I owe thanks to the folks who commented on my previous article (The Disconnect Between Supply and Demand in Gold and Silver Markets), and gave me a lot of new ideas to research.  The input has stimulated more precise calculations.  I am compelled to write a follow up on the issues previously presented.

According to the Wall Street Journal, “the latest bank failure came Friday, when Kansas regulators closed Columbian Bank & Trust Co., of Topeka, Kan. About $46 million of the bank's $622 million in deposits may have exceeded insurance limits...”  In the same article, the Journal notes that a June Gallup poll found that only 32% of Americans say they have a "great deal" or "quite a lot" of confidence in U.S. banks, down from 41% in June 2007 and 49% in June 2006. According to a Gallup poll, taken in July 2008, only 14% of Americans approve of the way Congress is doing its job. 

A Bloomberg poll finds that only 25% approve of President Bush.  When national institutions fail, whether from incompetence or corruption, people seek ways to protect themselves.  In the world of money, the only real escape from government control is provided by the precious monetary metals, gold and silver.  That is why people are buying them, in the real market.

No less of a luminary than former Chief Economist of the IMF, Kenneth Rogoff, has predicted that one or more of the biggest US based banks will fail within a few months! The Europeans are also talking about big bank failures, in Euro-land or Switzerland. The situation in Europe might actually be worse.  They don’t have FDIC insurance, and individual nations are too small to bail out the depositors of the biggest banks. For example, the size of UBS (UBS) dwarves the total gross national product of Switzerland, although, ostensibly, it is a Swiss bank regulated by the Swiss authorities. There are many other Europe-wide companies, but no real central government. They wouldn’t know exactly what to do if and when a big worldwide bank, like UBS, actually failed. 

The impending insolvency of Fannie Mae (FNM) and Freddie Mac (FRE), so-called government sponsored enterprises (GSEs) adds to the problem . Some $6 trillion worth of GSE debts are about to be added to the U.S. government’s existing $5 trillion existing debt disaster. This is, by no means, a surprise, as wise folks with a basic grasp of economics saw the end of these two entities as far back as 2001.  Warren Buffett, for example, sold Berkshire Hathaway’s (BRK.A) interest in Fannie and Freddie in 2001. A number of short sellers have been shorting these stocks for many years. 

How, then, were our big shot luminaries in government, like Secretary of the Treasury Paulson, Ben Bernanke, Alan Greenspan, and so many others, taken by surprise? The fact that so many investors hung on until the bitter end of the two GSEs is an example of the type of tunnel vision that is now, similarly, but in an opposite fashion, afflicting the gold and silver markets.

Anyone with foresight can see that both precious metals will soar very shortly. The number of people, however, who can block out the useless market “chatter” speaking falsehoods and fantasy are very few, indeed.  To sell the precious metals now is senseless, yet even some of the cleverest investors appear to have allowed themselves to become temporarily shell shocked by the actions of a small number of adroit manipulators.

Can we identify the identity of the manipulators? Probably we can, after a full investigation, with the full resources of a large banking institution which might have been burned by them, or with the help of the CFTC and/or the FBI.  But, if and when we do, identify the culprits, I suspect they will be connected at the highest levels.  So, it is unlikely that any help will come from the government.  The banks and hedge funds which were burned in early August, and so many times before, will need to lead the charge.

Bank failures, outsized government debts, and an astonishing level of consumer debt that is likely to be settled only with deeply devalued dollars, are not the only problems facing America.  In the absence of repeat money-giveaways, like the ineffective Congressional “stimulus plan” from April/May 2008, retail sales will collapse, except at the cheapest discount stores, like Wal-Mart (WMT) and Costco (COST). 

Unemployment is rising. Net income is falling. Jobs are still being exported to China, India, Mexico and other parts of the second and third world.  It is harder than ever for Americans to find and keep good jobs. American wages have been eaten up by massive dollar depreciation, but this allowed manufacturing to enjoy a small respite. That was the only bright spot in the economy, and it will end quickly, if the dollar is able to maintain its current high valuation in relation to other currencies. 

Meanwhile, our government continues to lose credibility by issuing fake statistics.  The most glaringly outrageous of these government statistical lies is the “new and improved” consumer price index [CPI].  Ben Bernanke, of America’s Federal Reserve, likes to say that current official inflation figures, at about 5.3%, are low and show that America is not returning to the stagflation era of 1970s.  Thou dost protest too much! 

Bernanke is a Ph.D. economist. He knows better. The government has been fudging the inflation figures since the Clinton Administration decided that it was politically impossible to materially change the system. The game has been continued under the Bush Administration, which tends to show that the two political parties are really not much different after all.

The current dismal economic situation is not the creation of one party or one president.  Many years of combined mismanagement, across party lines, perpetrated by a series of bipartisan scoundrels and scalawags, are the cause. It is necessary to lie about inflation, because it is too expensive for the nation to pay the elderly adequate increases in their Social Security cost of living allowances.  Instead of changing the system, responsibly, the scoundrels invented a faked up CPI, complete with a process of so-called “geometric weighting.”  

What the heck is geometric weighting?  It is the process of calculating lower inflation than really exists, by means of playing with numbers.  For example, the government uses so-called “hedonic” adjustment.  Hedonic damages is a relative concept, promoted at one time by trial lawyers to inflate the value of personal injury cases.  It was soundly rejected as junk science by most American courts.  But, that didn’t stop our government. 

Hedonics say that a new computer is worth more, and, therefore, should be considered “cheaper” than an older model.  This is because the computer chips are usually faster and memory is bigger.  So, if you bought a computer for $500 in 2005, and, then, 3 years later, you buy another one, to replace the first, and also pay $500 in 2008, the government says that you paid only $300 for the second computer, or something like that. Truth doesn’t figure into it.

It doesn’t really matter anymore, in our 1984-ish double-speak world of 21st century America.  The practice of creating fraudulent consumer price index numbers, however, goes well beyond hedonics.  The CPI geometrics also assume ridiculous things like, if the price of filet mignon rises, people will substitute hamburger for fillet mignon.  Instead of increasing the cost of a fixed basket of goods by the increased cost of the filet mignon, they simply remove the price of filet mignon, if it goes up in price a lot, and replace it with the price of hamburger meat.  Then, they justify themselves, by saying that this is correct economics, because the price of filet mignon meat has gone up too much, and people will start eating hamburger instead.  What do you think?  Is it fair?  Or, is it fraud?

John Williams is a good economist who is always very busy each month, recompiling the true CPI on a fixed basket of goods.  This is the same way CPI was compiled back in 1980, before the double-speak world began.  After you do the rather simple math, you’ll find out that the current inflation is NOT anywhere near what Ben Bernanke wants you to believe.  Inflation is already running at double digit levels, very close to the highest levels ever seen back in so-called “stagflation” days of the 1970s.  See, www.shadowstats.com.  Yet, we are only in the first innings of the current economic catastrophe. 

Instead of raising interest rates, as they should, and as Paul Volcker did, back in the 1980’s, the majority of the current Federal Reserve has voted to repeatedly lower them.  There is every likelihood that they will go lower still.  Bill Gross, CEO of the trillion dollar bond investment corporation, Pimco Investments, has agreed that the government’s inflation rate understates the true level of inflation.  Others agree also. 

What will this decade be called, in the history books?  The era of “Hyperinflation-Recession” or the “Age of Financial Fantasy”?  Either way, it will not be remembered fondly.  But, enough of this doomsday talk!  It just depresses me, and I don’t like being depressed.  We now have enough understanding to move on to other things. 

Let’s be stoic.  The handwriting is on the wall.  There’s nothing we can say or do to stop a natural course of events from following to its natural conclusion.  It is simply too late.  Even if honest leadership took over at the Fed, the U.S. Treasury, and on Wall Street (and there is no prospect of that happening any time soon), there is nothing that any of them could do, in the short term.  Sure, it would be nice to have some decent people, for a change, running things, but our society is beset by long term problems that have no short term solution.  We will have either a severe recession or an outright depression, and there’s nothing we can do about it. 

Ben Bernanke says it will keep the inflation rate from rising.  Hurrah!  However, common sense tells us that this particular recession will not break the back of inflation, but, rather, will be coupled with levels of real inflation that will be much higher than what we saw in the 1970s.  There is nothing we can do.  It’s a done-deal.  Too much damage has already been done to the financial system, by greedy, manipulative and downright stupid people.  Everything being done, now, is simply the equivalent of putting band aids on a sliced jugular vein.  The bleeding won’t stop.  The patient now needs surgery, not band aids.  If all they can do is add band aids, the patient will die.

Let’s talk about more practical matters – how to survive, and preserve our assets, for example.  The collapse of our current system of crony “capitalism” has been as steady as it has been inevitable, and this has translated itself into large price increases, over many years, in gold and silver market.  Is this trend going to stop?  Not likely.  People have lost faith, for one thing.  For another, there are simply more people.  There is more paper money.  There are more ways to split a very limited supply of commodities, including gold and silver. 

Americans no longer trust their institutions.  The seeds of what is happening, were planted many years ago.  It’s just that the crop has been slow to come to harvest. It takes many years of crony capitalism to destroy a system that was built by millions of hard working, honest Americans. Ours was once the greatest economy in the world.  Not anymore. Economists like to call our predicament a “credit crisis.” In reality, however, it is simply that a lot of irresponsible people, in leadership positions, decided to dump a lot of manure on the ever fertile fields of fraud. A crop of nepotism, corruption and outright thievery, among the ruling elite, has grown at an alarming rate, and we are now forced to harvest the result.

It is much more than merely a “credit crisis”. It is a crisis of lying, cheating and stealing from each other, and the result is that the big shots don’t trust each other anymore.  Why should they?  Incompetence, corruption and greed is now rewarded.  CEOs run their companies into the ground, take outsized salaries, approved by crony Boards of Directors, and rob their shareholders of a significant portion of the profits that are rightfully theirs. Yet they are later rewarded with rich bonuses, and golden parachutes. Nothing is as it should be.

Americans have lost confidence in banks, politicians, and insurance companies. They’ve lost respect for Congress, the President, and the Ben Bernankes of the world. Not surprisingly, none of these people and institutions have confidence in each other, either.  Banks, for example, don’t want to make overnight loans to other banks.  They know almost everyone in the banking business is lying, to one extent or another, about their real financial condition.  So, they can’t trust each other, and you cannot trust them.  It is a reflection and a sign of the times.

First, I want to make something perfectly clear.  In this discussion, when I say “markets”, I am not talking about COMEX fantasy futures “markets”, or their alleged “spot” market in New York.  In my most recent Seeking Alpha article, I put forward the thesis that such “markets” are not real, and I don’t want to repeat myself. When I speak of markets, I’m referring to places where real sales, of real physical items take place. These real markets occur in physical stores, and, to some extent, over the internet, to real people, who take real delivery.  Holders of COMEX fantasy futures may be selling out.  But, real people are buying.  In the real market, there is an explosion in demand.  Let’s talk facts and figures. 

The biggest news is that the U.S. Mint has suspended gold coin production.  It previously started rationing, but never actually suspended silver coin printing, two months ago.  Indeed, even with rationing, silver American eagle production has exceeded 1.2 million ounces per month, in the succeeding months, according the Mint’s website.  We can only imagine what how many ounces of silver would be purchased, if people could buy as many of them as they want. 

According to the ever bearish commentator, Jon Nadler, of Kitco, the U.S. Mint merely has a shortage of blank coin “rounds.” I don’t want to get sidetracked into a long winded discussion of Jon Nadler.  Let’s forget about Kitco.  Let’s just forget that it is taking people’s money, while refusing to guarantee a delivery date.  If you cancel an order, even if it hasn’t delivered for 10 years, it will impose a penalty.  What is the probability that a serious gold and silver dealer could stay in business doing that? It does clearly post the egregious policy in red ink, on the face of its website.  So, be warned!  Don’t send Kitco any money!  You may never see the product you ordered, and, if you do, it could be 20 years from now.  Don’t like it?  Too bad! It’ll just take your money.

Having satisfied ourselves by not ignoring the issue of Kitco and Jon Nadler, completely, let’s go on to something else.  It is true that there is a shortage of gold rounds.  However, to say that the current situation could just be a “shortage of rounds” is baloney, and I’ll tell you why.  According to the Mint website, in the first two weeks of August, before the suspension of sales, the Mint sold 65,000 ounces worth of gold eagle bullion coins.  These were sold at per ounce rates far exceeding the COMEX fantasy price. 

Meanwhile, the COMEX fantasy price, supposedly, dropped into the $800s and even, temporarily, into high $700s, during that time period.  Now, a lot a market participants feel that they have the right to buy at that price, because that’s the “spot” price.  But, can they?  A lot of people are paying premiums above so called “spot”, in order to buy real gold and silver, in the real market, and that’s happening, not only in India, but also in America.

Before I go on, let me remind you we aren’t talking about pig iron, here.  We are talking about gold, one of the rarest metals on earth. The American gold eagle coin has represented a major percentage of total physical gold sold in the USA, each year.  But, it is not the only form in which gold is sold.  You can also buy gold bars, maple leafs, kruggerands, Chinese gold pandas, British Sovereigns, Australian Nuggets, and a host of other products.  According to the reports, you need to pay a significant premium, above “spot”, in order to get someone, in the real world, to sell any of these to you.

Let’s digress, for a moment, and review some numbers.  According to the U.S. Mint, in 2007, 198,500 ounces of gold were sold in the form of gold eagles.  That amounts to about 6.2 tons of gold for the entire year.  In contrast, in the first two weeks of August, the Mint had already sold 65,000 ounces worth of gold eagles.  That is an annual rate of 1,690,000 ounces of gold.  It works out to about 52.6 metric tons.  In other words, demand for gold, in the form of eagle coins, increased by a factor of about 8.5.  

During all of 2007, total demand in the US based physical gold investment market was only about 16.6 tons, according to the World Gold Council.  This year, if the pace set in the first two weeks of August continues, and the ratio of American Eagle sales to total sales stays about the same, real market investment gold sales, in America, will total 141.1 tons.  But, that assumes the increases will stop.  There is no likelihood that this will happen. 

The economy is getting worse.  Even Ben Bernanke admits that.  Economic fears continue to grow.  The trend of ever greater gold sales is firmly in place and will surely accelerate.  About 145,000 ounces of gold eagles would have been sold in August 2008, if sales had not been suspended.  This compares to a pace of 22,000 back in August 2007.  In all likelihood, sales will continue to climb, especially when and if a big bank fails.  In the end, logic and reason tells us that we will see American investment demand climbing well over 250 tons, compared to only 16.6 tons last year. 

As I mentioned earlier, Ben (Helicopter) Bernanke admitted on Friday, that the U.S. economy will continue its ongoing deterioration.  A lot of other luminaries in the world of central banking, gave speeches in agreement.  Ben expects commodity inflation to moderate, in spite of increasing demand from billions of newly money-empowered Chinese and Indians.  How can that happen?  Only if he expect a whopper of a recession, bordering on a depression.  That is very bad for stocks.  Yet, the stock market and currency markets, started cheering.  “Yipee!  We’re gonna’ have a depression! Isn’t that wonderful!  What good news!”

We live in the age of Fed/PPT, and the Masters of the Universe seem to think that they can manipulate any market with impunity, and, to some extent, at least in the short run, they are right.  The currency market, stock market and commodities market appear to be regularly subjected to intervention by government operatives.  It is secretive activity, but Treasury Secretary Hank Paulson likes to speak in his own code about it, and he does so quite openly.  You just need to read between the lines. 

He talks about “calming the markets.”  “We believe in an orderly market”, he said, on television.  How can the market be forced into becoming orderly?  He is talking about the fact that the government is now intervening in the financial markets, almost every day.  It happens, every morning, at the so-called “repo” loan desks and the secretive “dealer discount window.”  The NY Fed basically gives away what is ultimately taxpayer money or taxpayer funded treasury bills, often in exchange for questionable collateral. The money is given away in the form of extremely low-interest “loans” and the loans have become essentially gifts, because the gracious Fed, ever generous with taxpayer largess, endlessly renews them, when they come due, so that the big bank recipients rarely need to pay them back.  This is the same Federal Reserve whose “regulatory powers” will be enhanced under Paulson’s “reform” plan!

On Friday, the stock market and currency markets applauded Bernanke’s forecast of the probability of a severe economic downturn.  Yes, that is crazy, isn’t it?  Such news should lead rational people to conclude that yet more Fed interest rate cuts may happen, or, at the very least, rates will not be going up.

Has everyone lost their minds?  Or, is the movement of the market catalyzed by illicit government cash, given out freely, and rarely talked about openly?  Logic tells us that paradoxical market movements are the result of temporary interventions by well connected entities with access to the Federal trough.  We know, from its published balance sheets, that the Federal Reserve has given $450 billion in cash and treasury bills to banks, and, in exchange, received the same amount of mortgage secured bonds. The only trouble is that, while cash is still “good”, for the moment, subprime mortgage bonds, including the type traded to the Fed, are defaulting at a rate of 41.7% and climbing.

A lot of people pile onto the band wagon when they see a market rising or falling.  There are hedge funds known as “momentum trading” funds, for example, who buy, regardless of the fundamentals, just to follow the so-called “momentum” or trend of the market.  These funds represent tens of billions of dollars worth of investment cash, and end up multiplying the effect of a few billion dollars worth of government market intervention.  Then, longer term investors who see stocks going up, and don’t want to be left behind, often follow. 

The mutual fund managers, and private investors begin to buy into fake rallies, and the PPT players, and momentum hedge funds sell into the frenzy, leaving the mutual funds, and their conservative Mom & Pop investors, holding the bags.  People’s pockets can be picked, and the powers-that-be will tell you that America has a “free market system.”

You can’t fool all the people all the time.  In spite of double-speak, cash injections, and massive short term market manipulation, a lot of folks are still rational thinking beings.  If they stay logical, cool and collected, they see through the false market chatter, to the real facts.  So, the market eventually heads down when the fundamentals are terrible, as they are now.  Economic downturns mean lower interest rates.  Lower interest rates mean a lower dollar value, in the long term, in terms of other currencies.  If other nations lower their interest rates to keep pace with a falling dollar, then we are looking at huge amounts of paper, chasing after a limited amount of goods.  That equals massive inflation, no matter what Mr. Bernanke hopes for. 

If our coming recession, or depression – call it what you will – is severe enough to bring down commodity prices, it will need to be a whopper.  The U.S. dollar cannot stay up in value, on its own merits.  Other currencies must fall.  We will see bank failures all over the world, on an unprecedented scale, bigger than anything seen since the Great Depression.  The more bank failures, the less confidence people will have, and the more the world will be looking toward precious metals for confidence.  Is it any wonder that we’ve seen a massive unwinding of short positions in the gold and silver markets?

The huge demand increase, in the 3rd quarter of 2008, is not yet showing in the statistics published by the World Gold Council [WGC].  However, in Q2 2008, WGC reported that demand more than doubled in China from 4.3 to 9.8 tonnes, and in the US, demand rose from 1.2 tonnes to 11.3 tonnes.   For the USA, that is a 940% increase, year over year, which is consistent with the numbers in the first two weeks of August, 2008.  It also shows that rising demand is not confined to Americans.  The Chinese are also feeling stressed.  Meanwhile, the Euro and British pound, having steadily risen for 8 years, are coming under pressure. Economists are now saying that the UK and the Euro-zone are heading toward severe recession.  The dollar is rising because the euro and pound are falling.  What does that mean?

The relationship between gold (and silver) and the U.S. dollar is temporary.  Prices are NOT based solely upon the value of the dollar, regardless of what the pundits would have you believe.  In the stagflation era of the 1970s, for example, as has happened, during the last 8 years, gold rose as the dollar dropped, and the price of oil soared.  Everyone assumed an unbreakable tie between the dollar and oil, on the one hand, and gold on the other, just as the manipulators would have you believe now. 

The United States government began to sell gold.  Those sales were open and above-board, as compared to today’s secretive activity.  It was a more honest era.  Back then, the government didn’t lie as much.  Things that shocked the public, in those days, wouldn’t even cause an eye to blink, today.  Eventually, the dollar began to stabilize.  But, it was only when the dollar began to stabilize against other paper currencies, back in the late 1970s, that gold really started to take off.  It shot up to about $850 per ounce, $2,300 or so in today’s money, after inflation, in spite of a relatively stable dollar.  What really counted was not the value of the U.S. dollar in relation to other paper currencies.  What counted then, and what counts now is supply and demand for gold. 

The rise or fall of a paper currency can affect the ability of some people to pay the price, but so long as the overall demand remains strong enough to soak up all the gold and more, using all currencies at whatever exchange value they may have, the absolute price of gold will rise in terms of all currencies.  That is, in fact, what we have seen during the last 8 years.  Gold has more than tripled against the dollar, but it has also risen substantially against the Euro and the British pound, as well as the Chinese yuan, the Russian ruble, and almost all other paper currencies. 

Manipulators can only control precious metals prices, temporarily, by cleverly using the highly leveraged fantasy futures market.  If they have central bank reserves to pull from, they can supply real gold into the marketplace, in the form of either sales or leases. If not, unscrupulous actors can, and probably do, issue bogus claims to gold and silver in “vaults.”  In the long run, however, paper gold cannot win. Real markets will always win eventually.

Precious metal prices are driven by two basic factors, and neither has anything directly to do with the price of oil, or the value of the dollar.  First, higher levels of anxiety, especially in the financial sector, drive people to buy.  There is a need for financial security in uncertain times.  Gold supplies that need.  Second, scarcity drives up the price. The world population is growing, and some parts of it, particularly in China and India, are growing much richer.  As they become capable of buying more gold and silver, so long as the overall stockpile of precious metals does not suddenly explode by virtue of some earth shattering technological advance, like anti-gravity, which would allow us to mine the asteroid belt, the same pie needs to be split more ways. 

The discovery of the Americas, in 1492, for example, crushed the price of gold and silver in Europe, because, suddenly, the continent was flooded with gold and silver from the New World, where it was so common that the natives didn’t value it very highly compared to Europeans. 

At any rate, without some destabilizing development that vastly increases supply, each part of the existing pie becomes comparatively more rare and expensive, causing the price to increase.  Since no destabilizing new technology is likely, in the foreseeable future, what has been true for the last 8 years will surely continue. The price of both gold and silver will go up.  This will happen, regardless of whether central bankers and/or fantasy futures market manipulators want it to.

There is no reason to believe that Europeans, with a long history of craving precious metal, and many wars and economic destruction, stretching from days of the Romans, to Napoleon, to the two world wars, do not still crave gold and silver.  Collective memories of the Weimar Republic hyperinflation, and periodic bouts of severe deprivation, will cause them to react much the same as Americans.  If the euro continues to sink, if banks continue to fail, and if there are increased levels of inflation, Europeans will eventually lose faith in the “coin of the realm” which, now, is the paper euro.  They will buy gold. 

The combined EU economy is bigger than that of the USA.  When gold buying mania hits, the numbers will be significantly higher than what we will ever see in the USA.  When the Euro begins to fall, and inflation starts to bite, Europeans will panic.  Both pound and euro have steadily appreciated against the dollar.  Inflation, up until now, has been low.  So, WGC statistics show that almost no gold was purchased, at least over-the-table, by the European population, last year.  However, when the European currencies begin to devalue, a lot will change.

The vast increase in physical demand is already happening to some extent, but it is mild compared to what is to come.  Let’s look at Vietnam, a nation wracked by war and incompetent government, for many years.  It is a nation of 86 million people, living on an average income of less than about $70 per month.  According to the WGC, “net investment demand in Vietnam in the first half of 2008 totaled 56.8 tons, already outstripping the 56.1 tons recorded for the whole of 2007.”  Only a very small percentage of the Vietnamese population can afford to buy significant quantities of gold. 

The U.S.A., in contrast, has 3.5 times as many people, and 55 times as much income per person.  This means that the gold buying potential, in America, is 192.5 times that of Vietnam.  If Americans had the gold buying propensity of the Vietnamese, they would be trying to buy approximately 21,500 tons of gold every year.  Europeans could purchase even large quantities. 

Worldwide gold mine production is only 2,475 tons per year.  It is unlikely that Central Bankers still have that much gold left in all their vaults.  The reason Americans have never demanded gold, like the Vietnamese, is that they trusted their institutions, their big banks, their government, and their U.S. dollars.  That trust has been deeply abused, and is in the process of evaporating.  Americans are changing the way they view the world.  The small beginnings are shown in a vastly increased propensity toward buying precious metals.  That trend will accelerate.

So far, American demand, given huge income levels, is still modest.  We have seen a rise in investment demand to 250+ tons, but that merely represents the diversion of approximately $11 billion from stocks and bank accounts into gold.  When we consider that the entire U.S. stock market cap is almost $24 trillion dollars, this is very small.  The shift represents about 1/20th of 1% of the U.S. stock market value. Nevertheless, this shift is incredibly meaningful to the gold market, because supplies are so small. 

Mining companies cannot find new sources, no matter what the profit level might be.  The supply is finite, and cannot rise to meet an increase in demand.  Only the price can rise.  Physical scarcity is the fundamental reason gold has been a monetary metal for 10,000 years.  Only 2,475 tons of the yellow stuff were mined in 2007, and the WGC projects that 2,485 tons will be mined in 2008.  Thus, supply cannot expand to meet demand.  The only answer is a major price increase, which will serve to ration existing supplies.

The mine supply situation is also constrained in the case of silver.  In some ways, the silver supply is more limited than the gold supply.  Most silver comes as a byproduct of base metal mining.  The supply is limited by the propensity of miners to extract base metals, like lead, zinc and nickel.  Last year, production was prolific, because base metal prices were high. Yet, we still had a mild deficit of silver that supported a major price rise. This year, however, the prices of base metals of the kind that occur in conjunction with silver, with the exception of copper, have fallen deeply.  Mines are already beginning to close or reduce production.  Therefore, the production of mined silver will take a big hit this year. 

In the face of recession, base metals will go even lower, or, at least, they won’t see any significant recovery.  This will cause there to be a much lower supply of silver, going forward.  The lower supply will take place against the backdrop of much higher investment demand and increasing new uses of the metal.  Many of the new uses are not price sensitive because they use an infinitesimally small per unit amount of silver, and nothing can be substituted because the electrical properties of the metal are unique.  Usage, for example, in RFID devices, and high energy batteries will increase, regardless of price, in the face of decreased supply.

Total world demand for gold was 3,518 tons in 2007.  As previously stated, total mine production was only 2,475.  This created a deficit of 1,043 tons of gold to balance the supply and demand.  A similar shortfall has been seen for many years, and has been offset by Central Banks selling and “swapping” their gold hoard, into the marketplace.  Secondarily, it has been met by the sale of a relatively small amount of scrap gold each year.  But, the sale of scrap gold has dried up this year, and Central Bank attitudes are changing. 

The Russian Central Bank is now a big net buyer of gold every year.  It purchased almost 150 tons last year, mostly from Russian miners.  Russia’s foreign reserves have ballooned in recent years, and former President Putin, who is still running the show, has committed to increasing gold’s share of Russian foreign exchange to 10%.  That means a huge amount of buying is going to take place, and Russian production, alone, will not be enough to satisfy the new gold demand from the Russian Central Bank.  Soon, the Russians will be forced to begin buying on the open market, if they are not already doing so. 

An unverifiable, but certainly very logical, rumor has it that the Chinese Central Bank is involved in a stealth project to convert some of its trillions of dollars into gold.  Chinese buying, however, cannot be confirmed, except on the private market, where demand is increasing quickly.  On Friday, August 20, 2008, the German Bundesbank issued a public statement, refusing to comply with politician demands that it sell gold to acquire euros to use in pumping up the economy.  The Bundesbank stated, quite clearly, that “financial and political uncertainty make gold reserves more important than ever before.” The International Business Times, in the course of reporting on the Bundesbank story, also noted that UBS, a huge Swiss bank, which also happens to be the biggest bullion bank in the world, is having trouble supplying its clients with physical gold.  

Bloggers all over the internet say that gold and silver is now selling at a premium over COMEX spot.  This means that COMEX is not reflecting the true price of gold.  Will GLD ever reflect the true price of gold?  The answer is, of course, yes.  First of all, if other investors understand how easy it is to manipulate futures markets as, hopefully, they now do, it will become harder to manipulate.  Their activities will become increasingly expensive if the private market long players, including some banks and hedge funds, starts watching, carefully, for manipulative activity.   

Furthermore, the various gold ETFs are structured as trusts.  Investors with a certain minimum size investment in the trust are allowed to exchange their shares for physical gold.  If the price goes significantly out of balance with the real price of gold (as opposed to the fantasy COMEX price), groups of investors could potentially pool their resources into limited partnerships, and redeem the gold.  They could sell the gold on the physical market, and earn profits. The value of ETF shares would no longer be the COMEX spot price, but, rather the value for an arbitrager who would buy your shares for just a little under the physical selling value after the shares were “cashed” in for the underlying gold. 

For this reason, the ETFs will eventually be forced to reflect real market prices, even if their sponsors would prefer otherwise.  If prices continued to follow the COMEX fantasy, the ETFs would be drained of their gold and silver, and put out of business.

The recent attack on precious metals has temporarily created an artificial price.  A lot of market participants are shell-shocked.  Bad though the losses may be for the victims, they can only occur because these victims do not understand the potential harm that can be perpetrated upon them by the manipulators.  As noted above, fundamental factors virtually guarantee huge price increases, in the very near future.