No, there are no shortages of gold and silver at this moment. Unless we go back to the gold or silver currency standard, with government demand for bullion locking massive new quantities inside central-bank vaults, I don’t see any physical shortage to come.”
That is how Miguel Perez-Santalla, vice president of business development for BullionVault, started his latest editorial. BullionVault is the physical gold and silver exchange, the world’s #1 provider of physical bullion ownership online.
He rightfully notes that many people write about gold shortages which could lead to a panic in the gold market. However, the truth of the matter is less dramatic, if not quite so simple.
He details in the following paragraphs the market practices in the physical gold market. Understanding those practices leads to the conclusion that, just like almost all other industries, the combination of inventory management at retail level combined with sudden demand changes can lead to temporary tightness. That’s a regular phenomenon however.
In most cases, supply issues with silver or gold coins are caused by surprising increases in demand from bullion coin buyers. Simply put, coins don’t come out of thin air. They need to be manufactured. This all takes time and money. No one wants to tie up their money in a product that is not going to sell. That exposes gold and silver buyers to “just in time” inventory gaps if it’s coins they want to buy. Imagine you are selling a low-cost product with a high margin. It is much more likely that you will have enough inventories for almost all eventualities. Look at a typical retail product – how about lip balm? I don’t really know the costs but I can guess. Some of the more premium brands sell individually for $10 each and more, but many quality brands sell for $1.00 or so. I have never seen a retailer that sells this product run out. Though it is possible, most likely that chance is very remote because I believe their profit margin is probably around 100% or more.
Now let’s take a look at gold coins. The price of gold currently is $1250 an ounce. If I am a distributor selling gold coins and the average quantity I sell in a month is 5,000 one-ounce coins that would represent sales of $6,250,000 plus my margin. This not only is a lot of gold but represents a lot of money. Do I always have on hand 5,000 ounces of gold? No, because financing eats away at the profitability, even at today’s low cost of interest. Also, tying up the capital in inventory may not let you properly cover all your expenses such as salaries, healthcare, supplies and utilities. So in the end I may stock 500 coins or maybe 1,000 at a time.
If I were making 100% markup then I may carry 5,000 ounces. But that does not exist in the gold coin industry. The wholesaler is lucky to make a quarter to half a per cent per ounce. Without doing the math it’s obvious that financing costs are significant in this scenario. But a comparison of the inventory of holding the full amount at a 6% financing would represent an overhead of over $31,000 a month. Holding only the 1,000 in inventory at 6% is a little over $6,000 per month. The decision to hold lower inventory levels is good management of capital. What this tells us is that the demand the manufacturer sees is usually on an as needed basis. Which means that they also go through the same motions to calculate cost, and to produce what they believe is needed. In the end the amount being produced on what is known demand will never be enough for an explosion of short term demand. But this does not mean that there is any difficulty in acquiring the raw material needed to produce the gold coins or bars.
Prior to the collapse of Lehman Brothers in 2008, for instance, the demand for gold and silver coins and bars began to grow. The pace became brisk and the industry began to expand. Unfortunately, the US Mint – like most other producers worldwide – was not prepared for the explosion that was to come in what proved the near future. This can happen in any market; it is not unique to gold and silver. For instance, as noted by Mr. Perez-Santalla, “when Apple launched the iPhone 4, I recall people lined up at the Apple store on Fifth Avenue for blocks to get in and be the first to buy the new phone. Some of the early buyers were already ready online to sell their phones at a tremendous premium, and make a large profit. Then they would come back a few weeks later and buy the phone again at the regular price.”
The same thing can occur in the gold and silver markets. “But there is a different concern, because of the investment value in owning physical bullion. Here the worry is that people may not be able to buy at the lower base price of gold and silver, and that the price of the commodity itself will also continue climbing. Hence they want to lock in their price on the product before it goes higher.”