April 15, 2015
Having written for several years about precious metals, the massive threat to our financial security (from our own financial institutions), and why gold and silver represent our best protection from that threat; it’s easy to forget that there are readers who are new to this sector. For those readers; it is necessary to review the fundamentals of supply and demand.
However, even regular readers and knowledgeable investors in this sector could likely benefit from such a review, although for entirely different reasons. After nearly four, solid years of extreme, unremitting downward manipulation of prices for gold and silver; it is easy for such readers/investors to forget (or simply lose confidence in the fact) that the dramatic, upward revision of gold and silver prices is both a necessary and imminent event.
Why is such a discussion necessary for newer readers? Because explaining to these readers how gold and silver are our financial shields against the systemic financial crimes directed against us is less-than-effective if those same readers don’t also know why precious metals currently fulfill such a function (and have always done so). It all starts with supply and demand.
For new readers previously only exposed to the pseudo-analysis of the mainstream media; supply/demand analysis will be totally alien. They are used to an exclusive diet of price analysis from the drones of the Corporate media. In the real world, however, that price analysis is utterly devoid of any validity or significance whatsoever, while only supply/demand analysis yields objective and unequivocal conclusions.
It is beyond the scope of this commentary to explain to new readers why price analysis is absolutely flawed, and thus totally devoid of all legitimacy. That is a separate subject on its own, and readers seeking understanding on this point will have to refer to a previous commentary specifically on that topic. This piece will explain why supply/demand analysis is irrefutable, at least with respect to the markets for all hard assets.
The Law of Supply and Demand is best illustrated by applying this conceptual framework to a specific (hypothetical) example, in this case the market for chocolate bars. As with any market, and any industry engaged in manufacturing; there are basic fundamentals which apply to the production of all goods.
The goods producer requires “inputs”, generally broken down into three categories: infrastructure, raw materials, and labour. These inputs all represent necessary and unavoidable costs, thus to produce a chocolate bar (or any other good) requires that purchasers meet (or exceed) a minimum price for that good. That minimum price must not only cover the full cost of production, but also generate at least some modest level of profit.
Why is “profit” necessary (in our capitalist economies)? Because that profit attracts the capital which is necessary to fund the reinvestment which is required to sustain any industry. Equipment wears out, over time, and must be replaced. Improvements in technology (intended to increase efficiency) require further investments – generally substantial ones.
In the case of non-renewable resources like gold and silver; massive reinvestment (of profits) is required to find new bodies of ore to mine, to replace the ore-bodies (and mines) which have been depleted through previous operations. Any long-term price for these metals which is below the full cost of production (plus necessary margin of profit) is not sustainable, and thus below the “minimum price”.
What happens when any good is priced below that minimum price? To answer that question; we merely refer back to our hypothetical example. Suppose that (one way or another) the “global price” for chocolate bars was manipulated down to 10 cents apiece, the normal price for a chocolate bar roughly 40 years ago.
The Law of Supply and Demand tells us exactly what would happen. With chocolate bars priced at this tremendous discount; there would be an explosion in demand, as buyers could obtain ten chocolate bars with the same dollar which used to only have sufficient purchasing-power to buy one. Meanwhile, as demand for chocolate bars exploded; the supply of chocolate bars would collapse. Today, no company could come close to covering their production costs at such an enormous discount (let alone make the necessary profit), and chocolate bar manufacturers would be forced to suspend production.
Very quickly; all of the store shelves (i.e. the global inventory) would be cleaned-out of all chocolate bars. That would leave only the remaining stockpile of chocolate bars — i.e. those chocolate bars still owned by various entities, but not yet eaten. The first and most obvious point is that none of these chocolate bar-holders would be willing to sell from their own stockpile at the heavily-discounted price of 10 cents apiece.
Irrespective of any previous price-manipulation; the real-world price for chocolate bars would rise (and rise dramatically), to whatever price was necessary to get a holder to part with a good which was currently not available for sale, and thus could not be replaced once sold. That (real-world) price for chocolate bars would continue to rise until…?
The price would rise until it was high enough to justify producers returning to this industry, and resuming production. Equally important; this “new price” for chocolate bars would not only have to be equal to the “old price” (the original, minimum price), it would have to be higher than that – at least over some shorter term.
There are two reasons for this. First of all; there would be a certain amount of lag-time between the time that the price of chocolate bars reached its (new) “minimum price” and actual, new production could reach store shelves. In the interim; anyone wanting to buy a chocolate bar would have to pay a significantly higher price than the Old (minimum) Price.
The second reason why the New (minimum) Price would have to be higher is risk and loss. Having already been driven out of business once; the producers returning to this market would only resume production once the New Price for chocolate bars had significantly exceeded the Old Price, to compensate for past losses and future risk.
To begin with; these returning businesses would have suffered financial losses from being previously forced to suspend production, and would seek to recover those losses through a higher New Price, their new “minimum price”. The New Price would also have to be higher to compensate these producers for perceived risk: the risk of being driven out of business againthrough price-manipulation (“once burned, twice shy”).
The important point to make here to newer readers is that this hypothetical example involving chocolate bars mirrors the fundamentals (and price-manipulation) currently taking place in the precious metals sector, in the real world. The prices for gold and silver have been manipulated below their minimum price. Producers have been driven out of business.
Demand does (greatly) exceed supply. The complete collapse of inventories of gold and silver is imminent. Thus a dramatic,upward revision of gold and silver prices is inevitable, and that new minimum price for gold and silver will be higher than the old minimum price. Naturally, the question on the minds of readers (old and new, alike) is “how high”?
Complicating the answer to this question, tremendously, is the medium of exchange which we still use (temporarily) to price all of our goods: the debauched and fraudulent paper currencies of the Western world. How rapidly is this debauched paper losing even its perceived value? A decade ago; the world’s largest gold miners were generating large profit-margins with the price of gold at $500/oz (USD). Today, even the Corporate media acknowledges that:
“$1,300 is not a sustainable gold price.”
Pricing gold at even $1,300/oz (USD) more than 2 ½ times the price of a mere decade ago is now below the “minimum price”, which is why these same gold miners are now suffering ugly losses on their bottom-line, with the price of gold bobbing above/below $1,200 (USD).
With the price of gold below its minimum price, ipso facto the price of gold must rise, to whatever new minimum price is necessary to restore supply/demand equilibrium. This is with respect to the long-term minimum price. As previously explained; over the shorter term, the price must go even higher than that long-term minimum price. That is the Law of Supply and Demand, and it is immutable.
The Law of Supply and Demand dictates that the price of gold must rise to a price somewhere above $1,300/oz (USD), and to an even higher price than that over the shorter term. So; why have “experts” like Nouriel Roubini and Dennis Gartman, and (supposedly) prestigious financial institutions like Goldman Sachs asserted that the price of gold was going to $1,000/oz, “expert opinions” which have been echoed hundreds of times by the drones of the Corporate media in their Chicken Little reporting?
Logically, there are only two possibilities. Either none of these so-called experts is familiar with the Law of Supply and Demand (and one of them was awarded a Nobel Prize in economics), or; they were/are lying to us when they insisted the price of gold should fall far below its minimum price.
Based upon supply/demand fundamentals for precious metals, and the accelerating collapse in value in the West’s dying currencies (most-notably the U.S. dollar); what is a reasonable, new “minimum price” for gold and silver? The answer to that more-challenging question will be the subject for Part II.
Courtesy: Sprott Money News
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