Will Miners Save Gold?

Fair enough, this is how the law of supply operates. We do not question this. We are economists, after all. But there is one small problem. Gold’s supply is so unique that the mechanism described above does not practically apply. Why? To understand this, you have to close your eyes and imagine what would happen if all oil producers ceased their production. Let me guess: you have pictured rising prices and social unrest. And rightly so. The reason is that without the oil production we would quickly run out of oil. Of course, people are wise enough to put some oil into reserve. According to estimates, the oil stockpile is equivalent to 40-50 days of production. It means that our oil-dependent civilization could survive without the oil production one quarter at most (assuming a reduction in consumption level).

OK, and now the most important part. Imagine that all gold mines cease their activities. What do you think would happen? Yes, you are right, don’t be afraid of the implications. Nothing. Of course, we exaggerate, because many people will lose their jobs and so on. But the truth is that the lack of fresh supply of gold will not significantly affect the global markets. We do not mean that gold is less important than oil for our modern economy, although it probably is.

The key thing is that there are massive above-ground holdings of gold. The above ground stocks are estimated to be around 190,040 tons. It means that the annual supply of gold adds only about 2.3 percent of the above-ground holdings of gold (and mining production even less – about 1.7 percent). Or in other words, the above-ground stocks of gold are almost 60 times larger than the annual flow of new gold from gold mining. It’s quite a difference between 50 days and 60 years!

Given such a high stock-to-flow ratio, and the fact that an amount equal to the annual mine supply changes hands in less than a week in the London market alone, the gold production costs do not provide a floor for gold prices. Actually, the opposite is true. When the price of gold drops, the least efficient miners exit the market, which lowers the average gold production cost. It means that gold prices are a determinant of producers’ costs, which is exactly what professor Brian Lucey of Trinity College Dublin et al. found in their article in Alchemist.

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If you enjoyed the above analysis and would you like to know more about the most important macroeconomic factors influencing the U.S. dollar value and the price of gold, we invite you to read the ...

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