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In the January/February 2006 issue, I expressed as my opinion that
trading within a range of $ 540-560, compared to a year-end 2005 close of $
513 per ounce and an earlier 25 year high of $ 574.60 on February 2, 2006,
the gold price might show a correction as a result of the negative impact of
price elasticity on demand at increasing gold prices. Two months later gold
has hit a new 25-year peak at $ 644,50 on April 20.
Most gold market watchers probably don’t care about the reasons
of the further price hike, but nevertheless they should ask themselves the
question whether the ongoing bullish sentiment for gold is driven by either a
positive change in fundamentalsor external
developments, and to what extent it will be sustainable.Looking
at supply and demand as reported by GFMS’ “Gold Survey 2006”, there
were no specific reasonswhich justified
gold’s further price increase, as in 2005 total both supply and demand
increased by 5%.
For supply the increase was attributable to a rise in official sector
sales of 87 tonnes to a record level of 656tonnes, a mine production increase
of 49 tonnes to 2,519 tonnes, and a scrap supply increase of 13 tonnes to861
tonnes. For demand the increase was chiefly due to implied net investment of
364 tonnes compared tonet desinvestment
of 59 tonnes in 2004, with mainly in the fourth quarter the impact of higher
industry pricesand a weaker yen.Other
forms of investment were lacklustre in 2005: official coin demand stopped by
5% and bar hoarding rosejust 5 tonnes despite a
strong first half year.
Jewellery demand accounting for about 70% of the total demand for gold
grew by 99 tonnes to 2,712 tonnes as first half gains outweighed second half
losses, with India
accounting for much of both swings. Other fabrication also rose, mainly due
to electronics.
Producer hedging activities generated net physical gold demand of 131
tonnes in 2005 compared to 427 ton-nes in 2004.
While this decrease was partially influenced by incidental factors, as
expected by me, the strong increase in the gold price has led to a number of
new project related hedging positions and might
reflect the first signs of a shift in producer behaviour.
Looking at 2006, the further increase of the gold price above $ 600
per ounce will have a negative impact on both jewellery and investment
demand, which would have to be compensated for by support from hedge funds,
pension funds and retail investors including Gold ETF's
(gold exchange traded funds), I expect that this will not happen, despite
existing ETF's adding 203 tonnes to gold investment
during 2005 and expected to increase to more than 400 tonnes in 2006, but
still limited to just 10% of total demand.
Also from a monetary point of view there are no signs yet that sales from the Central Bank Gold Agreement
signatories (western central banks) are offset by gross purchases outside the
group including Russia and
China,
as a hedge against the dollar. Actually, both parties misjudged the strong
performance of gold; the western central banks sold too early, and the
emerging countries failed to use the hike in the value of gold as a straight
hedge to protect themselves from a falling dollar in the years before 2005 when
it really would have made sense.
Goldletter
International 1 April 2006
Particularly as long as the Chinese yuan
remains pegged to the US dollar and China’s
economy continues to benefit from the $ 200 billion a year trade balance
surplus with the US, in
return for which China
is supporting the dollar by re-investing its surplus in dollar denominated
financial assets, the dollar will be protected from a fall.
Because the dollar did not fall in 2005 but to the contrary gained 15%
against the euro, this also didn't justify the gold
price to increase 17% from $ 438 to $ 513 as per year-end 2005. In addition, the
argument that the ongoing hike of the gold price is reflecting fears for
increasing inflation has been misplaced as inflation has been low in the last
few years and is still under control despite higher eco-nomic
growth and the strong boost in energy and commodity prices.
Regarding the latter one should expect that the fear for increasing
inflation should have a negative impact on Wall Street, enhanced by
increasing interest rates in the US to a current level of 5% for
both the official Fed rate and 10-year treasury bonds. However, but the Dow
Jones industrial index recently reached its highest level since September
2000.
This raises the question whether investors can have it all, both
higher equity prices and higher commodity prices, in concert with the outperformance of commodity related shares, including
gold and even more so silver shares.
I am convinced that this situation of overall excitement will not be
sustainable; either regular stock markets will come
under pressure or the commodity markets have to come down. Because of the
impact of globalization and the emphasis of economic growth and wealth moved
from the western industrialised world and Japan
to Asia and more specifically China
and India,
together with the im-pact of geopolitical tensions,
the latter being emphasised by the Iranian nuclear issue, I am convinced that
commodity prices are set to spiral even higher.
While the recent oil price hike to a new record level around $ 75 per
barrel gets most attention and is also referred to as an obvious reason for
the recent strong performance of the gold price well above $ 600 per ounce,
prices of base metals and energy related uranium have increased even more
spectacularly, with the copper price having quadrupled in the past four years
to $ 7,000 a
tonne.
Years of underinvestment by oil companies and miners during the 1990s
– following years of relatively low prices – together with the
unexpected surge in demand from China’s rapidly growing economy are to
blame for the current metals boom and will not be reversed because of a
shortage in supply in most industrial related commodities together with very
limited stocks for most of these commodities, including copper, nickel, zinc
and iron ore. This tight situation is in contrast with reserves that gold
companies are holding, which in average are well above ten years of annual
output.
Within the scenario that I have painted, the gold price could benefit
further from the overall bullish sentiment in the mining sector, even when it
is lacking the strong fundamental characteristics in demand and supply like
those of industrial related metals. In this respect, it is evident that the
exploration boom that followed on the gold price increase from $ 400 to above
$ 500 in
2005, will be further fuelled by the recent gold price boost above $ 600.
This will result in a growing number of reactivated and new gold projects
coming on stream which, I strongly believe, will also be translated into
higher gold share prices.
By :
Marino G. Pieterse
Editor, Gold Letter
International
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” button.
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