FACTS ‘N’ FIGURES — Evaluating gold’s slump

In Gold 1998, the latest annual survey of the gold market, Gold Fields Mineral Services (GFMS) focuses on the causes of the sharp fall in the gold price during 1997, when the average PM fix in London, at US$331.29, was at a 12-year low.

Above all, the price fell because of the increased supply which came onto the market via producer hedging, fund short selling and official sector sales. The supply from these components more than doubled, to 1,179 tonnes, helping push total supply to 4,254 tonnes, the highest level ever. The response from the demand side was reflected in record amounts of gold being used in jewelry fabrication and a jump in bar hoarding to levels not seen since the late 1980s. The survey notes that with the weakness of demand in Southeast Asia, as a result of the financial crisis of the second half of the year, the price had to fall very steeply in order to stimulate sufficient physical offtake to balance the market.

Together, hedging and divestment accounted for some 773 tonnes of supply.

These supplies had in common that the bulk of the metal involved was provided initially by the official sector (mainly central banks) in the form of deposits or swaps of gold placed with commercial banks. The borrowing and immediate sale of much of this gold represented the biggest area of increased supply last year, but, in addition, the official sector also contributed directly to the increase in supply by selling a net 406 tonnes.

It would be difficult to overestimate the influence of the official sector on the course of the gold price last year. A seemingly endless series of comments and announcements by central banks ensured that the future of official gold holdings was permanently at the top of the market’s list of concerns. Market participants seemed at times transfixed by the question of how much official gold, especially among European nations, might be sold in the run-up to the Economic and Monetary Union (EMU) and in light of comments made by Swiss authorities which clearly signaled the end of the country’s previously passive management of its large gold reserves.

Somewhat ironically, however, it was the announcement of sales from Australia which had the most damaging impact on the price during the year.

In spite of this and other large sales, more official gold came onto the market via hedging and private sector divestment. The motivation behind much of the hedging and short selling that constituted this total was the (sometimes exaggerated) fear of official sales. Thus, not only did the official sector’s disposals and announcements tend to boost hedging and divestment, but its willingness to provide the market with cheap liquidity undoubtedly facilitated such supplies.

Nonetheless, mine production rose by 4.6%, perhaps a surprisingly high figure given the fall in prices during the past two years and the significant increase in output in the previous year. The explanation for the rise is twofold. Firstly, very few of the cutbacks announced last year (in reaction to the fall in prices) were implemented in time to have significant effect on 1997 output. Secondly, supply was boosted by the startup of substantial new capacity that had been in the pipeline during the previous two to three years.

The 17% jump in the use of gold in jewelry in 1997 from the previous record set in 1996 was due mainly to India and the Middle East, where jewelry fabrication rose 41% and 31%, respectively. Purchasers in Europe and North America also increased their consumption of jewelry substantially last year (about 7% each), at least in part because of the lower gold price. The July market crisis had a devastating effect on the gold jewelry business across the Far East region, although this was masked in total 1997 figures because most countries had seen good demand in the first half of the year.

As for the 1998 outlook, market sentiment improved somewhat in the first months of the year, particularly when prices rose following the sale by Belgium of 299 tonnes. Also, North American funds moved into the long side in April, perhaps in reaction to suggestions that further gold sales by European countries are less likely as the EMU reached the end of its first critical phase. Overall, it seems unlikely that the gold market this year will have to absorb the massive wave of liquidity that nearly drowned it in 1997.

— The preceding is a summary of Gold 1998, published by Gold Fields Mineral Services, a London-based commodity research company.