Gold set for bull run: GFMS

Facts ‘N’ Figures

With the gold price firmly above US$600 per oz., perhaps you might think there wasn’t much room left to climb. Not so, says London-based precious metals consultant GFMS which recently published Gold Survey 2006, the 38th edition of its annual look at the world gold market.

The survey predicts levels safely over US$600, and goes one step further and suggests that the 1980 high of US$850 could be eclipsed.

GFMS says this bull run would be overwhelmingly driven by investment, and the report details the factors that sustained this in 2005, and that would likely continue to do so in future.

Much emphasis was placed on the supportive background of unsustainable global economic imbalances, revolving around the twin U.S. deficits.

“Investors often look for a reason to jump in and this arrived at end-August in the form of Hurricane Katrina and a rally in the energy complex,” says GFMS chairman Philip Klapwijk. Other key triggers listed in the survey were investors’ belief that central banks were becoming friendlier to gold, and a phase of marked yen weakness, which boosted investment in Japan.

For 2006, the chief drivers of investment were expected to remain the high probability of a sharp slowdown in U.S. economic growth and a slide in the greenback. Others include greater inflationary pressures and political tensions in the Middle East. The sheer success of investment to date in gold was also thought to be significant, and certainly would not harm another dramatic possibility: new players entering the market, not the least of which could be pension funds.

“You’re playing with fire if you ignore the weight-of-money argument, looking ahead into 2006. We’d only need to see a tiny slice of mainstream assets diverted into gold, which comparatively is a pretty small market, and the price could really take off,” Klapwijk predicts.

With the gold price having risen substantially in 2005, the Gold Survey contains a surprising statistic: jewelry demand rose by almost 100 tonnes in 2005. The report, however, notes that this strength was essentially confined to the first half, when price stability and a growing acceptance of prices in the low US$400s coupled with strong growth in Asia led to a surge in the jewelry sector. This was thought to have done much to underpin prices, at a time when investment was looking somewhat jaded and official sector selling was at its peak. In the fourth quarter (and into early 2006), however, marked weakness was noted in countries such as India as the price rally gained momentum.

These swings were also seen in scrap supply, which fell in the first half before surging in the fourth quarter. Looking ahead, GFMS sees physical offtake as an area of concern.

“From what we’ve heard for the first few months of this year, we could see jewelry demand slumping back almost 500 tonnes for the full year,” Klapwijk cautions. “That would leave jewelry offtake some 400 tonnes below mine production. That’s just not sustainable in the long term.”

A part of the reason for this threat is increasing mine production. The Gold Survey notes that this rose by a modest 2% in 2005, thanks largely to new projects in Latin America and recovery in Indonesia, but this growth should pick up to around 4% in 2006 as new mines come on-stream or ramp up to full capacity. Some compensation should at least materialize in the form of higher levels of de-hedging, which GFMS says could recover to 200-300 tonnes from around 130 tonnes in 2005.

The Survey reports that net official sector sales rose by 40% to record levels in 2005. Much of this was attributed to a jump in sales by Central Bank Gold Agreement (CBGA) signatories. However, there was no repeat of sizable purchases outside of this bloc, such as the one by Argentina in 2004. Looking ahead, the report pours cold water on the idea that some of the major East Asian dollar holders could purchase significant quantities of bullion in the short to medium term. However, it does expect decent levels of buying elsewhere, such that non-CBGA countries could swing from a typical position of net sellers of 100 or so tonnes to modest net buyers.

Supply Highlights:

Global mine production rose by 2% in 2005 to a little over 2,500 tonnes. Much of the increase was attributed to production in Latin America, where several new projects came on-stream, and to a recovery at Indonesia’s giant Grasberg mine. Other notable gains were recorded in China and Mali. In sharp contrast, South African output fell a hefty 46 tonnes — its lowest level since 1923.

Weighted average cash costs rose 7% to US$269 per oz., due to currency effects and higher prices for consumables such as energy.

Net official sector sales soared over 650 tonnes in 2005, an increase of 40%. The rise was primarily due to higher sales by the CBGA countries, particularly in the first half, though there was also a major fall in purchases by non-CBGA countries. Owing to historically low leasing rates, central banks continued to withdraw from the lending market in 2005.

Scrap production rose just 1.5% in 2005. There was a marked pickup in volumes in the fourth quarter due to the price rally, but the first half was subdued in countries such as India, chiefly as a result of growing price acceptance and a belief that prices could soon move higher.

Demand Highlights

In 2005, total fabrication grew by 4% to a 4-year high of almost 3,300 tonnes. Much was driven by the near 100-tonne rise in jewelry demand. This strength was essentially confined to the first half (up 218 tonnes), whereas the second half actually witnessed a marked decline (down 119 tonnes). These price-driven swings in each half were more pronounced in terms of fabrication, excluding scrap, and were strongly influenced by India. That country, China and Turkey all saw sizable full-year gains, while Italy suffered another substantial drop.

Other fabrication rose by 3%, chiefly as a result of strength in the electronics sector and in imitation coins, plus a modest contribution from other industrial offtake. Dental demand fell sharply.

Last year saw a dramatic surge in implied net investment to over 360 tonnes from net disinvestment in 2004 of almost 60 tonnes.

Much took place in the fourth quarter as the first half of 2005, in fact, saw slight disinvestment. The switch between these two phases was a result of the combination of a supportive economic background for gold investment and changes in investors’ view of the stance of central banks.

Other areas of investment, namely coin fabrication and bar hoarding, in contrast, were lacklustre. The former saw a 3% fall, mainly due to U.S. losses, while the former only saw a 2% increase, largely as India’s sizable gains were balanced by Japan’s drop.

Producer de-hedging slumped to around 130 tonnes in 2005 from comfortably over 400 tonnes in 2004. This was not a function of any mood change for the miners, who tended to remain hostile to hedging, but was instead due more to exceptional circumstances in 2004, such as the financial collapse of Australian miner Sons of Gwalia.

— The preceding is an edited version of an information bulletin published by London-based GFMS.