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GSPros Monthly Subscriber Digest for January 2019

Gold Silver Pros Monthly Subscriber Digest

You have no doubt come to Gold Silver Pros for the most up to date intelligence on what drives the price of the precious metals market. The good news is that I am going to tell you here what is driving the spot price of gold in today’s market. The great news is that last month’s subscriber digest already covered the drivers of the silver price, so head over and check that out if you haven’t done so.

Summary

  • The cost of producing gold has put a floor under the price of gold on the spot market. The spot price does not move below the cost of production.
  • Oil prices have an effect on the price of gold, but do not dictate the market price. Oil prices help set the floor of the gold price based upon their effect on the cost, and that’s about it.
  • Demand for gold in the form of ETF paper derivatives is largely correlated to gold’s spot price.
  • Physical demand for gold in the form of coins and bars is much less correlated to gold’s spot price.
  • When the stock market finds trouble, more demand goes into gold ETFs as a safe haven alternative.
  • When the stock market is soaring, gold prices trade within a range. When the stock market falters, gold’s spot price rises substantially.

Cost Components

Many analysts have previously thought that the cost of energy, mainly in the form of oil, is a primary cost driver for gold and therefore a price predictor. Therefore, they often track the rise and fall of oil in predicting the future gold price.

This was largely true from the mid 80’s through the tech crisis in 2000, at which point that relationship changed. See this chart of the oil and gold prices during that time period.

Gold vs Oil prices, historic

Data Sourced from Yahoo Finance

Notice that when the oil price crashed in 2009 after the financial crisis, the gold price rose. That is because energy only affects gold during normal markets and not during downturns. Further, even though the oil price fell precipitously in 2014, the gold price did not fall very much below the $1200 mark and has stayed in a relatively steady range the last several years.

Gold Price vs Industry AISC

Data sourced from World Gold Council, Company Reports, and Yahoo Finance

The average yearly gold price did not fall below the all in sustaining cost (AISC) of mining gold even during recent years when the price of oil fell sharply. Notice how the price of gold approximates the mining costs for the two largest historical producers, Barrick and Newmont.

Even though other gold companies, according to the World Gold Council, have lower aggregate AISC, the gold price does not fall below the mining cost of the largest producers to that lower cost level. As those average yearly producer costs have risen, so too has the average yearly gold price in tandem. Therefore, in this market we can follow the mining costs of the larger producers to predict the gold market price direction.

Demand Components

In this section, I am going to examine both the physical and gold ETF paper demand when the gold price changes. In the first chart, we look at ETF demand compared to the gold price.

ETF Demand vs Gold Price

Data sourced from WGC and Yahoo Finance

We can tell from looking at the chart that demand for gold ETFs since their inception in 2003 has closely tracked the price of gold. What this means is investors use ETFs to capitalize on gold price movements much like they do with stock investments. They buy when the price is going up, and sell when it is going down. There are two conclusions we can draw from this dynamic.

First, ETF investors are buying the paper to gain exposure to the price of gold and not as a true safe haven to protect their wealth. Long term gold holders using gold as an inflation or crisis hedge do not buy and sell their gold simply on price movements over the shorter term.

Second, investors who are buying ETF paper gold at the tops and selling near the troughs are going to lose money on their trades much like they would in the stock market. That is why most people don’t make as much money in the market as indicated by the rises and falls would indicate. This is principally because it is very hard to time short term market movements, as I wrote extensively in my book Drop Shadow: The Truth About the Economy.

Next we look at physical gold demand, defined as bars, coins, and jewelry, versus the price of gold.

Physical Gold Demand vs PRice

Data sourced from WGC and Yahoo Finance

Note that jewelry demand is by far the largest component of physical demand, and some analysts make the point that most people in Western nations don’t buy jewelry as an investment.

This is true; however, many people in Eastern nations do because they buy the higher grade 22 and 24k gold, and not the lower quality jewelry found in most Western jewelry outlets. And this jewelry is used in ceremonies such as weddings and passed down from generation to generation as a form of stored wealth. Therefore, we cannot really remove jewelry demand from the equation of gold investment demand without underestimating true physical demand for gold as a store of wealth.

As the price of gold broke out after the financial crisis, physical demand actually decreased. That is because less people are able to afford gold in jewelry form, and those that purchase physical gold for long term investment will simply wait for prices to fall before purchasing more. These investors are more patient and understand there would be more chances to accumulate physical gold at lower spot market prices.

The Fear Index

Gold has long served as a currency and long term store of wealth. However, in the fiat paper currency era that has stood in place since 1971 when President Nixon took the US off of the gold standard, gold has been seen more as a safe haven asset. This is where investors park their money when the stock and bond markets are having issues, at least where purchases of paper ETF gold derivatives are concerned.

Dow Jones Stock Index vs Gold Price

Data sourced from Yahoo Finance

Note in the graphic above that when the market crashed in 2008, there began a serious influx of demand for gold that lasted through 2012 before leveling off. This tells us that the gold price will rise during a recession and keep it until it is clear that the stock markets have sustained a recovery.

Dow Jones Stock Index vs ETF Demand

Data sourced from WGC and Yahoo Finance

What we see from this chart is that gold ETF demand spiked up during the recession period. Like the gold price, the ETF demand leveled off in 2012 and begun falling after it was clear that the stock market had a sustained recovery. Further, ETF gold demand increased during the market crash that started in October 2018. The gold price has gone up during this time as well.

Conclusions

Gold serves as safe haven for stock market investors during times of market turmoil. Demand largely flows into paper derivative ETFs when the market is experiencing a crash, and decreases when the stock market resumes a bull run. Conversely, physical demand increases when price is falling and levels out when gold is calmly trading within a range.

Energy costs help determine the costs of gold production, but have not been the main driver of gold market prices in quite some time. Rather, they help set the floor of the gold price as one of the inputs into the overall AISC of the gold miners. Gold spot market price does not fall below the costs of the largest two gold miners and does not fall to the lower world average production cost of gold.

These insights will help you understand the price movements in the spot market for gold. I provide more interesting insights for gold prices by diving deeper into this discussion in this month’s Monthly Subscriber Broadcast, so head over there for much more on this subject.

Premium Precious Metals Podcast – January 2019

February Preview

For February’s digest, I am going to be discussing what happens when the next big economic crash comes. The current market dynamics will completely fall apart, and the price of gold will be determine by much bigger market drivers. These are the ones you want to really pay attention to if you are investing in gold for the long term.

As a subscriber to this site, you are more likely to be a longer term gold investor and you are more likely to invest in the physical metal. I will describe why next month. Stay tuned!