Gold Peaked for Now?

How high prices hurt Gold and platinum demand – and what comes next for the industrial metals...

MIGUEL PEREZ-SANTALLA is vice president of sales for Heraeus Precious Metals Management, the international precious metals refining group based in Hanau, Germany.

   Here, he talks to Mike Norman of Hard Assets Investor...

Mike Norman: Miguel, why don't you tell us a little bit about your firm and what it is you guys do.

Miguel Perez-Santalla: Well, Heraeus Precious Metals is a company that was founded over 150 years ago by Dr. Bill Heraeus, and principally he was one of the original melters of platinum and helped to supply the jewelry industry.

   From there the company grew into many facets of the industry, manufacturing for platinum group metals and other precious metals as well in the jewelry market. We've now grown to having 12,000 employees worldwide. We have offices all over the world, including China, North America, South America. At this time, Heraeus is constantly growing and looking how to further produce product in those precious metals markets. So we're a consumer as well as a trading company.

Norman: Let's talk a little bit about those markets. Because you're on the industrial side of it, you deal with industrial companies, tell us – what are some of the factors behind the price run-up in precious metals?

Perez-Santalla: Well, the original factor, of course, was the new consumption coming out of Asia from China and India. That initial growth spurt sparked the market. Originally it was copper that drove it, then Gold, then all the other metals started rallying along with it.

   Once the metals were rallying, then there was news of the financial collapse due to the subprime mortgages, which then drove the metals even higher. In the platinum group metals, though, that was more affected by the problems in South Africa with the supply issues that started in February. That drove the price up to over $2,100 per ounce.

   Right now, we're starting to see a correction there, but fundamentally, what's gone on at these high levels is that the precious metals consumers have held back. Now that it's starting to correct a little bit, we're seeing some new fresh plans.

Norman: Is this a repeat of events that we've seen historically, where you get a spike in commodity prices?

Perez-Santalla: My personal opinion, from what I see, is that I do believe metal prices will correct. Will they go down from the levels we saw pre-2005? No. That was way undervalued, and then it started to come up.

   We're a little bit overvalued at the moment; there's going to be an adjustment. For instance, in the Gold Market, the metal is currently trading above $900 an ounce [mid-Aug.]. The greatest consumer of Gold in the world is the jewelry industry. Now the jewelry industry has come to a basic standstill with the price over $900 an ounce, because the consumer does not want to buy, so they've had to replace gold with other alloys.

   For instance, let's say a ring that would have been just pure 18 karat gold before, it may now be a 12 or 10 karat gold ring plated with 18 karats. So it looks the same, but in reality, you're getting less precious metal in that gold ring.

Norman: Let's talk platinum for a second. What would you peg currently as the cost of production?

Perez-Santalla: What I heard recently is the cost of production is somewhere around $800 an ounce. Of course, one thing you have to take into account when they say that figure is that they're building all their expenses into platinum and they're not really considering the residual gains they have from other metal by-products that come with the platinum group metals – which are rhodium...which by the way is an $8,000 an ounce metal...ruthenium and iridium, which are both around $300 to $400 an ounce.

Norman: So we won't see hip-hop stars with rhodium watches?

Perez-Santalla: I don't think so.

Norman: That's even out of their league, huh?

Perez-Santalla: Well, the interesting thing is that the biggest consumer of platinum and rhodium is auto catalysts, and I'm sure you're well aware of the fact that SUVs probably hold the most amount of precious metals out of all the cars out there.

   Now the SUV makers are getting whacked – not only are people not buying, but there are people ripping off the exhaust systems and having it refined somewhere, removing the catalyst.

Norman: But isn't there another element of demand besides the physical demand that industry needs? We're talking about investment demand now.

Perez-Santalla: Those factors have also been part of what's helped the metals grow in price so much. What happened early on in 2006 and 2007 is the exchange-traded funds came out, enabling smaller investors to buy physical metal without having to hold it – in essence, a way to hold the metal in paper form, such as the Gold ETFs.

   So that was a huge chunk of Gold that was taken off the market, and that affected the supply-and-demand factor. Then later on came the platinum group metals – platinum and palladium – they also created ETFs, and that also drove the metals higher.

   So these are fundamental causes that did drive the metals higher, and the investor demand has been there. But of late [summer '08], we have seen investor demand start to liquidate. I think because over the last few weeks we keep bumping our heads on the ceiling and investors said "Jeez, there doesn't seem to be any more upside potential here." And with the consumers – which is the industry – not buying and consuming, there's nowhere else for the price to go, and that's why I was bearish overall for the metals in the short term, expecting to see Gold, for instance, come down into the low-800s.

Norman: Let's characterize the different sort of players in here, because we have the speculators – who can go long and short, maybe exerting a short-term influence on prices –but then we have these big institutions like pension funds and endowments; they are long-only passive investors. They're not the ones who are liquidating, are they? Because they've decided they want a 3% or a 5% allocation. Once they put it on, they're going to hold it.

Perez-Santalla: You're absolutely right. The liquidators are the investment funds that are trading in and out of the market. Usually they're trading to show their quarterly gains, and as of this time, I think that they're liquidating because they're starting to have confidence back in the US stock market, in the bonds, and they're looking at paper again and starting to go in there. We've seen some really positive movement in those markets.

Norman: In the past, every time there's been a spike in commodity prices, you've seen technological advancements which led to a greater degree of productivity and efficiency, so we actually use less. Will this price-spike trigger the same sort of technological advancement?

Perez-Santalla: Definitely. In our business, industrial users call it "thrifting".

   Let's say they used one ounce of platinum to make something, and now they try to figure out what's the least amount they can use. This thrifting has also been a factor which has reduced the consumption of platinum, and that's why we've seen weakness in the platinum market.

   And I'll tell you another thing: Mines are not too thrilled to see platinum way too high, because they have the fear that someone will replace the metal eventually with something else if the science ever gets there. So for instance, back when platinum was at $800 an ounce, I would have had two researchers doing it. Now, at $2,000 an ounce, I'd have 10 looking for a replacement, because there's got to be a cheaper way.

   There have been reports recently of replacement of platinum in certain catalysts, not in great amounts. Like, for instance, it was Mitsui Mining replacing platinum catalysts with silver in heavy machinery, because there the size doesn't matter. Nisshinbo Manufacturing has found a way to replace platinum catalysts in fuel-cell technology, and they're going to replace it with carbon.

   These are little things, but little by little, they bite at that supply-and-demand factor for platinum and the other platinum-group metals, so that affects it.

Norman: So like they say, the Stone Age didn't end because we ran out of stone...we just found other things to use instead.