Gold's Down, Up, Down
By Jackie Steinitz
09 Apr 2008 at 05:55 PM GMT-04:00
resourceinvestor.com
LONDON (ResourceInvestor.com) -- Gold could rally strongly and post fresh highs later this year and into 2009. But in the longer term it is likely to fall quite rapidly to an equilibrium level around $600/oz, according to Philip Klapwijk, Chairman of the precious metals research consultancy GFMS, who launched the Gold Survey 2008 report at an impressive presentation in London today.
His argument in essence was that:
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The 50% price rally between September 2007 and the $1030/oz peak in March were driven primarily by investment demand. Since then the price has retreated by more than 10% to $917, but this is not surprising in light of the speed of earlier gains. The price could now move sideways for a while or correct further into the high $800s on the back of further stop loss selling and profit taking by investors.
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Eventually, however, bargain hunting by investors, stock replenishment and increased jewellery demand will underpin the price and there will be renewed investment interest which will drive prices higher. Investment demand will be supported by a number of factors including dollar weakness, lower interest rates, skeletons in bank closets, continuing weakness in the financial markets and ongoing interest in the commodities complex. Prices will be further supported by the lack of a supply surge this year as mine production is likely to be flat and official sector sales are expected to be neutral (though Klapwijk noted that higher prices could precipitate a significant increase in scrap sales which could act as a headwind on the price rally).
In such a frothy market GFMS note that predicting the top is a thankless task, and given the large involvement of speculators there are likely to be a number of corrections on the way to the peak such as the one experienced recently. However the report suggests that current “knowns” could easily push the peak price above $1100, but that it would take quite a few unknowns to push the price over $1200.
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Prices can remain high for as long as gold is supported by investment demand. This is likely to be for at least six months, and will quite possibly last into 2009, according to Klapwijk. However the longer prices remain high the more downside risk will increase because of the impact on jewellery demand. Eventually when there is a return to more propitious conditions in the economy and financial markets, and a more benign outlook for traditional assets the market may reach a point where investors in gold are no longer prepared to hold the baby. Prices could then drop quite rapidly back to $600 or so, as this is a level supported by production costs (which averaged $518/oz in 2007Q4).
Klapwijk concluded that the market must beware of “irrational exuberance” noting that positive sentiment in the market has recently reached similar extremes to the negative sentiment back in 1999. In the Q&A session Klapwijk was not unduly optimistic about prospects for share prices in gold mining companies despite the positive medium term outlook for the gold price because of increasing cost pressures.
Highlights in More Detail
The GFMS survey, now in its 41st year, is based on extensive research. This year the GFMS team of 18 analysts once again visited more than 300 companies and institutions in 39 countries, and updated a database of 700+ mines and projects. The report provides detailed estimates for the 10 years to 2007 on the fundamentals of the gold market, including supply, demand, stocks, investment, bullion trade and prices and looks at the outlook for 2008 and beyond.
A series of press releases about the report and the full presentation are available on the GFMS website, but perhaps some of the highlights are as follows.
Gold Prices
Prices have rallied in all currencies with, for example, prices in the first quarter of 2008 up 42% on a year ago in dollars and 24% in euros. Rupee prices which are an important determinant of demand (as Indian jewellery demand accounts for around one quarter of the world total) were relatively stable through much of 2007 but have risen sharply since September. Rand prices have rocketed on the back of the devaluing rand, but this has provided some much-needed relief to the South African producers who have faced a number of other problems.
Supply
Mine production in 2007 fell slightly (by 0.4%) to an 11-year low. China became the largest producer in the world, knocking South Africa, who has held the crown since 1905, to second place. South Africa, the U.S., Canada and Australia, traditionally referred to as the “Big Four,” now account for just 35% of world supply, compared to around 78% in 1970. Barrick [NYSE:ABX], Anglogold Ashanti [NYSE:AU] and Newmont Mining [NYSE:NEM] retained the top three spots in 2007. Production in 2008 is expected to remain broadly flat.
Production Costs
Cash costs have continued to rise relentlessly, partly because of the familiar reasons of rising energy prices and competition for labour and key consumables, but also because higher prices enabled producers to undertake more development and waste stripping work and to produce at lower grade. Total cash costs rose by $78/oz (25%) to almost $400/oz while production costs were almost $500/oz. Simple cash margins rose $13/oz in 2007.
Supply From Above Ground Stocks
Above ground stocks stood at 161,000 tonnes at the end of 2007 according to GFMS. This figure, which effectively represents cumulative historical production, is equivalent to around 65 years of production at current levels.
Stocks are held in a number of forms including jewellery, official bank holdings and private investment.
In 2007, supply to the market from the official sector rose 30% as sales by the Central Bank Gold Agreement (CBGA) countries returned to normal levels after a subdued 2006 while other central banks became net purchasers for the first time in a decade. Recycling however fell 15% against the strong 2006 figure mainly as potential sellers held off hoping for higher prices.
Total supply including mine production was down 1.7% in 2007. Mine supply and official sales are expected to remain flat in 2008 though, as noted above; higher prices may lead to a significant increase in the supply of scrap.
Demand
Last year was a year of two halves for jewellery demand. It grew an impressive 22% in the first half when prices were relatively stable, but fell 9% in the second half due in particular to the Indian response to higher prices and increased volatility. For the year as a whole, jewellery demand was up 5%. Anecdotal reports to date in 2008 suggest that jewellery demand this year could be down by as much as 20%.
Producer dehedging rose 9% in 2007 adding 450 tonnes (11%) to demand. However by the end of 2007 the hedge book stood at just 800 tonnes in delta-adjusted terms and so is now close to a steady state minimum level. The rate of dehedging is therefore likely to slowdown this year; GFMS are anticipating it will total just 150-200 tonnes.
Meanwhile investment demand in 2007 followed a pattern of famine then feast, according to Klapwijk. In the first eight months of the year there was net disinvestment as prices failed to breach $700 on a number of occasions, but since September and the onset of the credit crunch the growth has been stellar, driven by growing risk aversion, the weakening dollar and investor confidence in the financial services sector, all of which have brought gold’s safe haven status to the fore.
Although there was net selling in the over-the-counter market during 2007 investment ETFs, futures and physical metal all experienced marked inflows over the year.
Looking ahead in 2008 the double whammy of high prices and volatility could have quite a dramatic effect on jewellery demand. Other fabrication demand is less price sensitive but could be affected by the general slowdown in economic growth. Prospects for dehedging now limited in view of very low outstanding producer hedge book. Investment interest is therefore likely be the principal driver and there are a number of reasons, according to GFMS to expect that the effects of the sub prime crisis will continue to provide a strong investment case for gold.
So the game is not yet over for the current rally, say GFMS. But the end game is that sooner or later prices will have to fall in line with the supply/demand fundamentals suggesting an equilibrium price closer in the $600s/ounce. |
