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Inflation/Deflation vs. Supply/Demand


Glen O. Kirsch

The precious metals complex continues to remain in the forefront of the news. The bottom line message: the investment climate is improving, but for reasons that are not immediately apparent.

One profound change has taken place. Unlike precious metals markets of the past 25 years in which inflation--either official or unofficial--was the engine driving these markets, today the fuel pushing appreciation is good, old-fashioned favorable supply/demand fundamentals. Take silver, for example.

Silver... Silver's image was severely tarnished after the failed attempt by the Hunt family to corner the market back in 1980. Falling from a record high of $50.00/oz. in 1980, it finally bottomed in the mid 90's at $3.50/oz. where it has languished in a trading range of $3.50-$6.00/oz.

But all this changed in late 1997 when silver prices shot up to $6.38/oz. in reaction to dramatic reductions of warehouse stockpiles. It was confirmed in February that the highly regarded investor Warren Buffett had purchased over 130 million ounces of silver. Mr. Buffett is respected for his ability to find excellent long-term value investments. No one has ever gotten rich betting against his hard-core, research-based, fundamentals-first strategy.

Concerning silver, ponder this one inescapable fact: Worldwide demand for silver has exceeded mining production throughout most of the 90's. In our view, it is clear that for silver the supply/demand fundamentals have finally taken hold of the market. A similar reality is imposing itself in gold.

Gold... Gold's price range for 1997 was a high of $369.00/oz. to a low of $283.00. Recently, prices have recovered to $300+/oz. Despite much talk about Central Bank gold sales, the actual number of ounces liquidated have been unimpressively small. Keep in mind that worldwide gold demand has exceeded mining production for about 4 years. It is only because of Central Bank sales of gold filling the void that we haven't felt the supply deficit.

The Korean government, reeling from a currency crisis, appealed to its citizens by asking for gold donations. They were successful in amassing 120+ tons of gold. Isn't it interesting how, when all else fails, gold is still considered the currency of last resort! The prettiest paper currency just doesn't seem to have the same primitive appeal as the untarnishable gleam of gold.

There seems to be magic in the number 300. For many mines, it is $300/oz. That defines the pint below which it is uneconomical to remain in production. Recently, Anglogold, one of the world's largest gold mines, announced it would reduce it's gold production by 17%. (Why dig something out of the earth when it's worth less than it costs you to process?)

It's inescapable: Supply/demand fundamentals can be ignored for a period of time, but eventually they determine the course of a market.

Platinum and Palladium... Their supply is dominated by two producers, Russia and South Africa. Demand is concentrated in two other countries, Japan and the U.S. Russia's inability to supply PGM (Platinum Group Metals) on a timely basis has raised speculation that their large above ground stockpiles have been depleted. Russia PGM sales in the early 90's were twice their mining production, simply enabling the supply/demand equation to remain in equilibrium. Now the world users of PGM, like a heroin addict experiencing withdrawal (a supply deficit), must face the music of higher prices.

Reality is imposing itself. The myth that precious metals only go up during times of crisis is evaporating before our eyes.

Supply/demand fundamental can only be ignored so long. If this weren't so, you would never have heard the name "Warren Buffet."

Glen O. Kirsch is one of the principals of Asset Strategies International Inc., specialists in precious metals, foreign currencies, and asset protection.

Copyright © 1998 by Glen O. Kirsch.
The Investor's Library has reprinted this copyrighted article with the permission of the copyright owner from the March 1998 issue of Information Line, a publication of Asset Strategies International Inc.

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