Bank on the future

Global Economic Prospects, the annual compilation of economic forecasts made by the World Bank, is out, and the economists have good news and bad news for the mineral industries.

The good news is that the Bank expects most metal markets to move into a deficit in 2004, in response to a generally better worldwide economy. The Bank notes drily that metal prices had rallied several times in the last two years but “prospects for a strong economic recovery have kept being pushed back,” a familiar theme to anyone following base metal markets.

Now, say the bankers, the bad news: gold prices aren’t going to hold up.

The Bank observes — quite correctly — that when the gold price increased in 2002, it did so at a time when producers were buying back hedge positions. It argues that when hedge positions are reduced to a level that gold producers (and their shareholders) can live with, a significant support under the gold price will disappear.

That’s a sound point of view we have encountered before (indeed, our own metals commentators, Kevin Norrish and Ingrid Sternby of Barclays Capital, have held to this school of thought over the entire gold rally). There can be no question that having producers in the market buying gold to clear existing hedge contracts supports the price.

But producer de-hedging didn’t happen in a vacuum, either; it was as much a response to rising gold prices as it was a cause of them. When large producers with big hedge books saw the price turning, they had to shrink those positions or miss out on a big increase in revenue.

We can all agree that producer de-hedging supported the gold price over the last year or two. But that also implies that the old situation, where hedged producers could be counted on to come in and sell gold into any rally, put plenty of resistance into the gold market. Unless there’s a strong move back to hedging, future price rallies aren’t going to be drowned in a sea of forward sales and puts.

We’d name this point of view the Lassondite school, after one of its more articulate exponents among the non-hedging crowd. It holds that a gold market without the overhang of large producer hedge positions will be driven primarily by the 1,400-tonne difference between annual consumption and annual mine production, and by gold hoarding. One of those schools of thought is going to turn out to be right.

The World Bank forecasts also suggest that gold supply, and particularly mine production, are likely to “increase moderately as new low-cost operations come on stream.” We’re less convinced, not least because currency advantages in several large producing countries — South Africa most of all, but also Australia and Canada — are disappearing as the United States dollar descends.

We’re also less sure about the robustness of the “new low-cost operations” the Bank predicts. Some of those are projects that were shelved during the period of low gold prices; their feasibility studies are not all up to date and their cost projections may turn out to be a little — or a lot — optimistic. Cheap and plentiful gold is not a sure thing.

The principal danger in new mine production is not that the gold industry is likely to flood the market, but that marginal projects may be pushed into production in the hope that prices will hold up. The consequent waste of capital may be much harder on the industry than a moderate decline in prices.

As for hoarding, it has become respectable to own gold once more, at least on the hard-assets margins of the financial industry. That has spread, we understand, to central banks as well. The World Bank points out that the Washington Agreement — under which the European Central Bank and fourteen national central banks agreed to limit their gold sales — expires in 2004, and much will depend on whether the agreement is renewed.

Gold leasing, which the banks found very lucrative in the 1990s, is not nearly the moneymaker it once was, and interest rates remain low. We wouldn’t be surprised to see a new agreement, because the central banks have very little to lose by making one.