THE GOLD MARKET: TRENDS IN SUPPLY AND DEMAND

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• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83B00231R000100040001-9
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• Document Page Count: 17
• Document Creation Date: December 21, 2016
• Document Release Date: January 2, 2008
• Sequence Number: 1
• Publication Date: January 1, 1982
• Content Type: REPORT

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The Gold Marl~et:
Trends in Supply and Demand
A Research Paper
secret
GI 82-10018
January 1982
Copy 4 8 /
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Directorate of
r...ou;,.o.,,.e
The Gold Market:
Trends in Supply and Demand
A Research Paper
Information available as os 24 December 1981
has been used in the preparation of this report.
Comments and queries are welcome and may be
directed to the Chief Economics Division, OGI, on
Economics Division, Office of Global Issues.
The author of this report is
Office of Soviet Analysis
This report has been coordinated with the Office of
African and Latin American Analysis and the
Secret
GI82-10018
Januarv1982
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S cret
The Gold Market:
Trends in Supply and Demand
Overview The recent surge of interest in returning to some form of gold standard
stems from a desire to devise a monetary program that would simulta-
neously reduce interest rates, slow inflation, and ensure future monetary
discipline. For a gold standard to function, the supply of gold must be
adequate to meet both monetary needs and nonmonetary demand at a set
price. Developments over the past decade or so raise doubts about whether
the supply of gold will be sufficient to satisfy anticipated rises in demand at
The elevenfold rise in the price of gold between 1968 and 1981 reflects
large shifts in supply and demand components:
? World gold production declined from 1,500 tons' in 1968 to less than
1,340 tons in 1980.
? Soviet gold sales in the period of 1979-81 fell substantially below the
levels of the mid-1970s.
? Between 1972 and 1979 official institutions-central banks and the
International Monetary Fund (IMF}--were net suppliers to the gold
market. In 1980, official institutions became net demanders. Gold
purchases by central banks in less developed countries (LDCs) have been
steadily increasing; governments of the Organization of Petroleum
Exporting Countries (OPEC) alone purchased nearly 150 tons of gold in
1980.
? Since the removal of the $35-per-ounce ~ price ceiling in 1968, the desire
to hold private gold as an investment hed e against inflation has grown
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The introduction of gold futures markets into the United States in 1974 in-
creased the volatility as well as the sophistication of gold trading. The
ability to purchase and sell gold contracts at future dates on a highly
leveraged basis has sharply increased the volume of trading. Over 34,000
tons of gold-25 times world production-was traded in the US exchanges
' All tons in this publication are metric tons.
' All ounces in this publication are troy ounc
Secret
CI 82-/0018
January/982
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Gold production and some components of demand can be projected for a
few years with a fair degree of confidence. Production worldwide is
expected to increase by about 3.5 percent a year through the mid-1980s
and decline thereafter as high-grade South African reserves are exhausted.
But the amount supplied to the market by the Soviets or demanded by pri-
vate investors and official institutions is subject to wide, unpredictable
swings. Although Soviet gold production has been steadily climbing, sales
during the 1970s ranged from 3 tons to 401 tons per year. About 75
percent of gold production is controlled by the Governments of South
Africa and the Soviet Union, which do not produce or sell gold according to
short-term profit motives and thus impede market self-adjustment.
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The Gold Market:
Trends in Supply and Demand
The gold market is composed of buyers and sellers
dealing in bullion and in gold futures. Gold bullion
transactions are actual spot exchanges of gold bars or
transfers in gold accounts with banks and dealers,
which often do not result in physical movements of
gold. Contracts for purchases and deliveries of gold at
a specific date in the future are made on futures
exchanges
going long-or to sell gold he does not currently
possess-known as selling short. Transactions are set
for some specified date in the future. A key advantage
of dealing in the futures market is that investors do
not have to tie up as much money for a given amount
of gold. Nor do investors have to get insurance or 25X1
worry about the fineness and weight of the gold. Most
important, transactions costs are extremely low.~~
Bullion Market
London and Zurich are the main gold-trading centers,
with Hong Kong a distant third. Smaller markets
exist in New York, Frankfurt, Tokyo, and other cities.
The Zurich market, the largest in terms of volume, is
dominated by three Swiss banks: Credit Suisse, Unit-
ed Bank of Switzerland, and the Swiss Banking
Corporation. The Swiss banks handle almost all of the
Soviet Union's gold transactions and over half of
South Africa's
London continues to be the most influential gold-
pricing center despite having lost some of its volume
to the Zurich market. Until Britain expelled South
Africa from the Commonwealth in 1961, nearly all of
South Africa's gold was marketed through the Bank
of England. London dealers now handle about half of
South Africa's gold sales.
Hong Kong benefits from the time zone differences
between the Far East and Europe, operating when
European markets are closed. It also enjoys a relative-
ly free regulatory atmosphere and close connections
with London banks. The United States is increasingly
influential in determining gold prices because of the
large amount of funds available for investment and
the multiple forms of transactions offered in the US
futures market.
Futures Market
The introduction of futures trading in recent years has
added a new dimension to the marketing and pricing
of gold. The futures market gives an investor the
opportunity to buy gold for future delivery-known as
One of the prime objectives of the futures market is to
provide insurance against price fluctuations. On the
buyer's side, gold-product manufacturers in particular
have taken substantial losses over recent years by
issuing fixed price catalogues without owning the gold
they needed to produce the products. Such manufac-
turers are increasingly engaging in the futures rather
than the spot market in order to hedge. Some gold
mines and refiners have also started to use the futures
market to hedge future production.
The Commodity Exchange, Inc. (COMEX) in New
York and the International Monetary Market (IMM)
in Chicago are the two dominant trading centers.
Trade volume in US gold futures reached 34,000 tons
in 1980; COMEX and IMM accounted for 95 percent
of the volume (see figure 1). Markets in Singapore and
Sydney also handle gold futures, and in August 1980
the Hong Kong Commodity Exchange expanded into
gold futures trading. London is developing a futures
trading center which will fill the time zone difference
between the Far East and New York. Trading volume
outside the United States, however, is likely to remain
insignificant for several years, until expertise and
customer familiarity with the new exchanges are built
The supply of gold to the market comes from newly
mined production in the Free World, net sales by the
Communist countries, net dishoarding by private in-
vestors, and net sales by official institutions. An
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Figure 1
United States: Gold Futures Trading Volume
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estimated 1,053 tons of gold entered the world market
in 1980, down sharply from 1,778 tons in 1979. In
1980, non-Communist official institutions were net
purchasers of 186 tons, whereas in 1979 they had
been net suppliers of 567 tons. In addition, Commu-
nist gold sales-mainly from the USSR-dropped
from 250 tons to only 1 10 tons in 1980
Non-Communist Production
The massive fluctuations in the price of gold during
the past few years have created great uncertainty for
the world's gold producers (see figure 2). Moreover,
the large-scale financing and long leadtimes-up to
five years required to bring a new mine into produc-
tion tend to prevent rapid increases in output. Gold
production in the non-Communist countries actually
declined to an estimated 943 tons in 1980 compared
with 961 tons in 1979 Non-Communist
production is expected to increase y 175 tons by 1985
and then to decline toward the end of the decade. ~
Production in South Africa, which accounts for over
70 percent of non-Communist output, fell by nearly
30 tons to 674 tons in 1980. The reduction in output
was due to the lower gold content of the ore mined.
Between 1978 and 1980 the average ore grade
dropped from 9.4 grams of gold per ton to 7.3 grams;
since 1972 the gold content of South African ore has
fallen by 42 percent. For one thing, the South African
Government directs producers to mine lower grade
ore when the price of gold is high. This policy
increases the economic life of the mines, which are a
major source of tax revenues and employment. The
major reason for the long-term decline in gold produc-
tion, however, is the exhaustion of high-grade ore
reserves held by the major producers in the Orange
Free State (see figure 3).
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The cost of producing gold rose dramatically during
the past decade because of the mining of lower grade
ore and rising factor costs.
Figure 2
? In 1972, the average cost of producing an ounce of Average Annual
gold in South Africa was $27; the cost rose to $183 Gold Prices
in 1980 and is expected to be up another 20 percent coo
in 1981.
? The average depth of South African gold mines is
greater than 1,500 meters. The capital cost of Soo
developing a new mine can range from $200 million
to $450 million.
400
? Wages account for 50 percent of total mining costs
and represent the greatest concern for the mining
industry. The average wage for unskilled w~rkerc 300
increased eightfold during the 1970s.
Gold production in other non-Communist countries
totaled nearly 270 tons in 1980, up 11 tons from 1979.
In Papua New Guinea, where gold is produced as a too
byproduct of copper, output fell from 20 tons in 1979
to 15 tons in 1980. On the other hand, gold production I I I I I I I I I I 11 I I I
increased between 1979 and 1980 in Brazil from 25 to ~9~~ ~o ~s s i ~~
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Figure 3
South Africa: Gold Mining Centers
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Figure -1
Soviet Union: Principal Gold Mining Centers
Turkmen
~ S.S.R.
x~
Altay
vernment hee not recognized
Transbaikal
'k 5Z a
x .,,,
x
x ~,,
Magadan
Magadan
pblast'
'Ion-Communist production should increase during
the 1980x. During the next five years the combined
output of the United States, Canada, and Australia
should increase by more than 50 tons, while output in
the developing countries, especially in Latin America
also may increase by >0 tons. South African produc-
tion Crom existing mines and mines in the process oC
opening should remain relatively close to 700 tons per
year until 1987. It then is expected to decline steadily
to about half that level by the turn of the century,
causing total non-,Communist gold production to fall
during the 1990x.
Communist Production and Sales
Production. Communist countries produced an esti-
mated 395 tons of gold in 1980, 30 percent of the
world total.
bout one-fifth of total Soviet production
is a byproduct from processing copper, lead zinc, and
uranium ores. The principal gold-producing areas
were originally in the Urals, but large new deposits
were opened in northeast Siberia beginning in the late
1920s (see figure 4). The eastward trend was later
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reversed with the discovery of deposits in the south-
west, and in 1958 a major discovery was made at the
foot of Muruntau Mountain in the Kazakh Republic.
Output in the northeast still accounts for almost 35
percent of total Soviet gold mined, although produc-
tion in the region has increased little since 1970
because of the depletion of higher grade deposits. The
Muruntau complex now produces about 40 tons, or 13
percent of total Soviet output.
There is little information on which to base Soviet
gold-production costs; a best guess estimate would
place average costs at about $230 per ounce in 1980.
The Soviets make little effort to adapt mining equip-
ment to climatic extremes. For example, the same
basic equipment that operates in the permafrost of the
Magadan region is found in the desert heat of Murun-
tau.
Investment decisions already made indicate that Sovi-
et gold production will continue to rise steadily during
the 1980s, with annual production approaching 400
tons by 1990 and perhaps 500 tons by the turn of the
century. China, the second-largest Communist pro-
ducer, is devoting considerable effort to the search for
new gold mines and is likely to nearly double produc-
tion during the 1980s. Annual output could reach 60
tons by 1985.
Transactions by Official Institutions
In 1979 the US Treasury and the IMI~ both had gold
sales programs; together they added over 700 tons of
gold to the market-367 tons by the US Treasury and
353 tons by the IMF. Even after purchases by other
official institutions, net official sales in that year
totaled 567 tons, about one-third of world supply. In
1980, however, the official institutions became sub-
stantial net buyers of gold. The US auctions were
suspended in November 1979, and the IMF halted
sales in 1980 after supplying another 106 tons. Al-
though Canada sold some gold, official institutions
purchased a net total of 186 tons in 1980.
South Africa added 66 tons to its gold stocks in 1980
by withholding supplies of newly mined gold from the
market. OPEC countries accounted for the bulk of
other additions to official holdings: Indonesia in-
creased its gold holdings by 66 tons; the Iranian
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Official Free World
Gold Holdings ~~
Figure 5
World Gold Holdings: Distribution Among
Official Institutions, ]980"
Total
35,334
34,776
34961
35,066
UnitcdSLUes
8,597
8,230
8?~l
8?17
~ti'est Germany
3,690
3,963
? 960
?_960
France
3.177
2.548
~,54G
x,546
S.+~itzcrland
? 590
'.590
2,590
'.590
Italy
? 535
?,075
2.074
~.J74
tiethcrlands
1,704
1.368
1,36;'
1,367
E3elgium
1,325
1.061
1,063
1.1163
Japan
?46
75-1
754
754
l_nitcd Kingdom
710
568
586
588
Canada
688
690
653
x,50
Portugal
688
6S8
690
~'>90
lustria
6>4
6i'
6~7
,~'
S~~uth Africa
305
31 ~
378
38~
OPECa~tmtries
1.135
1,1-16
1.297
'.?9i
Other N'e~t European countrie;
1,087
1,090
1,096
I.(14?
Other :~sian countrie,
570
595
61 ~
DSO'
Other countries in the Western
5?0
608
650
666
I lemisphcre
Other ti1iddle Eastern countries
-150
4>3
457
756
Rest of Free world
31?
326
3?~
z3~
I~il
3.676
3,33
3?17
_'_17
Eurohean lgonc~ar~ Fund ~
(?
x,653
'.664
~.~~6h
l;r,pcci(ied
7j
-_
97
r)i
Source,: Intervrationa! Fina~rcrul.Stutistrcc. I \1 F. for all exccnt
OPEC. OPEC data are CIA estimate:.
'Through the end of June.
!'stablished in connection ~~~ith the European ~11onctarc System.
Government by an estimated 40 tons: and Saudi
nr?abia, Liby?a, Iraq, Qatar, and [~'igeria a total of 43
tons. OPEC central bunks purchased an additional 9Y
tons of gold during the first half of 1981 see table 4
and figure ~).
Net Private Investment in Gold
Gold held as an investment by the private sector ~.lisu
has increased markedly over the Iasi few years.
Private institutions and investors in developing coun-
tries normally purchase small gold bars or wafers .u a
South .lfricu i i.01
Othee C~~mmunist
(ountric, (ZJ
Japan 12.01
OPI~C Ccuntres
(3 ~~
l'SSR (4.71
European
ti1onetar~ Fund
i-.li
International
Monetarc Fund
13.6)
means of 5turing and transporting wrtlth. In contrast.
investor, in ~'~'estern countries ~encrally ~~iil accept
geld certificate; or open an account with a bullion
dealer. often un ~~ Icver,t