Has the gold market bottomed in 2013?

Several little-know macroeconomic factors are changing the global supply and demand of gold. Read on to find out what they are.

-Posted by Alejandro Guillú Mendoza

Introduction

This article tries to explain in a simple way to readers without a college degree in economics or finance some macroeconomic factors that are currently changing the global supply and demand of gold. They’re not often talked about, but they are very important to understanding the precious metals market!

Ground rules

Gold coins ARE NOT INVESTMENTS. Gold coins are still minted by countries to satisfy the unlimited demand for numismatists around the world. When you acquire a gold coin you are not only paying for the precious metal itself but also for the graphic design and for the minting.

Countries make billions of dollars each year buying gold by the ton and reselling it as coins.

There is nothing wrong with collecting coins if you ARE ALREADY A MILLIONAIRE. If you are not, then you need to sell your coin collection right now to the highest bidders.

The problem with gold coins is that you need to pay for insurance each year, and that cost eats some of your profits.

If you want to invest in gold then you need to buy either a gold mine or the ETFs IAU or GLD.

There are other financial instruments for more sophisticated investors that I am not going to cover in this article. If you want me to write about them then drop me a line.

Mexico is now a bullion superpower with a little help from Carlos Slim Helú

Only ten countries in the world produce more gold than Mexico. However, the annual gold production has grown at double-digit rates in 2005, 2006, 2008, 2010 and 2011.

Unlike other countries, in Mexico you don’t own the gold in your own land. If you find gold in your backyard then the government takes it. There is no such thing as a Mexican prospector.

There is no point in using modern technology to search for gold mines in Mexico and buy the land to make literally a ton of cash. As you can imagine, there is little demand for a geologist in Mexico because you cannot monetize the natural resources.

After over 300 years of gold mining, the United States of America, Peru and Canada remain the third, sixth and seventh largest gold producers in the world. Mexico is very similar to those countries from a geological point of view but nobody has mined that gold yet. In other words, there are mountains of gold in Mexico.

The supply of gold in the continent of America is too vast and unlimited if you consider the current global demand. We have enough gold to pay the entire debt of every country in the continent of America to the rest of the world.

Each year we find faster and cheaper ways to extract gold. Innovation also applies to the extraction of gold. One very important factor that you need to consider is that gold is usually found in very remote locations very far from civilization. Gold mines invest a lot of money in diesel to transport the precious metal to the nearest DHL, UPS or Federal Express location.

Electric cars will only increase the profits of gold mines in the coming years.

After the 1994 economic crisis in Mexico, experts were hired to avoid another economic crisis in the future, and one of the suggestions was to allow billionaires and foreign, publicly-traded mining companies to extract the gold and save it for a rainy day.

Fresnillo (London: FRES) is now a FTSE 100 company and the 30th-largest diversified metals and mining company in the world, according to Forbes. Annual profits are over $700 million. It is not a bad idea to set up a limit order to buy this company at $1,000 in case the price drops from current levels due to a panic sell-off.

Mexico currently holds over 125 tonnes of gold, and they will keep buying gold from Fresnillo and other mining companies currently operating in Mexico until the gold reserves are over 365 tonnes, which is what Venezuela currently holds.

Mexico is one of the richest countries in the world, and with over $170 billion in foreign exchange reserves, they certainly can afford to buy more gold. This “I will buy any amount of gold that you can extract” will attract a lot more gold mining companies. They don’t even have to invest any capital. Mexico will lend them any cash they may need to install the mine, and they can pay for the loan in gold.

You cannot even pay for your MasterCard at Bank of America with a gold coin, let alone a billion-dollar syndicated loan if you are a mining company. Unless Russia, South Africa, Peru, Canada, Indonesia, Uzbekistan and Ghana start a Golden Arches Bank where foreign publicly-traded mining companies like BHP Billiton (BHP) and Freeport-McMoRan (FCX) can apply for a billion-dollar loan to build new gold mines, everybody will just move to Mexico.

What is a Gold Mart?

India likes gold jewelry a lot. In fact, they buy more gold jewelry that anybody else with the exception of China.

One smart way for China, Australia, the United States of America, Russia, South Africa, Peru, Canada, Indonesia, Uzbekistan, Ghana and Mexico to increase exports of gold jewelry is to simply lend money to young entrepreneurs in Pakistan, Nepal, Buthan, Burma, Bangladesh, Sri Lanka and the Maldives to open a Gold Mart franchise.

The fictional Gold Mart franchises will be strategically located in cities near the border with India to encourage small business owners to buy gold jewelry and sell it to consumers in India.

Each Gold Mart will include a large selection of jewelry from small companies that just don’t have the infrastructure to export small quantities of gold jewelry to India. Each country will handle the logistics to ship their products near the largest market for gold jewelry. This will create a lot of jobs in the gold jewelry industry and a lot of tax revenue.

Obviously, I am not a consultant for any of the countries previously mentioned, but I am sure they hired people way smarter than me to help them keep the demand for gold high and they will come up with a lot more clever solutions to export more gold jewelry to India.

I am just a regular guy. Countries have entire armies of consultants just thinking how to solve their problems all day long.

Conclusion

India cannot force their people to stop wearing gold jewelry, but they can systematically sell their gold reserves every time the price of gold goes up more than usual until their reserves are depleted.

Gold stored in vaults does not produce any cash (unless of course, you lend the gold)

You can also lend shares in gold mines. Perhaps it is time for India to invest in the Ghana Stock Exchange, the Uzbekistan Stock Exchange and the Indonesia Stock Exchange. Just a thought.

As always, be prepared for volatility in the gold market, no matter what you do, and never allocate more than 30% of your portfolio to precious metals. Remember, gold is a hedge against a currency collapse, and no one can guarantee there will actually be a currency collapse. Preserving your capital should always trump the desire to make large profits!

Photo by TheRivo