Why Supply and Demand Matters
The reason why precious metal investors should follow the fundamental supply and demand trends is because they help determine the price.
Investing 101, how to make a profit: buy low, sell high.
The profit motive is often what drives investors investment decisions and studying the underlying market can help them make informed decisions.
The precious metals market is trying to find an economic equilibrium for the price and quantity produced of the underlying commodity.
Logically, when the price is low consumers of precious metals will buy more and producers will produce less, as marginal sources of supply are no longer profitable.
Vice versa, when the price is high consumers will buy less and producers will produce more as more marginal sources of supply become profitable.
A standard graphical representation of a supply and demand chart has quantity on the horizontal axis and price on the vertical axis.
The demand curve would be shown sloping downwards, showing a negative correlation between price and quantity demanded.
The supply curve would be shown sloping upwards, showing a positive correlation between price and quantity supplied.
Before concluding this brief introduction into microeconomics, it should be noted that markets are always forward looking.
This means that prices are often not determine by the current supply and demand conditions but rather the markets predetermined belief of where the market predicts the conditions will be in the future.
This is particularly important in the precious metals market, due to the long lead times associated with expanding existing mine production or exploring and developing greenfield projects.
The effect of these long lead times often results in volatile price swings in the precious metals market (as with many commodity markets).
Speculators often exploit and profit from these price swings using often highly leveraged financial instruments.
Precious Metal Demand
Every precious metal has a different supply and demand profile.
For instance, gold is often seen as a good investment during economic uncertainty or during periods of high inflation.
Whereas, silver, platinum, and palladium are often thought of as industrial commodities and therefore perform well during periods of high economic growth.
Factors to consider when analyzing demand:
- Who are the precious metal consumers?
- How large do each one contribute to overall demand?
- How much are each consumers demand changing relative to each other, and what effect does this have on aggregate demand?
Precious Metal Supply Sources
Factors to consider when analyzing supply:
- Who are the precious metal producers (global, country, company)?
- How large does each one contribute to overall supply?
- How large are above ground inventories? (this has a stabalizing effect during supply shocks)
- How fast can producers expand production?
- How long are the mine lives of current producers? (will there be a supply squeeze?)
- How much does recycling contribute to overall supply?
- Are exchange and exchange traded funds (ETFs) net buyers or sellers?