Investors the key to gold price

Thomson Reuters’ GFMS gold survey is a much-anticipated publication amongst gold investors. 

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

Meader began his presentation by examining broad technical indicators. 

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

Bearish investors say gold falling below its 200-day moving average is a sign that softer prices are ahead, but Meader counters that the last time prices broke below the 200-day average was in 2008. Prices quickly recovered, and surged to new highs. 

He described gold’s recent downward move as “2008 light,” and said it had to do with volatile markets overall, and 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 translates to US$2,320 per oz. with current dollars. 

He was quick to point out, however, that he doesn’t 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 reveals the supply and demand fundamentals that underlie the metal. 

On the supply side, mine production last year was up 2.8% to 2,818 tonnes (90.6 million oz.), from 2,740 tonnes (88.1 million oz.) the year before. This represents the third consecutive year of gains, which reversed a previous downward trend. 

Meader said the reversal shows how better prices sustain output in mature areas, while encouraging new projects to come on stream.

The 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 gold producers — 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 tells what miners and mining investors have known for some time: costs are on the rise. 

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

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

But supply from mine production pales next to above-ground stocks. Above-ground supplies for 2011 came in at 171,300 tonnes  (5.507 billion oz.), with 50% in jewellery.

And while the above-ground supply source is large, it is important to consider that it is no longer increasing the way it was from the 1980s into the late 1990s.

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 sold it into the market in the past.

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

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

But scrap supply increased in Europe and North America, and in the industrialized world there was more distressed selling — especially in Europe, because of the debt crisis.

When all of the supply sources are netted together, total supply was up just 0.6% to 4,486 tonnes  (144 million oz.) for the year. 

Next, Meader turned to the demand side of the equation. 

On the negative side, jewellery demand was off 2.2%, while institutional investments in gold instruments were down 90%. 

But a large 490% increase in central bank demand combined with increased demand for physical bar holdings.

The 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 large gold buyers for reserve accounts include Russia, Thailand and Korea, along with some Latin American and Central Asian countries. 

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

As for world investment demand, the sector demand was down 10% to 16,505 tonnes (530 million oz.), but in absolute terms it remained elevated by historical standards by making up 36% of total demand.

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

Meader said institutional investors hold metal at historically high levels chiefly because of low interest rates, sovereign debt issues, inflation threats in the Western world and inflation in emerging markets.

An interesting trend in the investment sector over the last five years is increasing demand for gold in Germanic Europe. 

Germany, Switzerland and Austria showed a large increase in physical demand, and Meader offered it was likely fuelled by thoughts of the hyperinflation seen after the First World War. 

Also of interest was the resilient demand for the metal from exchange-traded funds (ETFs). Demand from the funds was up slightly last year, and it is moving steadily 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 a place for speculators — and it is there that the large drop-off in gold demand occurred. The downward trend on the Comex began 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 argued that that disconnect shows the significance of other sectors, such as central-bank buying, when it comes to determining price. 

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

Meader said, however, that the issue requires a distinction.

“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 will combine with an increase in scrap selling. This increased supply will meet with a slight decrease in jewellery-making, continued official-sector buying — although less this year than last — and more demand on the investment side. 

With fabrication demand down, market surplus is set to grow. But Meader says the macroeconomic environment points to sufficient support, 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.”

Things look rosier further out, however, as U.S. debt problems come home to roost. Any story that hints at another round of quantitative easing could 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 an average gold price for 2012 of US$1,731 per oz.