Lear Capital: The Gold Pushmi-Pullyu

2010_01_05_17_53_260001(Los Angeles, CA – (Lear Capital, David M. Engstrom)  Today is an historic day.  Today I broke my personal record for consecutive days lived.  And, it was on this day that the Gold Pushmi-Pullyu worked hard to drive the gold price lower than its all-in cost of production.  The Pushmi-Pullyu is a fictitious animal character of Dr. Dolittle lore that has two heads.  A Gazelle at one end and a Unicorn on the other.  The derivation of its name is obvious.

The Gold Pushmi-Pullyu is also a fictitious animal – a fake if you will.  It was created by Gold traders who pretend to be buying and selling physical gold.  The truth be known however, these traders really buy and sell nothing but pieces of paper.  Some call them bets.  Others call them futures contracts.  In either case, it is a rare occasion when an actual piece of physical gold ever changes hands.  In fact, in some cases, traders sell gold they don’t even own.

These traders always seem to be at odds with those who actually buy and sell the physical gold.  But, because the paper traders can deal in quantities far greater than what actually exists, it is they who tend to initiate moves in the gold price to phony levels  Levels that are, more often than not, at odds with the physical market.

Of late, the Gold Pushmis have worked hard to push the price down while the Pullyus have worked to pull it back up.  In recent weeks, the gold price has been pushed down so far that it has reached levels well below the average all-in cost of production. That’s when physical demand soared and the price was pulled back out of the hole.

In the end, physical demand will win the day.  It is physical demand that has the real power to fix a fair market value and drive the gold price much higher.  When a mine can buy gold for less than it costs to produce, the motivation to produce more — vanishes.  Mines will halt production until they can profit from what they produce and then resume production only at a time when the market screams for supply by raising the bid.

Generally, the gold price has traded at a price double its cash cost of production.  See the chart.  Cash cost is the lowest measure of production costs.  Also referred to are the marginal costs and all-in costs.  By these standards, the gold price today could easily be trading near $1800 an ounce.  That means any disruption in supply, such as would occur if mines stop producing, could pull the gold price back up as easily as it was pushed down.

Those who challenge the need for physical gold at all, calling it a relic of an investment, do so in the face of skyrocketing physical demand by the world’s central banks.  China, Russia, India and Brazil are all buying physical gold.  Who are we simple and small investors to challenge the wisdom of those who control the world’s supply of money?

Don’t sell gold short.  This reverse tug of war could rage for a time and then the truth be told.  But as always, this is just my opinion.  If you agree with it you may consider following me @DaveTheGoldDr.  If you don’t agree with it, go buy some bonds or something.

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