The latest GFMS report shows how far the gold market has come...
Global Watch: 16th April 2007
A snippet from the latest weekly issue of GoldForecaster.com
GFMS in LONDON have provided, as always, a most competent gold report of what happened in the gold market last year.
Their conclusions highlight the evolution of the gold market over the last 7 years, starting when the Washington Agreement – limiting central bank gold sales each year – was signed in 1999.
At that time, the gold market was clouded by the constant threat of unexpected central bank sales, as well as the treatment of the metal as a commodity, plus accelerated gold production. Output was fuelled by the hedging of future production at prices persistently higher than those achieved when each new mine actually came into production.
Since then, the path of gold has been remarkably steady. At first a key change was the announcing of central bank sales of gold ahead of the event. This limited sales to agreed "ceilings", removing the fear of unexpected sales – such as those dumped on the market by Gordon Brown at the UK Treasury in May 1999.
Back then the gold price was also at the mercy of hedge and speculative fund dominance making the gold price rise – and then fall – 30% each way.
Jewelry demand, along with other uses for gold grew steadily, absorbed price rises until it became apparent that the gold price was going far higher. Demand from this source stabilized, most noticeably in the West, but also in times of volatility in India, the world's largest market.
But as gold prices rose the metal moved out of the reach of the smallest consumers, driving a more to lower caratage gold, so reducing tonnage demand. After all, jewelry consumers still wanted something they could afford and that looked like gold, so price was very important to them.
Investment vs. adornment in 2007
Jewelry making remains a key source of demand for gold even now. Off-take in the sector fell sharply in 2006 by 428 tonnes to 2,280 tonnes, marking a 15-year low. Gold imports into the Middle East, which were cut by half last year, could be reduced again this year if price volatility remains in place. Turkey, Saudi Arabia and Egypt accounted for 80% of the decline in imports, which were affected by increased scrap supplies and less jewelry production.
On the other side of the consumer market, scrap jewelry volumes leapt 34% or 112 tonnes last year. The outlook for this year is not much brighter if prices continue to rise, which would mean jewelry demand could contract even further – but the pull back is unlikely to be as steep as in 2006. The lost jewelry demand has to be replaced with investment demand or prices will fall to a level where jewelry demand returns.
But in the Indian sub-continent gold demand grew as it held true to its promise of financial security and reliability. Gold provided a savings account out of the sight of a corrupt officialdom, satisfying privacy requirements as well as fulfilling local religious and social requirements.
Higher prices eventually brought in wealthy individual and institutions, all looking to gold for long-term investment. Last year – like 2005 – saw a gear-shift in the attitude to gold as an investment rather than as a commodity or even simply jewelry. But investment tonnage dropped in 2006 compared to the previous year, as the market adjusted to a more active buy and sell activity, rather than just buying.
Implied net investment fell 20% in 2006 to just under 400 tonnes. But GFMS states that, “Continued weakness in the US Dollar, ongoing geopolitical tensions and strong commodity prices, coupled with fundamental support appearing on price dips, continue to make the investment case for gold strong.”
Here at GoldForecaster.com, we agree completely, but would like to add that further gains will come increasingly on the back of falling global confidence in paper money and uncertainty over the stability and prospects for the global economy.
Central banks return to gold – slowly
The most recent bull market in gold also coincided with a change in attitude of the central banks. They're fully aware of the dangers facing the Dollar as well as other paper currencies. We've now seen a transition from the gold overhang of 1999 to some central banks buying the metal, wanting to lower their exposure to the Dollar.
But the most important move by the central banks, led by Germany and Italy, was their refusal to sell their gold, saying that it was a “useful counter to the Dollar”. This stated its monetary value as an integral part of their reserves. Central bank gold sales slowed sharply in 2006, declining 51% to 328 tonnes as signatories to the Central Bank Gold Agreement (CBGA) recorded lower sales and some other banks starting to buy gold.
On the one hand, Agreement signatories seem set to continue to sell below their annual quota, and on the other, the appetite for certain central banks to diversify away from US Dollar and into gold is likely to generate further purchases.
The volumes of purchases are expected to be constrained, however, at least for the short to medium term. There is even a possibility that the announced gold sales of the Central Bank Gold Agreement will be virtually exhausted by the 26th of September, the end of the C.B.G.A. year.
Central banks are faced with a gold market in which they find it difficult to buy gold in volume without setting the gold price shooting up. Plus they need to propagate their own national currencies, but they're becoming unhappy with holding huge amounts of paper money, all now set to fall in value.
The gold market will continue to evolve, we believe, into an investment market for central banks, institutions and wealthy individuals with gold prices rising to a level that makes gold most gold jewelry just too expensive. Indeed we expect the commodity side of gold to diminish, where replacement metals are an alternative. At some point in the future we would expect institutional demand to provide sufficient liquidity for major central bank transactions as in the past.
Sound too rich? Just take a look at the data from the European Central Bank for the week before last, in which the sales of gold from their members was, yet again, overshadowed by the quarterly revaluation of their reserves. The revaluation of total gold reserves, after the sales of the week, was the equivalent of buying nearly 250 tonnes of gold. However, this point seems to be lost on those still fearful of more central bank sales and on those central banks still selling gold.
Is it any wonder that wealthy individuals and institutions want to follow Germany and Italy in holding gold?
De-hedging confirms rising prices
The very act of de-hedging is a statement by gold producers that they believe in a rising gold price and don’t want to lose profits by selling their gold ahead of production. So last year continued the strong trend of producer de-hedging, buying back 373 tonnes. The de-hedging will continue in 2007, with a total of between 210 tonnes and 300 tonnes for the full year.
The total outstanding forward sales, loans and the delta hedge against option positions stood at 1,364 tonnes at the end of 2006 giving producers an ongoing nightmare. Every time a producer reports that he sold for between $350 and $430, when he could have got $675 if he had waited, he does so with head hung low.
Isn’t it better to take that lost opportunity now by buying back the hedge immediately? Miners will get to benefit from the continuing price rises, rather than watch their position steadily worsen.
On the supply side, the picture looks brighter for 2007 after global mine output fell by 79 tonnes last year to a 10-year low. The decline was led by Asia, Africa and North America. Cash costs rose by $45 per ounce, double the increase in 2005. New mines, ramp ups and less of a swing at some of the world’s larger operations that dampened the impact of new production in 2006 should support production level to above 2,500 tonnes.
But don’t expect that to rise to the point where the present levels of demand will be satisfied.
For the entire report, please subscribe to GoldForecaster.com