> Annual production and demand are not relevant when it comes to
> determining the long term price of gold. At best, they are only short
> term influence. The reason is because of a very large above ground
> inventory that is at least 40 times larger than annual
> production/demand numbers. The past decade saw a steady
> annual deficit which was covered by gold dumped on the market by
> various sources holding inventory including mostly central banks
> and bullion banks playing the "gold carry trade".
The price of gold is the intersection of supply and demand curves. Gold has
two demands -- demand for consumption and demand for investment (inventory
building/bullion stockpiling). The non-investment demand (a.k.a non-monetary
demand) is determined by the marginal revenue product of gold in industry.
This will be like any other industrial input, subject to dimising returns
the more it is used, and thus its demand curve will be downward sloping. The
supply of gold is made up of mining and recycling supplies, and the supply
function is similar to that of other competitive industries (i.e. number of
firms is that which minimises average cost, price equals margin costs,
supply is an increasing function of price etc.).
The price of gold can therefore be modelled as a traditional supply/demand
curve graph. The price can be read from the graph by finding the price where
the surplus (supply less non-monetary demand) equals the gold accumulation.
In the case of a sharp accumulation the price of gold would rise, reducing
non-monetary demand and increasing supply, in the case of a reduction in
accumulated stocks the price of gold would fall, increasing non-monetary
consumption and reducing supply.
In the long term the price of gold is tedetmined by the marginal cost of
extraction and the marginal revenue product in industry, in the short term
it is influenced by inventory accumulation or reductions.
David Hillary
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