Ft. Atkinson, WI
By A.B. Dada
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Gold’s recent price-rise has been connected to the fall of value in the US dollar due to the recent federal rate drop by the Fed in September, which is a price-rise that I concur with, but I believe is limiting in being the only reason. Some analysts are also connecting the rise in the currency-price of gold as connecting with the Indian marriage season, where families buy a significant amount of gold jewelry that is used in the wedding ceremony and as a form of early-savings for the newlyweds, but this too is not enough to try to understand the reason for gold’s current boom, and what may lay ahead in the future.

On area that most analysts are forgetting, and many goldbugs are ignoring, is the production of new gold from mining companies. Historically, gold has been produced in about the same amount as is used in industrial processes. This means that we’ve been fairly consistent over recent decades than when 1 ton of gold is “used up” for industrial needs, another 1 ton of gold was mined. While it isn’t a 1:1 ratio, the ratio is consistent enough that the industrial demand for gold is well balanced with the mining supply of gold produced — leaving gold’s price moving sideways due to the close connect between new supply and demand.

Yet one area where mining companies have been a cause of keeping the price from rising is the fact that most mining companies have been operating using cheap commercial paper loans to extend their capacity to mine more gold than they would be able to based on their available cash alone. Buying shares of a gold mining company gives the company no new cash to operate — you’re just buying from a previous owner of the shares. In some cases, a gold mining company will issue brand new shares to sell, but these new shares dilute the ownership value of previous shares, so it isn’t done often for the larger producers.

In the past, commercial paper-backed loans are loans that are created from commercial deposits, which are generally paid a low interest rate to the depositors. Commercial paper loans have also been used significantly by the recent mortgage loan industry, part of the reason for the massive bubble in housing price (easy and cheap loans backed by short term commercial paper led to easy credit led to overfinancing led to too much money aimed at buying houses led to prices skyrocketing until the commercial paper market crashed).

Just as the commercial paper market has crashed in terms of providing easy money for buying homes, it is also crashing in terms of easy loans for gold producers. The effect, though, is quite the opposite. When there is easy money to build and buy homes, prices in home skyrocketed because people were sending a huge influx of new cash into an existing market. In the gold mining industry, that easy credit led to prices to FALL for gold because of the influx of cash into the development of mines (heavy equipment, labor, processing and excavating). With the reduction in available loans for mines big and small, their ability to find new veins of gold, hire the labor to mine it, buy the equipment to support the labor, and process the ores mined is reduced. A reduction in production supply for gold should bring with it a reduction in the new supply of gold. If demand stays high (which may not happen as the price continues to rise), and supply drops due to mining companies having to produce on budget rather than with easy credit, the price of gold could continue to rocket upwards.

It is important to understand the limited supply of gold in the world today, and the intricacies of bringing in a new supply. The process of producing new gold is not as simple as finding a vein and bringing it up. It is very expensive industrially and chemically, as well as a very time-consuming process. Many mining companies fail because they misread how much gold they think they have access to, or they misread the costs of converting the mined ores to pure gold. With a reduced loan capacity to continue their operations, I believe we’ll see a reduced supply of new gold in the coming months and possibly as long as 2 years. This would definitely put upward pressure on gold until such time that a new source of credit can be found for the gold producers.