contracts).
In other words, a lot of physical metal has been taken off the market and won’t likely be available again, except at higher prices.
And the supply problem gets worse. According to the recent GFMS Gold Survey by Thompson Reuters, “… due to lower production at more mature operations and a lack of new mines coming on stream, we currently forecast global mine output to shrink in 2016, marking the first annual decline since 2008 and the largest in percentage terms since 2004.”
Low gold prices have crushed exploration and development budgets in the industry. Most estimates show that at least a third less money has been devoted to exploring and developing new gold deposits than in 2011. It doesn’t take a math degree to understand that if you spend less money looking for gold, sooner or later you’ll produce less of it.
The perfect storm here is that demand for physical gold products is already elevated and available supply is tight and growing tighter.
This matters because once fears about the economy or markets or bonds or central bankers turn into realities, more investors will buy gold. And that will lead to higher prices, drawing in more investors, which tightens supply further, which pushes prices higher, which… you get the idea.
It’s not because gold’s had a great start to the year and the broader markets haven’t. It’s because systemic risk is high right now. The higher the risk, and the higher the fear of those risks, the more likely that investors will want to own gold and push the price higher as a result.
I like the way Grant describes it: gold is your unsurance policy. The degree to which you’re unsure about the future tells you how much gold you should own. If you think there’s a 5% chance of a major global dislocation, then maybe you should own 5% gold in your portfolio.
Watch Grant’s video and see more of why a tipping point could be coming that pushes pension funds and other institutional investors into this sector and sparks the next gold rush.
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