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In this Issue:
- Gold losing its lustre as a safe haven 1
- Price sensitivity puts jewellery and retail investment demand under pressure 2
- Fall in gold demand in first half of 2008 led by India 3
- Demand of ETF’s also suffers from price sensitivity 4
- The ending positive impact of dehedging on gold price 5
- Gold looking for new balance in demand and supply 6
- Conference Agenda Goldletter Media Partner 7
Gold losing its lustre as a safe haven1
With the sub-prime mortgage crisis having turned into a credit crisis and international political problems having fuelled by the war between Russia and Georgia, one should expect that gold would have benefited as a safe haven in times of insecurity. However, it didn’t, like it didn’t respond to increasing global economic tensions as a result of booming oil and food prices.
Ironically enough, it is the dollar rather than gold that has been benefiting lately from political and economical unrest in the world, thereby emphasizing my view that there is no monetary alternative to replace the dollar as the world’s key currency and to justify a further decline of the dollar.
Precisely in line with my forecast in the June-issue of Goldletter International, from the moment it became clear that the gap in interest rates between the US and Europe is not going to widen any further, which is due to the fact that both the Fed and the Central European Bank have a joint strategy in common now to fight inflation, the dollar showed a strong recovery against the Euro from a high of $ 1.60 on July 22 to $ 1.47 at present, a 7.4% correction within one month.
Contributing to the dollar’s recent strength is that up to only a month ago attention from the financial world was particularly focused on the threat of a recession in the US, compared with better economic growth rates in the Euro zone. However, the situation has changed in the last few months, making it clear that the Euro zone edges closer to recession now than the United States do.
By noting this, at a present federal funds rate of 2% against 4.25% for the Euro zone rate, the Fed has more room to increase interest rates to fight inflation than the ECB has.
Consequently, as I already predicted in the June-issue, there is no fundamental reason for a further decline of the dollar against the Euro, leading to a higher gold price.
With the world’s economies feeling the impact of oil volatility, and the Brent oil price having fallen 13% from its peak of $ 146 early July, and the course of the oil price being dominant in the 17% fall of the gold price from a level of $ 940 to an interim low of $ 784.75 on August 15, it became once again clear that gold doesn’t run its own course as a safe haven.
Does my earlier scepticism on the outrageous market performance since September 2007 mean that I am bearish on gold? The answer is no. I only didn’t want to range myself on the side of more than 90% of gold market watchers having an opportunistic bullish view on gold not doing their homework on the impact of economic and monetary developments, in conjunction with fundamentals on supply and demand.
Going back just a year ago (mid-2007), when the gold price was around $ 650, and a favourable picture for growing demand was painted, I set a price target for $ 700 - 720, 10% above year end 2007. Since then, driven by booming oil process, the gold price skyrocketed to a high of $ 1,030.80 in March in this year. However, not justified by the moderate increase in physical demand and also not accounting for gold’s price sensitivity as shown earlier in 2006 when the gold market also demonstrated a big volatility, I only wanted to disassociate myself from blue sky optimism.
In stead, in my June-2008 report on “Myths on gold as a safe haven”, I already noted that looking at short-term demand and supply, because of its proven price sensitivity, gold had to find a new balance like happened in 2006.
Price sensitivity puts jewellery and retail investment demand under pressure 2
In contrast with the dated view of most gold market watchers, jewellery and investment demand have not been the main drivers of the rise of the gold price since 2001.
Within the last ten years jewellery demand, representing more than 60% of total demand, dropped from 3,300 tonnes in 1997 to 2,400 tonnes in 2007, with a further decline expected in 2008. What actually happened has been a shift in demand from western countries to emerging countries, with India having emerged as the largest gold consumer
Indians have a special relationship with gold deeply rooted in the Hindu culture and traditionally used as dowry for brides.
In 2007, according to figures by the World Gold Council, total demand in India increased 7% from 721.9 tonnes to 773.6 tonnes, representing 27% of the world’s total demand of 2,831 tonnes, of which jewellery demand 558.2 tonnes (+ 6%) and net retail investment 215.4 tonnes (+ 10%).
Second in demand was the Middle East, where total consumer demand increased 10% to 348.4 tonnes (+ 11%) of which jewellery demand 328.1 tonnes (+ 6%).
Third in demand was China, where total consumer demand increased 26% to 326.1 tonnes (+ 26%) and net retail investment 23.9 tonnes (+ 60%).
With China to be seen as the consumer market with the strongest growth potential, it should be noted that, also compared to India, it still is relatively small. This means that even considering the strong growth figures in 2007, this applies to an increase of 70 tonnes only.
In contrast to growing demand in emerging countries, demand in the major western countries, led by the United States, is declining.
In 2007, demand in the United States declined 18% from 306.1 tonnes to 278.1 tonnes, of which jewellery demand 262.9 tonnes (- 14%) and net retail investment 15.2 tonnes (- 53%).
Turkey showed a positive performance last year with 11% higher demand at 249.3 tonnes, of which jewellery 188.1 tonnes (+ 14%) and net retail investment 61.1 tonnes (+ 1%).
Fall in gold demand in first half of 2008 led by India 3
Being severely affected by booming gold prices since the second half of 2007 and the first quarter of 2008, consumer demand in the second quarter of 2008 fell 22% to 619.8 tonnes compared with 790.2 tonnes in the corresponding quarter of 2007, in the first half of 2008 gold demand declined 23% to 1,125.4 tonnes from 1,466.3 tonnes in the first half of 2007.
Most notable is the fall in total consumer demand in India, which was the main driver in demand in the last four years, from 498.3 tonnes for the first six months of 2007 to 263.5 tonnes in the first half of 2008, a decline of 47%, thereby showing an unexpectedly high price sensitivity enhanced by the country’s economic growth dampening.
With the Middle East also showing a strong decline of 14% from 181.7 tonnes to 156.6 tonnes, demand in China was still up with a growth of 12% to 160.2 tonnes to 180.1 tonnes.
Apart from the recent fall in overall gold demand, gold investors shouldn’t be mislead by overstatements on Au impact of net retail investment demand on the gold price as it only represents 16% of total demand compared with a robust 68% of jewellery demand.
Demand of ETF’s also suffers from price sensitivity 4
A positive note is that over the last couple of years Exchange Traded Funds (ETF’s) have emerged as a meaningful component of gold demand accounting for 7% of total demand in 2007.
However, having contributed 260 tonnes and 253 tonnes in 2006 and 20087, respectively, also demand of ETF’s has been showing a strong price sensitivity due to the dramatic increase of the gold price since September-2007. Demand was only 4 tonnes in the second quarter of 2008 compared to 73 tonnes in the first quarter for an aggregate 77 tonnes in the first half of 2008 and 3 tonnes in the first half of 2007. This was followed by a strong boost in demand in the second half of 2007to 227 tonnes, which will be difficult to match in the second half of 2008.
Bullion holdings of the world’s largest gold exchange traded fund – the New York listed SPDR Gold Shares fell on August 12 to 659.03 tonnes, down 6.7% from a peak of 705.9 tonnes in July.
The ending positive impact of dehedging on gold price 5
Having already refuted the argument that growing jewellery and retail investment demand have been the main drivers behind the strong recovery of the gold price since 2001, the question is what the big driver has been.
The only answer which fits is the impact of net producer dehedging in contrast with a period of hedging in the preceding years. Both in 2006 and 2007 dehedging contributed more than 400 tonnes to demand compared to more than 500 tonnes of net producer hedging in 1997 and 1999.
According to VM Fortis’ hedging and financial report, every year since 2002, with the exception of 2005, has seen annual reductions in the global delta adjusted hedge book of 11 million ounces (340 tonnes) and 2006 and 2007 saw a reduction of over 13 million ounces (more than 400 tonnes).
At year end 2007, global hedging amounted to 27.7 million ounces (861 tonnes), a level of 74% below its peak in the third quarter of 2001, when it stood at 102.8 million ounces (3,360 tonnes).
In the first half of 2008, the gold hedge book fell another 8.1 million ounces, leaving outstanding hedging at just 18.7 million ounces (583 tonnes).
The decline in the first and second quarter, with 4.6 tonnes and 3.5 tonnes, respectively, were the 25th successive quarterly declines.
AngloGold Ashanti accounted for the majority of the fall as they accelerated their hedging program announced in the second quarter. On a delta-adjusted basis their book was reduced by 2.7 million ounces, on a committed ounces basis by 3.1 million ounces. This leaves just 0.8 million ounces of their dehedging programs to be completed.
Given AngloGold Ashanti’s second quarter 2008 dehedge, most of the planned dehedging for 2008 has now been done and as such the pace of dehedging is likely to slow sharply over the rest of the year into 2009.
Compared with 8.1million ounces cut from the global book in the first six months, in the second half of the year it is likely to be 2-4 million ounces (63 - 126 tonnes).
The market-to-market valuation of the global book has improved to stand at a negative $ 9.0 billion at the end of the first quarter of 2008, $ 1.7 billion better than at the end of the first quarter of 2001 and the best figure since 2005.
With the gold price having dropped from an average of $ 924.83 in the first quarter to an average of $ 826.29 in the second quarter and just above $ 800 at present, recent dehedging has lost its lustre and contributes to the ending positive impact of dehedging on the course of the gold price.
In my view, also considering the negative impact of the financial crisis on the availability of high risk financing, this means that after a period of dehedging, gold companies particularly for the development of new projects, have to look for alternative funding through the hedge of future production. This might particularly apply to emerging gold regions, with higher geopolitical risks.
As a result, the positive impact of dehedging on demand, particularly in 2006 and 2007, might be reverse.
This would implicate that also the negative market sentiment toward hedging is dated and has to be adjusted.
In this respect, it is important to know that the average gold price jumped from $ 695.39 in 2007 $ 603.77 in 2006) to $ 910 in the first half of 2008, corresponding with an increase of 31%.
With reserves of major gold producers valued between $ 500 and $ 550 per ounce, and representing an average of 17 years of production, the strong increase in the average gold price has made it lucrative to hedge gold production from new projects at prices above $ 800.
Gold looking for new balance in demand and supply 6
Talking about the myths of gold as a safe haven, apart from a structural decline in gold demand, in my June-issue I also referred to gold not being a hedge against inflation, referring to the $ 850 peak of the gold price in January 1980, followed by lows of just above $ 250 in both 1999 and 2001, like I did on the monetary myth on gold with gold nowadays representing 12% of total monetary reserves only compared with 73% in 1965, and gold having been officially demonetized in 1971.
I agree that this situation could be totally different if Asian central banks, led by China, would have been buyers of gold as a hedge against their strongly growing dollar holdings ($ 3,000 billion at present). They didn’t, however, due to prevailing economic priorities to secure future growth and wealth, thereby contributing to more balanced growth and stability in the global economy. Actually, Japan followed this strategy already in the 1970s when it expanded to the world’s second economic powerhouse.
Consequently, Asia and Arab countries, through their Sovereign Wealth Funds are buying hard assets in western countries, by far the most in dollars, rather than buying gold.
With the skyrocketing gold price since September 2007 not being justified by physical demand, it goes without saying that the gold price, like many commodity prices, not running its own course, has been driven by speculative demand from booming oil prices.
This is clearly demonstrated by a strong increase in activities in gold futures on the New York Stock based Comex-exchange in 2007. Total volume rose above 25 million contracts, equivalent to nominal 77,947 tonnes (2006: 49,509 tonnes).
Net positions in Comex-futures ended the year at a net long of 238,412 contracts, up by 135,344 contracts, equivalent to 421 tonnes nominal, significantly higher than the impact of net retail investment.
The negative impact of price sensitivity was clearly demonstrated in the week ending August 5, when gold reached $ 886 and speculators cut the net lot position by 10% to 163,728 lots compared with the previous week.
Since the steep correction of the gold price to under $ 800, there might be light at the end of the tunnel with particularly demand in India expected to pick up supported by the Festival and wedding season. This could help to find a new balance in total demand and supply in a trading range of $ 810-830, as earlier forecast by me in June. The figures in the third quarter are going to speak for themselves.
On the other hand, considering the correlation with the oil price and to a lesser extent the dollar price, the outlook for gold remains clouded. Lower oil and food prices are calming fears about inflation, while I expect the dollar to remain relatively strong against the euro in the remainder of 2008. This view is partly based on the Euro zone current account having posted a shortfall of € 7.3 billion in May, reversing an € 1.5 billion surplus in April due to a fall in exports by 3.4% and a rise in imports by 4.5%.
In addition, the reduction in the Federal Funds rate from 5.25% to 2% and tax rebate checks from the US Treasury of over $ 100 billion this summer, as well as gasoline price having come down, will give ample stimulus to the US economy to distinct itself in a positive way from the Euro zone economies.
CONFERENCE AGENDA – with Goldletter International as Media Partner 7
2008
October 1 – 3 Minex ’08 - Moscow *
October 7 – 9 Commodities Week - London
October 13 – 16 MENA MINING CONGRESS - Dubai
October 28 – 29 Russia & CIS Mining Congress 2008 – Moscow
November 6 – 8 2008 China International Silver Conference – Haikou, China *
November 6 – 8 Discover Mongolia 2008 – Ulaanbaatar, Mongolia
November 13 – 17 China Mining- Beijing, China *
* Marino G. Pieterse will be a speaker at this event
Marino G. Pieterse,
editor Goldletter International
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Goldletter International, Rokin 115, 1012 KP Amsterdam, the Netherlands - Information and investment comments are independently and thoroughly researched and believed correct. No guaranty of absolute accuracy can be given however. - Investment decisions are fully made for own risk. - tel.:+31-20-5287585 or +31-20-4700249 - fax: +31-20-5287587 - www.goldletterint.com - e-mail: info@goldletterint.com
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