Gathering portents foretell a rise in the price of gold
Apr 12
Trevor Sykes
Somewhere out there, maybe next month or more likely in about two years, a great rally in the gold price is lurking. This was the inescapable conclusion from the Australian Gold Conference in Perth last Monday and Tuesday.
view graphic
There are bound to be sceptics. After all, the gold price has been in decline since 1980; all gold conferences like to hear good news; and the fact that physical demand for gold has exceeded demand for the past decade has not stopped gold's chronic price sag. So why should things be any different in future?
The answers are that (a) the supply-demand imbalance is about to grow worse, and (b) the gap in the past has been filled by hedging and central bank sales, factors that are likely to change and may well have begun changing on March 9.
Demand for gold is growing steadily. Jewellery and industrial uses (there's gold in every computer, for example) are soaking up about 3,800 tonnes of gold a year, while only 3,200 tonnes comes onto the market as physical supply (in round figures, 2,500 tonnes from mines and 700 tonnes from scrap). That leaves a gap of 600 tonnes which has been filled by the central banks and hedgers.
Demand for gold is likely to continue rising by a few per cent a year. Supply has peaked and is about to fall over a cliff.
Daniel McConvey, vice-president of Goldman Sachs, which is probably the largest gold broker on the Comex, told the conference that world mine production was likely to be static for the next five years and then begin declining to about 1,800 tonnes by 2014. There are several reasons for the looming decline in gold mining, but the overarching one is simply that the lower gold price is making mines uneconomic.
Experts from all over the world broadly agreed with McConvey's forecasts. The chief executive of Harmony Gold, Bernard Swanepoel, said gold mines had been closing in South Africa and 300,000 workers had left the industry over the past five years.
The mines staying in business are sometimes resorting to high-grading to survive. Mining the higher grades is more profitable, but shortens the life of the mine.
The chairman of Kinross Gold of the US, Bob Buchan, said the average mine grade of the top five North American miners was now 40 per cent higher than the reserve grade. That implies the average and lower grade ore is being left and may never be mined. Those five companies, incidentally, account for 80 per cent of North America's production.
Buchan also said that exploration spending - the lifeblood of any form of mining - had fallen from $US550 million in 1997 to $US200 million ($401 million) this year. Worse, the bulk of the exploration was brownfields, which means looking for extensions of existing mines. "Eighty per cent of current gold exploration is within sight of the headframe," he said.
Greenfield exploration (on new areas) is being inhibited - particularly in North America and Australia - by native title and environmental issues. But it is also being inhibited by economics. All the easily found gold has been discovered and future finds are going to be at depth or beneath sand or salt cover, so exploration will become more expensive.
By and large the gold industry has been generating poor, and in some cases negative, returns for investors. The natural consequence is that funding from both investors and bankers has dried up, not only in Australia but around the world.
Until now, the supply-demand gap has been filled by central bank sales and hedging, but there are signs that both may be changing.
The recent spike in leasing rates, which ran to an intra-day high of 6.8 per cent on March 9, is ominous for any speculators who have been shorting gold.
In a normal forward sale, a central bank lends gold at a leasing rate of maybe half a per cent to a bullion bank, which sells it immediately and invests the proceeds in a riskless security such as a US T-bond yielding, say, 7 per cent.
The bank deducts a commission for itself and the rest of the income from the security goes to the gold miner. The maturity of the T-bond will be matched to the period of the forward sale.
Everyone is happy. The bullion bank gets a commission, the central bank gets 1 per cent on an otherwise sterile asset, and the miner in the above example gets a contango of 5.8 or 5.9 per cent compounded over the period of the loan.
The borrowers of gold now appear to have bumped against a ceiling. There ain't no more to lend. The chief lender until now has been the Bank of England, which has 70 tonnes of its own to lend, plus an unknown amount which it holds on behalf of other central banks.
In March dealers who needed gold overnight tried to borrow from the BoE and were told it did not have any more to lend. They were forced to borrow it for a month instead, and the leasing rates shot up from 0.5 per cent to 6.8 per cent.
At these rates the borrowers were losing money on the deals because falling interest rates means the return on a riskless security is now about 5 per cent. The leasing rate has since retreated, but is still about 2.6 per cent, which is high by traditional standards.
It appears that the central banks are determined to get a better return on their gold loans and that at current interest rates, the miners face sharply reduced contangos on their future forward sales. And short sellers must have received a nasty fright.
It's too early to say yet, but it may be a portent of things to come. The gold price will turn one day and when it does, it may be brutal.
--------------------------------------------------------------------------------
afr.com |
