I would hope that the gold producers are not over hedged, i guess it would be possible if there is a change in the nearby contract and distance contract spread, and their is a front month shortage.
here is some analysis of the Gold Fields Mineral Service 1st half report on supply and demand. I think its be a great article, and pretty bullish on Gold Fundies
GOLD: GFMS Headlines Bearish; Data Holds Promise
Homestake Mining Co(HM)
Rating: 2S
9/17/1999
Salomon Smith Barney ~ September 20, 1999
--SUMMARY:----Precious Metals
* We attended the Gold Fields Mineral Service first-half update on
supply/demand and official sector activity.
* The presentations had a decidedly bearish spin, despite underlying data
that support our thesis of a large deficit.
* Unlike GFMS, we maintain our view that mine production will decline this
year, and we note that dramatic improvement in "new gold" demand (net of
scrap fabrication) corrorborated the 1999 gains reflected in the World Gold
Council quarterly surveys.
* The second UK gold auction of 25 metric tons (mt) will take place on
Tuesday.
* Recent volatility in gold lease rates suggests the potential for higher
prices -- and we remain positive.
--OPINION:------------------------------------------------------------------
We attended the Gold Fields Mineral Services' first-half survey of gold
supply, demand, and the official sector. The tone was somber, and with
Hurricane Floyd overhead it was indeed "raining on gold in New York."
Consistent with current supply-dominated market psychology and GFMS's
bearish bent, discussion focused on gold that has been mobilized to
market -- through outright central bank sales as well as lending that
provides liquidity for producer hedging and speculator short selling.
According to GFMS, gold fabrication demand is "weak" year to date, and
mine supply is climbing, with the market overwhelmed by successive waves
of new producer hedging in the first half -- and headed for a further
drubbing by central bank sales in the second. GFMS indicates that there
is a substantial, non-British central bank sale currently underway. If
confirmed, this would help to explain gold's recent weakness in the face
of the Asian recovery and dollar weakness. GFMS has a second-half gold
price estimate of $252 per ounce, within a $240-270 range.
We have examined the GFMS first-half data and second-half estimates, and
we continue to take issue with several of its conclusions:
(1) GFMS reports first-half mine production of 1,230 mt, a 1.3% gain
from the year-ago period; its second-half estimate of 1,339 mt brings the
1999 total to 2,569 mt -- 120 mt above our estimate. First-half
production declined in 13 of the top 20 gold producing countries. Based
on the outlooks from the North American and Australian companies under
Salomon Smith Barney coverage, and educated estimates about South African
and other major producers, we believe that GFMS is overestimating the
second-half production strength. We note that two of the major additions
to supply in the first half, the Grasberg mine in Indonesia and Pierina
in Peru, should see production declines in the second half in line with
planned reductions in ore grades, offset in part by further gains at
Yanacocha in Peru and a production rebound at several Australian
operations. We maintain our full-year mine production estimate of 2,450
mt, a 4% year-over-year decline. We note that GFMS suggests that mine
production is set to decline in subsequent years as mine closures,
high-grading, development deferrals, and the collapse in exploration
continue to take their toll.
(2) Western world cash costs averaged only $200 per ounce in the first
half, a marginal gain from $198 in the second half of 1998 -- held low by
the remarkable performance of such mines as Pierina ($38 per ounce) and
Yanacocha ($113) in Peru, Meikle ($96) and Pipeline ($48) in Nevada,
Granny Smith ($81) in Australia and Sadiola ($113) in Mali. Average cash
costs in Australia, South Africa and Canada have been climbing since the
third quarter of 1998, as the one-off currency benefits to overseas
producers are reversing. Of more importance longer term, some 58% of
mine ounces worldwide show total production costs (including DD&A) above
$261, underscoring our belief that at long term gold prices at or below
$250 per ounce, there is no gold mining industry.
(3) We spoke to the World Gold Council regarding the apparent
discrepancy between the WGC's demand survey that showed dramatic demand
gains of 62% and 16% in the first and second quarters, respectively --
while GFMS's "fabrication demand" number shows a 3.2% decline in the
first half. GFMS includes scrap in its figures, so the one-time massive
dishoarding that took place in Asia in early 1998 served to boost GFMS
fabrication demand numbers in 1998, and the sharp dropoff in scrap
supplies this year will mute that measurement of demand. Adjusted more
to an "apples-to-apples" basis by subtracing scrap, the WGC notes that
Gold Fields "new gold" demand increases year to date were an impressive
39%. In our own supply/demand estimates, we have adjusted our fabricated
jewelry demand estimate down by 125 mt to 3,175 mt, which is offset by a
100 mt decline in our scrap supply estimate to 550 mt. Bar hoarding and
coin demand appear stronger than we had estimated earlier this year, and
we raised our bar hoarding estimate to 275 mt. We are raising our
"deficit" estimate modestly to 1,050 mt for the year.
(4) Like GFMS, we remain most focused on the dynamics of how the
supply/demand gap is filled -- whether by central bank sales or lending
that provides liquidity for producer forward sales and speculator short
selling. GFMS takes the bearish slant on every aspect of this dynamic,
noting that although reported net central bank sales were almost
nonexistent at 19 mt in the first half, they will surge to 236 mt in the
second half. Moreover, GFMS strongly suggests that another large
non-British sale began in August, and that it is ongoing in "lumpy"
fashion. We have been surprised, frankly, by the ongoing lack of
confirmation of speculation regarding large central bank sales in recent
years, but we assume GFMS may be correct this time.
(5) The recent volatility in gold lease rates -- and the likely strength
in lease rates through year-end -- appears inconsistent with GFMS
forecasts of further significant gains in hedging and short selling in
the second half. Ironically, lease rates were not climbing during March,
when first-half producer hedging gains were most evident. Producer
forward sales and derivatives added 252 mt to supply in the first half,
and GFMS estimates the full-year total to approach 400 mt. One-month
lease rates spiked as high as 5.05% last week, with three-month and
six-month rates as high as 4.13% and 4.35%, respectively. We expect that
further hedging gains -- and the propensity of speculators to add to
short positions -- may be constrained by the still-high rates. Moreover,
we understand that dealers are attempting to entice producers with fixed
lease rates embedded in their hedging strategies to switch to floating
rates -- a possible sign that dealers are growing nervous about the
potential for gold to flirt with backwardation. Key players who added
hedging positions in the first half were AngloGold, Barrick, Placer Dome,
and Ashanti, with Newmont following suit. South African forward
positions expanded dramatically, while Australian forwards fell for the
third consecutive period in favor of structured option strategies. Total
hedging including forwards and options now stands at about 3,800 mt, or
1.5 years' world mine production.
(6) For the first time, GFMS took its critics head-on, disputing reports
of total outstanding central bank loans of 10,000-12,000 mt based on
surveys of central banks and their counterparties. (We note the larger
numbers, which we have increasingly come to find credible, are predicated
on an identical methodology.) GFMS estimates that central bank lending
increased by 200-300 mt in the first half to total some 5,000 mt. The
demand for loaned gold liquidity is broken down into producer hedging
(50%), fabricator borrowing (20-30%), speculator shorting (20-30%), and
official sector operations. At year-end 1995, there were 67 banks
lending 2,670 mt, compared to 82 banks now lending 4,490 mt. They break
down the lending position as follows:
Loan Number of Total
Range Banks Loans
>150 t 12 2,460 t
50-150 13 1,250
<50 57 780
In its reports, GFMS corroborates the growing awareness that high lease
rates are the result not only of hedging and short-selling demand, but of
central banks withholding gold from the lending market. To some extent,
this a normal seasonal consideration ahead of year-end, likely
exacerbated this year by Y2K and credit concerns. In our view, the key
point is that additional lending is required for supply/demand balance to
be achieved.
In its report, GFMS underpins its view of price weakness by noting
"circumstances are ideal for short selling: abundant above-ground bullion
stocks imply low leasing rates, a high contango and therefore a bias to
the downside." The fact is that lease rates are high and the contango is
low. We continue to believe that gold will participate in the commodity
up-cycle. Against a backdrop of Asian economic recovery, U.S. dollar
weakening, emerging inflationary signals, and rallies in base metals and
oil, gold demand will strengthen while supplies will be increasingly
constrained -- with a potential central bank lending shortfall between
now and year-end. Moreover, many derivatives positions are lopsidedly
short and too large for the underlying market, should gold prices begin
to rally as we expect.
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