Bull and bear markets in natural resources are usually framed by issues of supply and demand. The economic idea is that when resources are scarce, they become expensive and so less are consumed. At the same time, more money is available for producers to bring new sources of supply on line, thereby increasing the supply, driving prices down.
Of course there can often be distortions introduced into the market, as occurs when farmers are subsidized. In New Zealand, we know this to our cost, as we have often had to compete with our produce against subsidized farmers in Europe and North America.
There are also issues around what is termed elasticity of demand or supply. Basically, demand for a product is inelastic if a large change in its price does not reduce demand very much, if at all. Drinking water is an example of a substance whose demand is inelastic – we just have to have it – we can’t replace water with substitutes.
On the other hand, demand for meat could prove to be elastic – if the price went high enough. Demand for uranium for use in nuclear power stations is also elastic – if you’re going to keep the plant running, you have to buy the uranium, no matter what the cost. Elasticity of supply concerns the question of how quickly new supply can be brought on line, once extra demand is apparent.
Now to the question of gold. Gold is very unusual in that virtually all of the gold that has ever been mined is still available and accessible. This is a very different situation than exists for silver, by the way; we will have more to say about silver in other articles. With regard to increasing supply once a shortage is perceived, it’s “Houston, we have a problem”. It’s simply impossible to ramp up gold production quickly.
Demand for gold arising from the jewelry market is definitely elastic. What really affects the gold market though is investment demand, which is really the driver of the gold market. This demand is often called a “safe haven” demand – when fiat currencies seem vulnerable, many investors switch assets into gold as insurance.
It is interesting to note that, historically, in both extreme inflationary and deflationary scenarios, gold has done well. At the present moment in history, the jury is out as to whether extreme inflation or deflation is imminent. However, from the point of view of gold ownership, you win either way.
7 Signs of a bull market in gold.
(1) The price of gold bullion has increased, on average, in every year since 2001. The price in 2001 was, on average USD271 per oz. Today, as of July, 2009, the price is of the order of USD920 per oz.
(2) China has increased its gold holdings from 600 tonnes in 2003 to over 1000 tonnes in 2009.
(3) Over recent months, delivery times for gold bullion and coins has increased markedly at certain times, indicating substantial increases in demand.
(4) Certain of the most astute hedge fund managers, e.g. David Einhorn and John Paulson, have taken substantial gold positions.
(5) In the institutional world, gold is starting to be seen as an important asset to hold for hedging purposes against financial assets, which are being seen as increasingly fragile.
(6) Gold is being viewed as a proxy for “real assets” as opposed to “paper assets”. Marc Faber, a very sophisticated money manager and investor, who writes the “Gloom, Boom and Doom Report” and who is the author of “Tomorrow’s Gold”, advocates a portfolio which contains 20% or more of real assets – with the primary real asset being gold.
(7) Meanwhile, central banks, especially the Federal Reserve, print, print and print yet more fiat currency into existence to try and counter current deflationary forces, which threaten to engulf us in a deep economic depression. There is enormous danger in this approach; an ocean of new money can be created with a few keystrokes, but where any resulting tsunamis wash up in the form of giant new financial bubbles cannot be controlled by the Fed. The most likely outcome is that this money will slosh its way into “real assets”, and in particular, the precious metals.
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