GFMS Survey: Investors hold the key to gold price

The publication of the Thomson Reuters GFMS Gold survey is a much anticipated event amongst gold investors.

This year’s presentation of the survey was conducted by Neil Meader, research director of precious metals at GFMS, and while overall Meader was optimistic about the price of the yellow metal he presented some data that could give bullish investors some pause.

Meader began the presentation with an examination of some broad technical indicators.

He pointed out that the 2011 gold price rose 28% — beating the previous year’s gain of 26%. Such an increase in price growth suggests that momentum isn’t running out any time soon, he argues, as if it were the year-over-year increase would have been smaller.

As for bears who point to the gold’s falling below its 200-day moving average as a sign that softer prices are ahead, Meader countered that the last time prices broke down below the 200-day average was in 2008, and prices quickly recovered and surged to new highs.

He describes the recent move as “2008 light” and said it had to do with volatile markets over all, and as such, is best considered as noise that doesn’t mean the rally is over.

But what of those who argue that recent gold prices are unsustainable because they are at uncharted highs? Meader points out that when adjusted for inflation the 1982 high actually translates to US$2,320 per oz. in today’s dollars.

He was quick to point out, however, that he doesn’t necessarily believe gold will reach that inflation adjusted number.

“You’d have to be quite brave to suggest we’d be over that daily high at some point this year,” he said.

Digging deeper into the gold story the survey also focuses in on the supply and demand fundamentals that underlie the metal.

On the supply side mine production last year was to up 2.8% to 2,818 tonnes from 2,740 tonnes the year previous. That represents the third consecutive year of gains, which reversed a previous downward trend.

Meader said that such a reversal shows the impact of better prices which are sustaining output in mature areas while at the same time encouraging new projects to come on stream.

Those new projects are sprouting up in areas that haven’t had large scale commercial mining before which means a greater geographical spreading of mines for the industry.

In fact, the traditional big four producers of gold — the U.S., Canada, South Africa and Australia — are all seeing their share of global production diminish.

On the cost side of the equation the GFMS survey bears out what mining investors have known for some time: costs are on the rise.

Indeed in just one year cash costs for mining production ran up 15% to US$643 per oz. from US$560 per oz. The single biggest contributor to such an increase was decreasing grades, which was responsible for US$28 of the inflation.

The only area that reduced costs was increased byproduct production, which cut costs by US$10 per oz.

But supply from mine production pales in comparison to that from above ground stocks. Above ground supplies for 2011 came in at 171,300 tonnes, 50% of which was in the form of jewelry.

And while the above ground supply source is large, it is important to consider that it is no longer increasing as it was from the 1980s into the late 90s.

The key reasons for the tail off are a lack of hedging by gold producers and an increased appetite for gold from Central Banks — who had been selling it into the market in the past.

As for the other key source of above ground supply, scrap, this facet of the market was down surprisingly given gold’s high price.

Supply from scrap fell 3.4% to 1,661 tonnes and that represents the second year it fell. Meader offered that one of the reasons for the decline was that in India many people were holding on to their gold in anticipation of higher prices.

Scrap supply did however increase in Europe and in North America. The key reasons for the difference being that in the industrialized world there was more distressed selling — especially in Europe because of the debt crisis.

When all of the sources of supply are netted together total supply was up just 0.6% to 4,486 tonnes for the year.

Next Meader turned his attention to the demand side of the equation.

On the negative side jewelry demand was off 2.2%, while institutional investments in gold instruments were down 90% (more on that later).

On the positive side there was a large increase in Central Bank demand of 490% combined with increased demand for physical bar holdings.

Those positives slightly outweighed the negatives and overall demand was up by 0.6% to 4,486 tonnes.

Meader also pointed out that increased Central Bank buying often has a multiplier effect as other investors take the official sector buying as a positive signal and make more purchases themselves.

As for which countries are buyers, he said Mexico was the largest purchaser. Other key buyers of gold for their reserve accounts were Russia, Thailand, and Korea along with some Latin American and Central Asian countries.

“In general it’s mid-tier countries that are buying,” Meader explains. “We’re not seeing the very large tier countries buying.”

As for world investment demand, overall the sector demand was down 10% to 16,505 tonnes but in absolute terms it remained elevated by historical standards by making up 36% of total demand.

Meader says the 10% decline was a “little surprising” but attributed it mainly to profit taking by speculators.

As for why the metal continues to be held by institutional investors at such historically high levels, Meader said the key reasons were: low interest rates, sovereign debt issues, the threat of inflation in the Western world and actual inflation in emerging markets.

An interesting trend in the investment sector over the last five years is the increased demand for physical gold in the Germanic part of Europe.

Germany, Switzerland and Austria all showed a large increase in physical demand and Meader offered that the factor fueling such demand is likely the memory of hyper inflation after the First World War

Also of interest was the resilience of demand for the metal from Exchange Traded Funds (ETF). Demand from such funds was up slightly last year, and while it wasn’t a large increase it continues the one way direction of steadily moving higher.

“It is illustrative of the type of investor that is getting into ETFs,” he explained. “They are investors with longer time horizons. It is not the home of the speculative buyer.”

The futures market, however, is the place for speculators and it is there that the large drop-off in gold demand occurred. The downward trend on the COMEX began roughly one year ago.

“There is a disconnect between what is happening in the COMEX and what is happening with the gold price,” Meader said.

He argues that that disconnect is evidence of the significance of other sectors, such as central bank buying, when it comes to determining price.

Despite the importance of such other players in the market, gold bugs can’t get away from the disturbing fact that the market value of the surplus in gold supply is actually growing.

Meader, however, did say that an important distinction needs to be made on this issue:

“The value of the surplus has been growing more than volume of the surplus. But it is not necessarily bearish if there are people that are willing to pick up that surplus,” he said. “We are reliant on investors to pick up that surplus.”

With the data from last year succinctly analyzed, Meader turned to forecasting this year’s situation.

On the mine production side GFMS is predicting a marginal increase to combine with an increase in scrap selling as well. That increased supply will meet with a slight decrease in jewelry fabrication, a continuation of official sector buyer — although less this year than last — and more demand on the investment side.

With fabrication demand down, market surplus is set to grow but against that Meader says the macroeconomic environment points to sufficient support for gold and that should push up prices later this year.

“We think it is quite possible to see short term weakness,” he said. “There is seasonal weakness in Chinese demand and if the situation in Europe plays out in the wrong way we could see the dollar strengthen and it would be quite possible to get below US$1,600 per oz. with a trend to US$1,500 per oz. not coming as any surprise.”

Thinks look rosier further out, however, as U.S. debt problems come home to roost, and any story that hints at another round of quantitative easing would provide fresh impetus for gold prices.

“By year end we expect prices in the US$1,900 per oz. range which would be a fresh nominal high,” he said. “Whether it gets to over US$2,000 per oz.? That is more likely a next year event.”

The GFMS survey predicts a 2012 average gold price of US$1,731 per oz.