Lighthouse Investment Management

Gold Bug Galore

April 2017

Gold Bug Galore - April 2017 Page 1

 Lighthouse Investment Management

Contents

Introduction ............................................................................................................................................ 3
Consumer Demand: Jewelry .................................................................................................................... 4
Consumer Demand: Coins & Bars ............................................................................................................ 5
Consumer Demand: Total ........................................................................................................................ 6
Global Gold Demand by Volume .............................................................................................................. 7
Global Gold Supply by Volume................................................................................................................. 8
Global Gold Demand by Value ................................................................................................................. 9
Global Gold Supply by Value .................................................................................................................. 10

Gold Bug Galore - April 2017 Page 2

 Lighthouse Investment Management

Introduction

Gold bug: Term frequently employed in the financial sector and

among economists in reference to persons who are extremely bullish
on the commodity gold as an investment and or a standard for
measuring wealth. Depending on the circumstances the term can have
one or a combination of closely related and often overlapping themes
that extend beyond the support for gold as an investment, including in
some cases the use of the term as a pejorative.1

A gold bug believes gold is the best way to preserve wealth in general, and during times of
unorthodox monetary policy in particular.

Gold bugs are often mocked for their beliefs. Warren Buffett, the renowned investor, famously
dismissed gold in a speech given at Harvard in 1998:

Gold gets dug out of the ground in Africa, or some place. Then we melt it down, dig another
hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching
from Mars would be scratching their head.2

While it is true that gold has little utility (other than dental fillings and connectors for semiconductors)
the same could be said about a dollar bill (you can start a fire with it). Gold is simply very practical for
storage purposes; it does not rust or deteriorate as it does not react with most substances. It does not
have to have a utility; if it had, it would be used and consumed for that purpose.

The main condition for something to have value (in the material world) is rarity. You cannot sell air, for
example in plastic bags. But, compressed air in a can has a certain value and can be sold for money.
Separate air into its constituents (oxygen, nitrogen) and you will be able to ask for an even higher price.

Average mining grades are generally 1-10 grams of gold per ton of rock. That means you must move,
grind and process up to 1 million times as much rock to obtain one part of gold. This makes gold mining
expensive and keeps gold rare.

In this report we look at global gold supply and demand.

If you are not a gold bug, doesnt that make you a fiat bug?

1
Gold bug - Wikipedia
2
Warren Buffet, speech at Harvard University in 1998, in: The Times (UK), July 21, 2003

Gold Bug Galore - April 2017 Page 3

 Lighthouse Investment Management

Consumer Demand: Jewelry

Around half of consumer demand for gold, roughly 2,000 tonnes per year, stems from jewelry
Asia makes takes the largest share, with Greater China3 demanding 700 1,000 and India 500
650 tonnes per year. Gold as dowry for marriages plays an important part in Asian societies.
Strong economic growth and a rapid increase in wealth in Asia were able to offset a steep rise
in gold prices.
Other regions, despite larger share of world wealth, do not have a big impact on overall gold
demand for jewelry.

3
Greater China includes Hong Kong and Taiwan

Gold Bug Galore - April 2017 Page 4

 Lighthouse Investment Management

Consumer Demand: Coins & Bars

Similar picture in gold demand for coins and bars: Asia dominates the picture
Greater China leads with 200 400 tonnes per year, followed by India (150 400)
Western Europe is showing a very consistent demand of 200 250 tonnes per year, with
Germany (100 140) and Switzerland (50 tonnes) being dominant
Compare the UK (10 tonnes) to Vietnam (40 90) and the USA (50 90) to Thailand (70 150
tonnes).
Japan is a complete outlier within Asia; it has shown selling of coins and bars in seven out of the
past 10 years. Given record-high debt-to-GDP levels and a very aggressive monetary policy by
the Bank of Japan one wonders why Japanese would not want to own gold.
Consumers in most regions except Asia seem to have woken up only during the Great
Financial Crisis of 2008/9 when the global financial system came very close to collapsing and
many banks required taxpayer bailouts.
On the surface, the financial system has been stabilized, but consumer demand for gold has
remained strong. Once trust in banks and monetary system has been tainted it is hard to gain
back.

Gold Bug Galore - April 2017 Page 5

 Lighthouse Investment Management

Consumer Demand: Total

By adding demand for jewelry and coins / bars together we obtain total global consumer
demand
Not surprisingly Asia dominates here, too
CONCLUSION: earnings estimates are pretty much useless.

Gold Bug Galore - April 2017 Page 6

 Lighthouse Investment Management

Global Gold Demand by Volume

Other important buyers of gold include industrial (75% electronics), Exchange Traded Funds
(ETF) and Central Banks.
Central Banks had been substantial sellers of gold at very low prices, most famously the Bank of
England4. But in 2009 they stopped selling and turned buyers, adding fuel to the fire of a rapidly
rising gold price (Central Bank behavior in the gold market will be subject of a future report).
SPDR Gold Shares ETF (ticker GLD), at one point the worlds second largest ETF by assets, was
a child of desperation. In 2002, gold mining companies considered withdrawing funding from
the World Gold Council, a marketing organization whose objective was to promote private
ownership of gold. Gold prices had been falling for two decades. In a last attempt, the Chairman
of the World Gold Council helped launch a gold ETF in November 2004. The idea was to make it
as easy as possible for private investors to buy and sell gold, just like they did with shares. The
ETF attracted $1bn in assets within the first week and ballooned to $77.5bn in August of 2011.
Ironically, gold ETFs can lead to a reduction in demand for physical gold as investors purchase
paper claims rather than the actual metal.

4
From 1999 to 2002 the BoE sold 395 tonnes of gold for an average price of $275 per ounce

Gold Bug Galore - April 2017 Page 7

 Lighthouse Investment Management

Global Gold Supply by Volume

Recycling recovers 1,100 1,700 tonnes of gold per year; compared to 3,000 tonnes mined this
is quite substantial. Of course recycling has been helped by the rise in gold price, as it makes
extraction from used electronics more attractive.
ETFs have been sellers of gold particularly in 2013 (916 tonnes). Selling stopped during the first
three quarters of 2016, but resumed in the fourth (193 tonnes). ETF selling exacerbates any
price pressure in the underlying gold market. It can be considered hot money that can leave as
quickly as it came (due to easy of transaction). Bars, coins and jewelry are very sticky types of
investment, as they are usually never sold but rather passed on from one generation to the
next.
Look at how slowly mining supply reacted to the rise in the gold price; from 2004 to 2011 gold
prices rose by 370% while mine supply initially fell for a couple of quarters and then rose by only
21%. This has to do with the long-term nature of gold mining (prospecting, verifying, getting
permits takes years). Furthermore, gold mining companies had sold a lot of production yet to be
mined at fixed prices in the futures markets (hedging; usually makes sense to lock in profits and
to benefit from higher prices). As gold prices rose sharply, mining companies tried to close out
those hedges by buying back their forward sales, reducing the amount of gold available to the
market.

Gold Bug Galore - April 2017 Page 8

 Lighthouse Investment Management

Global Gold Demand by Value

The previous two pages showed demand and supply on a volume (tonnes) basis. But since the
gold price more than quadrupled from 2004 to 2011, both demand and supply increased much
more when looking at them on a value (volume multiplied by price) basis.
Normally, rising prices, at some point, lead to a reduction in demand (substitution, buyer
fatigue, more owners motivated to sell). But with gold this does not seem to be the case. On the
contrary the higher the price, the higher the demand. Apart from dowry for Indian weddings
and a bit of industrial demand there is no reason why buyers needed to purchase gold from the
standpoint of utility.
The rise in gold prices is even more surprising given that it happened in a period of low inflation.
And the rise began far ahead of the Great Financial Crisis in 2008/9, hence long before Central
Banks let loose in terms of monetary policy. Negative interest rates (making gold with 0%
interest a better investment relatively speaking) have only been introduced in recent years.
Valuing gold is not easy (it has no dividend, no earnings). We will look at ways to determine fair
value in a future report.

Gold Bug Galore - April 2017 Page 9

 Lighthouse Investment Management

Global Gold Supply by Value

Gold supply by value (volume x price) rose mostly because of rising prices.
As seen on previous pages, neither gold demand nor supply (in volume terms) seem to be sensitive
to price.
Central Banks are political and hence not price sensitive (they sold gold at low prices and started
buying at higher prices)
Gold supply from mining can only react to price changes after a couple of years.
However, most of gold ever mined (estimated 150,000 185,000 tonnes) still exists and is therefore
available as potential supply. Even subtracting Central Banks holdings of around 31,000 tonnes
leaves a lot of potential supply. But it does not seem to come to market.

CONCLUSION:

Goods where demand and supply are price-inelastic usually experience large swings in prices (as seen
with crude oil). For many years gold prices had been held back by selling from Central Banks. This cap
on prices is now gone (which also brings price volatility). Mining supply is slow to react, recycling limited
to what has been used in electronics. Demand from Asia should remain strong. Europe and the Americas
could see spikes in demand in case of another financial crisis. Japan, with its large amount of private
savings, remains a wild card.

Gold Bug Galore - April 2017 Page 10

 Lighthouse Investment Management

Any questions or feedback welcome.

[email protected]

Disclaimer: It should be self-evident this is for informational and educational purposes only and shall not be
taken as investment advice. Nothing posted here shall constitute a solicitation, recommendation or
endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that
accounts managed by Lighthouse Investment Management or the author may have financial interests in any
instruments mentioned in these posts. We may buy or sell at any time, might not disclose those actions and
we might not necessarily disclose updated information should we discover a fault with our analysis. The
author has no obligation to update any information posted here. We reserve the right to make investment
decisions inconsistent with the views expressed here. We can't make any representations or warranties as to
the accuracy, completeness or timeliness of the information posted. All liability for errors, omissions,
misinterpretation or misuse of any information posted is excluded.
+++++++++++++++++++++++++++++++++++++++
All clients have their own individual accounts held at an independent, well-known brokerage company (US)
or bank (Europe). This institution executes trades, sends confirms and statements. Lighthouse Investment
Management does not take custody of any client assets.

Gold Bug Galore - April 2017 Page 11