In the November/December
issue of Goldletter International, I already
noticed that boosted by Asian demand, gold had breached finally through the
psychologically important $ 500 barrier. The question is, however, whether
the price increase was caused by growing physical demand, rather than by
While net long speculative position on Comex/Nymex
in November 2005 increased from 16.03 million ounces to 18.05 million ounces,
the position increased only modestly further to 18.92 million ounces by the
end of December 2005, compared to a peak of 21.4 million ounces in October
2005. Consequently, the Comex/Nymex was not the driving
force behind the increase in the gold price this time. This was accounted for
by aggressive Japanese buying through the TOCOM (Tokyo Commodities Exchange)
as a currency hedge against the Yen, which had fallen by over 10% since the
beginning of September 2005 to a level of Yen 120 against the dollar. While
the net future Comex/Nymex position stayed
relatively stable, trading in Japanese TOCOM gold contracts showed a strong
increase, which caused the authorities to raise the margin requirements on
its precious metals contracts.
Compared to a year-end 2005 close of $ 513, the gold price was driven
up by 12% to a new 25-year high of $ 574.60 on February 2, compared to an
increase of 17.1% during the year 2005.
The surge of the gold price is quite remarkable as during the same
period the dollar was easing only modestly against the euro
and a lack of fundamental support was demonstrated by lesser fear for
inflation with the oil price having traded lower until recently. Also,
long-term interest rates still remain at a historical low level due to
growing of liquidity surpluses available for investment, thereby keeping
Nevertheless, I noticed already earlier that after demand and supply
had been in balance since some time, the odds are looking to turn in favour
of a shortage in supply, with new developments occurring both on the demand
and supply side.
Positive for demand has been the increase in Gold ETFS (gold exchange
traded funds), which are expected to have increased to approximately 350
tonnes in 2005, an increase of about 200 tonnes compared with 2004. Also
positive has been increasing investment demand from Asia and the Middle East,
the latter enhanced by strongly growing revenues from increased oil revenues
by the OPEC countries.
However, with the gold price having further increased to a current
trading range of $ 540-560, growing price elasticity above $ 500 could have a
negative impact on overall investment demand, at least in the first half of
2006, resulting in a correction of the gold price. This already happened
recently when the gold price fell back to $ 535 before recovering again to
the current level of $ 550.
In this respect, it is noteworthy that GFMS of London, the world's
premier gold research institute, expects jewellery demand, which represents
72% of total gold demand, to decline 352 tonnes to 1,485 tonnes in the first
half of 2006, compared to the first half of 2005. This decrease should be
offset by an expected increase of net investment of 323 tonnes particularly
in Gold ETSF.
Regarding other elements in supply and demand, GFMS forecast for the
first half of 2006 on the supply side an increase in mine production of 56
tonnes to 1,236 tonnes and an increase in gold scrap of 52 tonnes to 451
tonnes. Official sector sales are forecast to fall by 85 tonnes, which
applies only to Central Banks who signed the Second Bank Gold Agreement.
On the demand side, apart from the fall in jewellery demand against a
strong increase in net investment, GFMS forecast for the first half of 2006
hoarding to fall 76 tonnes to 87 tonnes and net produced hedging to increase
26 tonnes to 118 tonnes.
At the supply side I expect production to stabilise in the foreseeable
future, with a shift from traditional countries (South-Africa, Australia, US
and Canada) to new regions like West-Africa, South-America, Russia and
CIS-countries, but geopolitical problems in the emerging energy and mining
industries of undeveloped countries, requiring a higher stake in their
mineral wealth, could have a negative impact on future gold supply and cause
a squeeze in future supply.
Last but not least, it is the course of the dollar, which is a
determining factor for the behaviour of the gold price. In this respect it is
remarkable that while the gold price increased by 9.5% in dollars in 2005,
the dollar recovered by 15.4% against the euro.
The strong revival of the dollar was broadly unexpected (myself not
included), thereby having increased the vulner-ability
of the gold price. This can only be reversed when central banks who did not
sign the Second Bank Gold Agreement with the option to sell up to 600 tonnes
of gold over the duration of 5 years from end September 2004, are deciding to
purchase gold as a hedge against the dollar. Rumours in that direction
pointing at China and Russia,
haven't become hard facts yet and have in my opinion to be taken for granted,
particularly as long as trade balance benefits from a stable dollar to the
economic benefits of emerging countries prevail.
I also expect that after a period of de-hedging, particularly new
producers could decide to use hedging again to secure future cash flows,
enhanced by a lesser easy access to bank loan financing on projects which are
only economically viable at today's high gold prices.
Decisions in favour for hedging should be considered as a serious
option when this creates added value to future cash flow, rather than to keep
away from hedging because the market is against it for the wrong reasons. Even
when the plusses and minuses would be in balance, and the gold price would
stabilise at a price level well above $ 500, this is still good news for gold
exploration and development as is demonstrated by a strong increase in
world-wide exploration almost back to 1997s record level of $ 5.2 billion,
before falling to a 12-year low of $ 1.9 billion in 2002, an overall decline
of more than 63%.
Gold Supply and Demand Balance *
Marino G. Pieterse
Editor, Gold Letter
Marino G. Pieterse
has been an independent financial analyst and gold specialist for more than
25 years. He is the chief-editor of Goldletter
International, the only gold investment market letter in English in Europe focusing on emerging gold regions in the world,
as well as reports on individually featured companies and special reports on
other metals, including uranium. You can receive Gold Letter
International’s reports for free by clicking on the “Subscribe”