Brace Yourself for the Coming Gold Shortage

Brace yourself for the impending gold shortage. Gold shortage? Yup. With the launch of a flurry of ETF’s devoted to the barbaric relic recently, total ETF holdings have soared well past 60 million ounces worth $65 billion, more than total world production in 2009. The grand Daddy of them all, the SPDR Gold Shares (GLD), now has a staggering $42.7 billion of the yellow metal, making it the second largest ETF by market capitalization, and the fifth largest gold owner in the world.

When gold suffered a hair raising $150, 12% pull back from the all time high in December, I was deluged by traders asking if this was the peak, if it was the final blow off top, and if gold is finished as an asset class. My answers were no, never, and not on your life.

A tidal wave of fiat paper currencies is now flooding the world financial system at an increasingly alarming rate. Obama has not suddenly become a paragon of fiscal restraint. Bernanke has not morphed into a tightwad. When I pull a dollar bill out of my wallet, it’s as limp as ever.

In 2008, South Africa suffered its steepest decline in gold production since 1901, falling 14%, to a mere 232 tons. It now ranks only third in global production of the yellow metal, after China and the US. Severe electricity rationing, a shortage of skilled workers, and more stringent mine safety regulations have been blamed. Choked off credit has frozen the development of new capital intensive deep mines, as it has for everybody else. Rising production costs have driven the global breakeven cost of new gold production up to $500 an ounce.

In the meantime, the financial crisis has driven flight to safety demand for gold bars and coins to all time highs. Last year, the US Treasury ran out of one ounce $50 American Gold Eagle coins, now worth about $1,150. Competitive devaluations by almost every central bank, except Japan, mean that currencies are not performing as the hedge that many had hoped, especially the Euro.

It all has the makings of a serious gold shortage for the future. The huge growth of the middle class will impact gold prices, as it has with other commodities. Linear growth in supply will get overwhelmed by a Malthusian, exponential growth in demand. Last year’s downturn is looking increasingly like a mere blip in the eight year bull market.

If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. We could be seeing a replay of 2008-2009, where the yellow metal traded in a sideways range for many months before blasting through to a new all time high and quickly tacking on 25%.
Start scaling in around $1,040. That’s where the Reserve Bank of India started the recent love fest for the barbaric relic with its 200 ton purchase in November.

If the institutional world devotes just 5% of their asset to a weighting to the yellow metal, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all time high, or higher.

ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP). Stock investors can entertain shares in Barrack Gold, the world’s largest gold producer. I would also be using the current bout of weakness to pick up the high beta, more volatile precious metal silver (SLV) and platinum (PPLT), which have their own long term fundamentals working in their favor.

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