Gold, Explained

Gold often comes into the limelight when there is heightened geopolitical risk because it is viewed as a store of value during volatile times. Yet the gold market and the various methods to access gold are quite nuanced. The following analysis seeks to shed light on gold by answering four key questions:

  • How does the gold supply chain work?
  • What are the main sources of demand for gold?
  • What is the outlook for the supply and demand balance?
  • What are the key differences between the various ways to access gold?

How does the gold supply chain work?

Gold is a rare element, with an average concentration of just 0.005 parts per million. In other words, just 1 gram of gold can be extracted from 250 tons of ordinary gravel.1 Given its scarcity, it is seldom found in concentrations that make extraction economically viable. In order to support a profitable mining project, gold explorers conduct geological surveys targeting concentration levels that are 1000 times higher than normal. After discovering  an ore, geologists and engineers will engage in a feasibility study to determine whether the project has economic value, prior to the commencement of any mining operations. They will also seek approvals from the appropriate governing bodies, including local governments and environmental agencies, to proceed with the mining project.

The next phase focuses on efficiently extracting gold from other natural materials in the mine. There are two processes for doing so: milling and amalgamation. Milling is a chemical process whereby the ore is ground into a fine powder and mixed with water to form a slurry. This slurry is then passed through a carbon-in-leach circuit, which attaches the gold particles to carbon, separating it from other materials.2 In amalgamation, gold ore is dissolved in mercury and then the mercury is distilled away.3 Once the gold is purified, it is smelted and pressed into gold bars to be sold in the market.

A more detailed look at the mining life cycle can be found in the chart below.

What are the main sources of demand for gold?

Jewelry: Until relatively recently, jewelry constituted the vast majority of all gold demand. To this day, gold jewelry remains one key source of demand for the precious metal.

Investing: Gold has gained popularity as an alternative asset class that can potentially hedge against inflation and geopolitical risks. Holding gold directly though physical ownership of bars and coins or indirectly through investment vehicles like ETFs and futures are popular ways of gaining exposure to gold.

Central Bank Reserves: Central banks are net buyers of gold. They often fill up their treasuries with gold bullion, which serves as a reserve. This circumstance is partly due to changes in banking regulations, which as a result of Basel III now classify gold as a tier I asset (a primary measure regulators use to evaluate a bank’s financial health).

Currency: Gold continues to be used as a form of non-fiat currency around the globe, particularly in underdeveloped economies which struggle with high inflation.

Industrial: Gold’s malleability, conductivity, and non-reactivity make it a useful component for a variety of applications, including personal electronics, medicine, and aeronautics, among other uses.4

What is the outlook for the supply and demand balance?

Some commodities, like oil, can demonstrate rapid changes in supply due to changes in spot prices. Gold production, however, has been relatively insensitive to changes in gold spot prices compared to other natural resources. This phenomenon is largely due to the geological challenges that prevent a rapid increase in production. For example, the gold mining industry already faces challenges with the depletion of existing mines and fewer new discoveries, which constrains supply growth. Additionally, increased government and environmental regulations, higher production costs, and falling ore quality, can constrain supply growth. Gold supply constraints have temporarily eased, and production is expected to increase through 2022, backed by higher gold prices and mine investments, boosted by stronger company financials.

Actual supply and demand numbers, however, can change rapidly. The major factors expected to drive supply and demand trends in 2019 include:

    • Geopolitical Risks: With perceived political risks increasing worldwide, demand for gold could increase as investors look for store of value assets in times of uncertainty. We believe the U.S.-China trade war poses the biggest risk. Middle East politics, new dynamics in the U.S.-Saudi relationship and their potential impact on the oil market, uncertainties surrounding Brexit, and an outburst in European populism also remain as risks.
    • Equity Market Risks: In 2018, U.S. equities performance was at a 10-year low, and the market remained highly volatile on concerns about a global slowdown, the Federal Reserve’s (Fed) rate tightening, and inflation fears.5 In these times of volatility, investors could look to diversify away from equity and increase exposures into low-correlated assets like gold.
    • Weakening U.S. Dollar: U.S. dollar appreciation in 2018 is expected to reverse in 2019 and 2020, and this could possibly make gold a more preferred investment option. With the Fed unlikely to hike interest rates much higher in 2019 and U.S. growth moderating, factors that strengthened the currency are weakening. The U.S.’s high current account and fiscal deficit would also put pressure on the currency.6,7,8
    • Rising Debts and Deficits: The world has become very indebted, with debts surpassing pre-financial crisis levels. According to recent estimates by Bureau of International Settlement, global debt stood at 217% of GDP. Further, the U.S. budget is increasing and is estimated at 6% of GDP in 2019, a level generally not seen during a period of high growth. These high levels of debts and deficits pose a threat, especially as interest rates are rising. Gold as a real asset can act as a hedge against these rising debts.9
    • Central Bank Demand: Central banks continued to increase their gold purchase in 2018, reaching the highest annual pace since 2015. Emerging markets, which generally have a small portion of reserves in gold, were ardent purchasers of the yellow metal during the year. This trend is expected to continue in 2019, particularly in China, Russia, and Turkey, and new central banks are expected to focus on gold purchase.10
    • New Technological Trends: Gold is a component of almost every electronic piece. New technological trends, like the adoption of the Internet of things and shift to hybrid and autonomous vehicles, should lead to an explosion in the sale of electronic goods and components, boosting the demand for gold.11
    • Supply Constraints: Though supply constraints have temporarily eased and gold production is expected to increase through 2022, in the long run, supply will be constrained by increasing operational costs and inadequate gold discoveries.12,13

What are the key differences between the various ways to access gold? 

There are a variety of methods for gaining exposure to gold, each of which has different characteristics with respect to its correlation to gold prices, fees, taxation, and liquidity.

Segmenting the Gold Equities space

Gold mining companies are distinguished by their role in the supply chain and size.


Explorers begin operations at the earliest stage in the discovery process. These companies look to evaluate potential exploration projects, electing to use their expertise and scientific due diligence processes to strategically purchase assets. Often, explorers may have the rights to only a handful of projects. Once gold has been discovered, explorers can elect to engage in M&A activity with a mining company or undergo the mining phase themselves. These companies’ economic success are often tied to their ability to successfully find economically feasible gold ores as well as changing prices in gold. Companies that explore are sometimes equated with venture capital in that investments in gold exploration companies are early stage, high risk, with high potential reward.

Junior Miners

Junior Miners are smaller-sized companies that can be involved in a variety of stages of the gold cycle, including exploration, development, or mining. They are primarily defined by their size, which can make these companies more nimble and more able to pursue smaller opportunities that are overlooked by larger mining firms. These smaller firms can also have higher risks than larger mining companies, as smaller firms tend to have less efficient operations, less access to capital, and fewer mining projects in their portfolios.

Larger Miners

Larger mining firms tend to own a variety of gold projects around the world and have greater access to the capital markets through debt and equity issuances. While these firms can sometimes lower their costs through economies of scale and operational efficiency, they tend to be dependent on acquisitions of new mining projects to grow their production. Therefore, these firms ultimately depend on explorers and junior miners to grow.