In the 110 years since 1900 the world's annual gold production has risen rather steadily from 386 tons to 2,500 tons, a compound annual growth rate of only 1.7% a year. That's about half the long-term real growth of the US economy. Rising output has been facilitated by new discoveries, but even more so by technological advances in machinery, mine design and especially in the late-1980s by rapid adoption of "heap leaching" as the preferred method of separating the precious metal from its ore. This has made economically feasible the working of lower quality ore deposits.
Mine output shrank during both world wars of the 20th century as these enormous conflicts drew manpower and resources away from precious metals mining. A third decline occurred in the 5 years following the cessation of gold convertibility with the US Dollar, when central banks dumped tons of gold on the market. And finally, mine production peaked in 2002 and has not regained that level since, despite the increase in the market price.
A long period of price weakness for gold was 1980-2000 (see gold price chart on page 7), during which the average annual price fell from about $650/oz. to $279.
During these 2 decades, global mine production soared from 39 million ounces to more than 82 million ounces a year! Double the production and the price falls 50%!
Just supply and demand at work.
The uptick in production in 2009-10 (see chart) was partly a response to the surging gold price (it became profitable to mine lower quality ores), and partly it reflected increased production of polymetalic gold (e.g. gold that is produced as a by-product of copper mining). But for most of the past decade, despite rising gold prices annual global gold mine output was actually shrinking. At the same time demand was rising because of both prosperity in the emerging economies and growing currency concerns in Europe, Japan and the US. We'll get to that in a moment.
On balance, we believe that physical gold production will grow grudgingly if at all over the coming decade, unless rich, new deposits are discovered. There haven't been any in recent decades, but hope springs eternal!
Central Bank Sales
That leaves two other supply sources: gold sales by central banks and the melting of jewelry. We have not found any convincing data about the conversion of jewelry to investment gold, but suspect it is a very minor issue in the overall picture. But Central Bank (CB) reserves policies have sometimes played a big role.
As you can see (with a magnifying glass, perhaps) in the charts below, gold bullion makes up only about 10% of CB reserves,way down from the 60% area in 1980. Even if CBs continue to be net sellers, their potential impact on supply has been marginalized. As a matter of fact, selling virtually dried up in 2010, down 96% from the prior year. It seems that these banks had been giving their balance sheets a boost by selling non-yielding gold holdings in favor of interest-bearing overnment bonds. But now, especially with their remaining gold rising in value, they tend to favor the security of gold over sovereign debt. A recent survey of many European central banks indicates they have no intention to sell. Finally, the Central Banks of China, India and Russia have become net buyers, of gold!
The cessation of Central Bank selling is effectively a 20% reduction in the annual supply of investment gold compared with the previous decade. It seems unlikely to us that even aggressive mine expansion could replace this lost source of supply. With the gold supply outlook flattish, the price behavior is going to depend on the demand factors. Let's take a look.