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4 Reasons Gold Remains a Safe Haven

4. Supply and Demand

The supply and demand factor is pivotal in supporting high gold prices. From 2005 to 2009, the gold industry received 59% of its supply from mining production, 31% from recycled or scrap gold and 10% from central bank sales. Central banks are no longer selling their gold, the amount of scrap gold is falling as investors hoard the metal, which leaves just mine supply.

In the World Gold Council's recent Gold Demand Trend report for the second quarter 2011, mine supply surprisingly grew 7% to 708.8 tons but total supply was unchanged as gold producers de-hedged and sopped up excess gold.

The above ground supply is estimated to be around 165,600 metric tons. Half of that is in the form of jewelry. Of the 82,500 tons remaining in bullion, 30,000 tons are owned by central banks and the rest is privately held.

Total gold demand for the second quarter was 919.8 tons, outpacing the growth in mine supply.

Gold has, however, lost a big buyer recently -- the miners.

Miners had been buying gold from the open market to eliminate hedging positions, where they had previously locked in gold sales at a certain, lower, price. Now, all the big hedges have been eliminated. The move in of itself is a bullish indicator, but the role of producer de-hedging had been instrumental in pushing gold prices higher and without it the market loses a key driver.

Matthew Piggott, metals analyst with GFMS, says the end of de-hedging will force "the [gold] market [to] look to other areas of demand to make up the difference in the absence of price support from de-hedging activity."

One factor that could help is the advent of physically backed gold ETFs. Along with the GLD, the iShares Comex Gold Trust (IAU) and ETFS Physical Swiss Gold Shares (SGOL) hold around 1,400 tons of gold, more than half of annual gold production.

Over the past three years, cumulative gold supply has grown 59% while demand has surged 62%. This upward trend is expected to continue as investors seek ways to diversify their portfolio. As Ash points out, U.S. investors have accumulated $111 billion of gold exposure over the past 10 years versus $11 trillion of net worth, meaning that gold is still a very small amount of investors' wealth.

"We're going to go into a period like the tech market where there is a mania," says Rob McEwen, CEO of U.S. Gold (UXG), who thinks the market is about half of the way there.

"Your curve is like any other area of the market that suddenly people wake up to and say I have to have it and it goes parabolic ... at some point up there gold is going to achieve a point where its purchasing power relative to other assets is going to be at its zenith and that's when you want to start thinking about trading out."
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