Sup­ply side is tight, look­ing pos­i­tive for price of metal

Financial Mail - Investors Monthly - - Contents - Paul Liquor­ish is an in­de­pen­dent an­a­lyst: liquor­ish­

My first gold-re­lated ar­ti­cle for the Fi­nan­cial Mail (“Re­turn of a golden age”) was pub­lished in Au­gust 2001 and my most re­cent con­tri­bu­tion about it was 11 years ago, so I guess the time has now come to res­ur­rect the sub­ject.

The first ar­ti­cle was in­spired by my be­lief that the 21-year bear mar­ket in gold had ended, pri­mar­ily as a re­sult of the sign­ing of the Wash­ing­ton Agree­ment, which re­stricted the 15 cen­tral bank sig­na­to­ries to to­tal an­nual sales to 400 t. It ef­fec­tively put 85% of of­fi­cial gold hold­ings out of play.

The bul­lion mar­ket had been fight­ing the head winds of hedge fund short-sell­ing and for­ward gold sales by pro­duc­ers, but th­ese ac­tiv­i­ties be­came less at­trac­tive as the yield on US trea­suries had shrunk from 6% to be­low 4%. Di­min­ish­ing yields made short-sell­ing less prof­itable and more danger­ous (smaller mar­gins of er­ror) and for­ward sales less com­pelling, the one-month for­ward rate hav­ing fallen from 5,8% to 1,6% dur­ing the course of 2001. Ex­change traded funds (ETFs) had yet to be in­vented, but the mar­ket had ab­sorbed the un­rav­el­ling of a large spec­u­la­tive long po­si­tion in the gold fu­tures mar­ket, and this was end­ing.

A ma­jor ob­sta­cle mask­ing gold’s charm as a store of value was the in­ex­orable rise of the US dollar, which, on a trade-weighted value, had climbed 25% be­tween 1995 and 2000 and added a fur­ther 11%, to reach a 15-year high, by mid-2001. Does this pat­tern not seem familiar to­day?

The euro re­cently hit 1,08 to the dollar, a 12-year low, and the yen has fallen from 76 to 120 to the dollar in the past 3½ years. Th­ese days mines gen­er­ally don’t sell for­ward — it up­sets their share­hold­ers — and hedge funds have lost too much of their bravado to short gold se­ri­ously. As for cen­tral bankers, the shock­ing ex­change in 1999 by Gor­don Brown (the then-UK Chan­cel­lor of the Ex­che­quer) of over half of the Bank of Eng­land’s gold re­serves for US dol­lars, has made dis­in­vest­ment a rather un­fash­ion­able ac­tiv­ity. The pre­text prof­fered for this move was that gold had been a bad in­vest­ment. The price was $280/oz at the time. In fact, cen­tral banks have been net buy­ers of gold for the past five years and have added a to­tal of 1 430 t to their re­serves in the past three years. I just won­der how long it will take the public to cot­ton on to this change in trend, or are they per­haps bet­ter in­formed than bankers?

The as­sump­tion that cen­tral banks pre­fer gold to the fiat money of other coun­tries may, in part, lie in the thought that it takes less than an hour to print the cost of a ton of gold ($38,4m) — in $100 notes — less time than it takes some un­der­ground min­ers to reach the stope face.

The prin­ci­pal ar­gu­ments put for­ward by the cur­rent pack of gold dis­be­liev­ers are: the strong US dollar, the prob­a­bil­ity of higher US in­ter­est rates and the ab­sence of in­fla­tion in Amer­ica. Th­ese are be­liefs that held wa­ter 30 years ago.

At present the US ac­counts for just 10% of phys­i­cal gold de­mand while emerg­ing mar­kets ab­sorb 70% of this mar­ket.

In the lat­est news let­ter from the much re­spected World Gold Coun­cil, it is high­lighted that the gold mar­ket is mov­ing steadily from West to East and the im­por­tance of the dollar price of gold is di­min­ish­ing.

They also note that global re­serves of US dol­lars have fallen from 66% in 2000 to 55% in 2015 and that this trend is likely to con­tinue as the world adopts a more mul­ti­c­ur­rency model. In­ter­est rates are go­ing to stay low longer in the eu­ro­zone and Ja­pan than in the US, where in­fla­tion is still be­nign. The same can­not be said of many of the emerg­ing mar­kets.

Gold pro­duc­tion is flat at present, but is due to de­crease given that the av­er­age all-in cost of pro­duc­tion is presently es­ti­mated by GFMS to be $1 208/oz. Above-ground sources from cen­tral banks, ETFs and re­cy­cling are dry­ing up. ETF hold­ings are 1 759 t, down 34% from their peak, and gold re­cy­cling is at a seven-year low. Thus the fu­ture sup­ply-side of the equa­tion looks in­creas­ingly tight and pos­i­tive for the gold price.

De­mand also looks look­ing health­ier. Jew­ellery and tech­nol­ogy now ac­count for 60% of to­tal de­mand. Emerg­ing mar­kets de­voured 70% of last year’s gold sup­ply, In­dia and China to­gether ab­sorb­ing 47% of this. Since emerg­ing coun­tries’ con­sumer mar­kets are the fastest grow­ing, the fu­ture for gold de­mand seems in good hands.

Global stock mar­kets and the US dollar are both look­ing ex­pen­sive: should ei­ther fal­ter, gold’s rep­u­ta­tion as a store of value would surely be en­hanced. Fi­nally, lest we for­get, the world is not get­ting any safer.

The last ma­jor bear mar­ket (Jan­uary 1 1980-April 1 2001) con­tained three bear phases, each last­ing just over five years. Since the cur­rent bear run on gold is of less than 3½ years du­ra­tion, my thoughts of a re­ver­sal may be pre­ma­ture but things do tend to move faster th­ese days.

Jew­ellery and tech­nol­ogy now ac­count for 60% of to­tal de­mand


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