Adrian Douglas: The cataclysm awaiting gold is just disclosure

By Adrian Douglas
Saturday, October 24, 2009

If I had interviewed New York University economics professor Nouriel Roubini with Index Universe yesterday, (http://www.indexuniverse.com/sections/features/6777-nouriel-roubini-big-...), I would have put this to him.

Let's not talk about gold for the moment. Let's talk about pure economics and commodities.

I don't think you would dispute that it is the imbalance between supply and demand that drives the price of anything, including, of course, the price of any commodity.

Let's take the situation with oil, which has doubled in price over the last year. On Aug. 14 the International Energy Agency released a report based on a study on the oilfields that make up 75 percent of world supply showing that not only is production declining but it is declining at double the rate of just two years ago, now 6.7 percent per year. The IEA concludes that for the first time in history supply, not demand, is going to drive prices.

In other words, though demand has dropped dramatically due to the economic collapse, the oil industry is struggling to meet even the reduced demand, which is why prices have risen so quickly.

Saudi Arabia sits on 20 percent of the world's oil reserves and produces 12 percent of the world's daily oil output. Imagine some sort of cataclysmic event that took out Saudi Arabia's reserves and producing capacity. Wouldn't economics tell us that the price of oil would make an astronomical jump, as the world, which needs 86 million barrels each day, somehow would have to manage with just 75 million? Wouldn't economics tell us that to ration the drastically diminished supply, the price would have to go drastically higher?

It is very difficult if not impossible to imagine a cataclysmic event that would knock out not only Saudi production but its reserves too, but nonetheless it is a good intellectual exercise to contemplate the laws of economics.

I think you would also agree that if such an event happened, the adjustment in the price of oil would be so rapid that changes in the money supply would be irrelevant. In other words, the change in price would not be a monetary phenomenon but one of simple supply and demand imbalance.

Let us return to gold. Let's forget the discussion of inflation and deflation, because it seems that there can be no consensus on this. Let's imagine that some cataclysmic event suddenly reduced physical stocks of gold above ground from 210,000 tonnes to only 160,000 tonnes. In other words, 50,000 tonnes of gold just vanished in this cataclysmic event.

In such circumstances what would happen to the price of gold?

This would be equivalent to the imaginary cataclysmic event that we just considered that made 20 percent of world oil reserves suddenly unavailable. It would represent 21 percent of all above-ground gold stocks just disappearing.

Wouldn't you agree that from an economics standpoint the resulting stampede to redistribute 160,000 tonnes in a market that believed 210,000 tonnes was not only available but had actually been sold would drive the gold price to unimaginable levels?

What sort of cataclysmic event could trigger this?

Revealing the true condition of the gold market could trigger it.

From the most recent work of the Gold Anti-Trust Action Committee there are strong indications that the London bullion market operates on a fractional-reserve basis. It would appear that at least 64,000 tonnes of gold have been sold via unallocated accounts against a maximum reserve of only 15,000 tonnes.

The cataclysmic event in gold could be triggered by an audit or simply by purchasers asking for delivery of their gold.

Mr. Roubini, I couldn't expect you to know as much as GATA about the gold market because GATA has spent 10 years researching this opaque market and you have not. But as an economist I am sure that if what GATA says is right, then the future direction and magnitude of the gold price are not in doubt at all.

Further, with this supply-and-demand problem in the gold market, inflation and deflation do not have to enter the discussion, because the adjustment in price could happen so quickly that the fiat money supply could remain totally static.

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Adrian Douglas is a member of GATA's Board of Directors and publisher of the Market Force Analysis newsletter (www.MarketForceAnalysis.com).

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