Gold Needs Inflation

Stimulus hasn't done it. China's demand hasn't back-stopped the crash...

 

VINCENT PISANI has been senior resources analyst at Shaw Stockbroking in Sydney, Australia, for four years.

 

Prior to that Pisani served as an institutional dealer at Shaw, and was managing director of Cazenove Australia for three years and director of resources research at UBS for nine years, as well as a Buy Side fund manager with Prudential and Bankers Trust before that.

 

Here Pisani tells The Gold Report how cost-cutting miners in Australia – known Down Under as "toe cutters" – are adjusting to the sharp drop in mineral prices so far, and why gold needs inflationary pressure to turn higher.

 

The Gold Report: In the last Shaw Stockbroking quarterly report, you wrote that although sentiment in the resource sector is poor, companies have driven operating costs down and reduced capital spending to the point where it could signal the start of a more positive story moving into next year and beyond. Would you please elaborate?

 

Vincent Pisani: The Australian gold companies have probably been the most proactive in reducing their cost structure over the 12 months. Since gold peaked at $1800 per ounce in September 2011, it's been pretty much a relentless drive on the cost side for a large number of our gold producers. 

 

The minnows – companies that produce between 200,000 and 400,000 ounces per year – have done some amazing work to reduce their cost structures to ensure that they generate positive cash flow throughout their divisions.

 

TGR: What will be the trading range for gold in 2015?

 

Vincent Pisani: I look at how much economic stimulus has been done in the last three years and what that has done to inflation – and that's basically nothing. It might have spurred a little economic growth or stopped economies from collapsing but Japan has already seen a large stimulus package and it has negative growth. We recently had a G-20 meeting in Australia where global leaders agreed to elevate world economic growth by 2% annually over the next five years. To accomplish that, there could be another round of stimulus packages for big infrastructure projects. Stimulus hasn't done much for the gold price thus far. We've seen unprecedented Chinese demand for gold all the way up to $1800 per ounce and then all the way down to $1200 per ounce, and it hasn't really backstopped prices. Gold's fundamentals need inflation.

 

TGR: We're covering a range of mined commodities today. Are the fundamentals for copper positive? Will the red metal stay above $3 per pound for most of 2015?

 

Vincent Pisani: Over the next six months, copper is going to stay between $3 and $3.20 per pound. There isn't much fundamental demand driving copper prices. If we look at copper and aluminum as commodities, it's probably cheaper to substitute between the two, with aluminum at $2000 per ton versus copper at $7,000 per ton. There is currently about 400,000-500,000 tons in surplus copper.

 

TGR: Moving from copper mining to nickel mining, how is the ban on nickel concentrate exports from Indonesia affecting the fundamentals of that commodity?

 

Vincent Pisani: The Indonesian ban started on Jan. 14, 2014. People panicked because Indonesia is a big supplier of nickel concentrate to the Asia Pacific market, particularly China. The nickel price went to $20,000 per ton from $14,000 per ton over five months. The panic wasn't justified because the Chinese had bought a huge amount of nickel concentrate in advance of the ban. Chinese stainless steel producers, which use most of that nickel, were probably in much better shape to handle an Indonesian ban than the stock market expected. Consequently, we've seen the nickel price fall over the second half of 2014.

 

Since August, London Metals Exchange (LME) nickel stocks have gone up by about 30%, which suggests a surplus, and producers, in general, have maintained production. But most of the demand is in the Asia Pacific region where we've seen nearly 10 months of zero supply from Indonesia. By April 2015, we could be in another period of technical shortage in the Asia Pacific region, much as we saw with aluminum. There was a big increase in aluminum LME stocks throughout 2013 and into 2014, but premiums in the Asia Pacific market for aluminum have been $300-400 per ton above LME. This is likely to happen with nickel, too. I'm bullish on nickel at current levels. It could move back up to $20,000 per ton. A few of our nickel companies are extraordinarily cheap for the cash flow they produce.

 

TGR: Another commodity that you follow is graphite. What's your outlook for graphite, given its growing use in lithium ion batteries, permanent batteries and refractories?

 

Vincent Pisani: I'm probably not as bullish as others. Graphite is a bulk commodity. There are plenty of graphite resources around the world. The graphite market is still developing. And forget graphene as an investment thesis because demand from the graphene-related technology will be low for the next three or four years.

 

Graphite use in batteries is on the rise but analysts tend to get a bit too emotional about how quickly some of these industries are going to soak up all the world's graphite. If a company plans to provide flake graphite to the lithium ion battery market, think again because there are probably 15-20 companies negotiating with the same end users. Bulk graphite production is probably a smarter space to be in long term because it has much lower costs of production, so those companies are going to be profitable at lower graphite prices.

 

TGR: In your recent quarterly report, you noted that graphite prices dropped 5-7% in the previous quarter. Should investors expect further price weakness?

 

Vincent Pisani: Graphite prices are probably going to be fairly stable over the course of 2015. Let's see what happens after any new production comes on-line.

 

TGR: What is next for graphite companies?

 

Vincent Pisani: The next question for a lot of companies is will they have the resource good enough to get financing in this environment? Very few companies are capitalized over AU$100 million. It's going to be an interesting 2015 for graphite companies.

 

TGR: Is it the same story for lithium? Companies in that space are also largely dependent on offtake deals.

 

Vincent Pisani: Lithium is slightly different because there are only a few good deposits. If a company is producing lithium and has a track record in lithium, it is probably in good stead. But there are very few. How many producers are there in lithium? A lot less than there will be in graphite, so there's probably a better market in lithium than there is in graphite at this point.

 

TGR: What are the catalysts for lithium? Is it all about the electric vehicles?

 

Vincent Pisani: That's about it. We will probably see more electric vehicles sold in 2015 than in the history of mankind – and that number will only go up. Tesla is selling thousands of vehicles per annum, and that's just one of many manufacturers. From BMW to Land Rover to Mercedes, just about every car manufacturer is looking at electrical vehicles. Who is going to be supplying those manufacturers? We have to look at the big Japanese car manufacturers and if a company is not aligned with some of those with graphite or lithium offtake contracts, then it doesn't have much of a chance to succeed.

 

TGR: Thank you for your insights, Vincent.