Understanding the forces and drivers of supply and demand in the physical market is essential for understanding the derivatives markets.
For all four of the main precious metals, gold, silver, platinum and palladium, new supply comes to the market from mining production and recycling of scrap and obsolete material.
Mining product accounts for between 70-85% of the total new supply, depending on the metal, with recycled material accounting for the remainder. The proportion fluctuates with time, reflecting the changing cost of production, reclamation values and the economic outlook, amongst other factors.
For gold, supply from these two sources amounts to around 120 million troy ounces per year, equivalent to around 3,700 metric tons. This production has a value in the order of $150 billion, which represents the highest value of production in the precious metals space.
Gold mine production comes from countries throughout the world. Chinese mine production has risen considerably in recent years, and now China is the world’s largest producer, accounting for around 16% of global output. In contrast, South Africa, which used to be largest producer has seen declining output in recent years, and now accounts for around 5% of production. Australia, Russia, the U.S., Canada, Mexico, Peru and Ghana also produce significant quantities.
Silver has the largest supply volume of the four metals at an excess of 30,000 metric tons per annum. This has a value in the order of $17 billion. As with gold, Chinese mine production of silver has increased substantially in recent years, although Mexico remains the largest source of silver mine supply. Australia, Russia and Peru are also significant suppliers of mine production. Silver is often a co-product of the mine production of other minerals, such as gold or copper.
Platinum and palladium have lower production volumes; 230 metric tons for platinum and 290 metric tons for palladium. South Africa and Russia are the most significant producers of mined metal. For platinum, South African production dominates the market, representing around 2/3 of global mining output.
The mined ore, and recycled metal is refined and normally formed into bars for transportation and storage. Platinum and palladium are also formed into a powder, known as sponge, for use in various industrial applications.
Production from mines and recycling is not the only source of supply to the market. Once manufactured, bars are stored in vaults. The stock of stored metal in these vaults that has accumulated over many years is also available as supply to the market.
There are no reliable estimates of the amount of precious metal stored in vaults. Some is owned by central banks, some is owned by investment funds and some is owned by individual and corporate investors and intermediaries.
Investment demand is a significant element in the market for precious metals and has an important role to play in establishing market prices for metals. However, investment transactions usually represent the transfer of ownership of stored material. This brings valuable liquidity to the market, but will have little impact on the overall supply and demand. Taken as a whole, investment behavior can be seen as either a net buyer of metal, and therefore a source of demand, or a net seller of metal, and therefore a source of supply. The overall impact of investment will reflect investor sentiment of how ownership of metal will compare to other investment opportunities over their investment horizon.
Gold is the most widely held investment commodity. As well as private investments in gold, central banks hold a significant amount of their reserves in gold. The IMF and the World Gold Council estimate that the world’s central banks hold around 33,000 metric tons of gold, worth over $1 trillion. Changes in this amount will affect the net supply or demand in the market.
Silver is widely used in the production of coins. The U.S. and Canada are the largest producers of silver coins. The U.S. Mint produces in excess of 40 million American eagle silver dollars each year. It is estimated that the global use of silver for coinage accounts for around 14% of annual silver production.
Also, on the demand side, all four metals have a wide range of industrial uses, reflecting their physical properties.
Gold is used in electronics and in medical and dental applications, amongst other industrial uses.
Silver also has extensive demand from the electronics sector, and has seen increased use in photovoltaic cells. Silver used to be used extensively in photographic production, but this has decreased sharply with the advent of digital photography.
A major use of platinum and palladium is in the creation of vehicle emission control devices. They also have applications in the electronics sector.
Precious metals are also widely used in the manufacture of jewelry. Jewelry use is the primary physical use of gold, with the amount used equating to over 2/3 of annual production, i.e. over 2,500 metric tons each year. The use of silver and platinum for jewelry is relatively lower, at just under 1/3 of annual production. Palladium is used in jewelry, but the amount is much less significant.
In conclusion, thousands of tons of precious metal are produced each year from mining operations, adding to the stock of metal available. These metals are used in industry and in jewelry, from where they can be recycled back into the market. Precious metal is also held in store as an investment and as part of countries’ official reserves. The combination of all these factors creates an active global market for precious metal.