LAWRIE WILLIAMS: Is global gold demand beginning to slip?
There are signs that world gold demand may be beginning to slip. Central bank purchases are falling with some of the past major protagonists having dropped out of the purchasing scene altogether; the latest figures on Indian gold imports seem to show that the country’s gold demand is slipping back sharply, although a commentary out today suggests demand there may be picking up again as the wedding season gets under way; Chinese gold demand as represented by Shanghai Gold Exchange withdrawals is running at its lowest annual level in nearly ten years; and lately we have been seeing some substantial gold and silver liquidations from the big gold ETFs – for most of the year ETF inflows had been strong, driving total global gold ETF holdings to a new record high but in the latest quarter we have been beginning to see some slippage – not yet perhaps sufficiently so for undue alarm amongst the gold investment community, but it could indicate the sign of the start of a developing trend.
Supply has been strong too – not because of an increase in new mine production (indeed the reverse may have been true) but because the higher gold price level has seen an increase in scrap supply. This has become pretty obvious this year from Swiss gold import figures. Usually supplies to the Swiss refineries have come from gold producing nations, or from countries like the U.S. and UK. which have been gold vaulting centres. This latter has involved moving good delivery gold bars (the LBMA good delivery specification applies to .995 fine gold bars weighing between 350 and 430 ounces), which are too big for the bulk of the demand from the big physical gold bullion investment sector, to the Swiss refiners for re-refining into the even higher purity smaller sizes most in demand as investment gold. What we have been seeing in recent months is that a good proportion of Swiss gold imports has been coming from countries which have mostly in the past been major recipients of Swiss gold exports. This gold flow reversal suggests running down of inventories among gold traders and/or profit taking returns – particularly where demand has been slipping. It may also have been because gold hoarded, in countries where gold has been held by individuals and families as an emergency store of wealth, has been being liquidated in the light of coronavirus-related economic difficulties.
Coming back to new mined supply there are indications that this may have slipped a little this year due to restrictions placed on mining activities due to coronavirus protection and control measures imposed by some governments. This has come at a time when global new mined output has been plateauing anyway due to lack of new big deposits being found and exploited and as older operations are seeing depleted reserves and even shutting down permanently as the gold runs out, Mines have limited lives and while higher gold prices have meant that many older mines are managing to eke out life extensions due to now being able to work previously unpayable ore that has now become viable to mine. However such life extensions only have a minimal effect on global supply given the lower grades of the ore being brought back into now mineable reserves.
For the investment sector, though, the gold producers have opened up another area of prospective investment gain. Most of the bigger gold producers mine their gold at a cost of between $1,000 and $1,200 an ounce – some less. This means that at current gold prices these operations are now hugely profitable and this additional profit is beginning to flow through to investors in terms of increased, or new, dividends. The big increases in free cash flow are also enabling some companies, which had built up crippling debt positions, to run these down to much more manageable levels, either by utilisation of free cash and/or by streamlining operations through disposing of non-core assets at good prices. Thus many major gold mining companies have been reporting dividend increases quarter after quarter and offer decent yields more than comparable with financial fixed interest options, and with the prospect of serious capital gains should metal prices resume their rising path.
Cutbacks in gold exploration have also contributed to a potential gold shortage as likely to occur in the years ahead, while the dearth of potential new mega-projects, and the realisation that the past concentration by some of the gold majors for growth at almost any cost, was misguided and counter-productive. Also potentially multi-billion dollar new mining projects have on occasion, and in some jurisdictions tended to face arrays of environmental and social problems and consequent delays, and sometimes project demise, that seem to go hand-in-glove with such proposed developments.
The ultimate cancellation of Barrick’s massive cross-border Chilean/Argentinian Pascua Lama gold mine development, after billions of dollars had already been spent on it, is very much a cautionary example of a project that proved to be perhaps way too ambitious! Indeed one suspects that the Pascua Lama debacle may have been one of the defining factors behind the Barrick merger with the much smaller, but more tightly managed, Randgold, and the absorption of the Randgold management team into the top echelons of the merged entity in an attempt to slim down the mega-miner’s management and inject a note of reality into the merged company’s overall direction.
So, to sum up, although we may feel that gold demand may be beginning to slip a little, we also feel that some of the slippage will be countered by a small fall in supply, albeit perhaps a temporary one. The main gold price drivers are probably not the supply/demand factors anyway – investment demand tends to balance out basic supply/demand discrepancies – but external geopolitical and economic factors will always tend to be the primary price drivers. Currently the COVID-19 pandemic is probably affecting both major drivers with some economic sectors probably never to recover fully from the virus impact until well into the future, if ever. We still think gold’s overall path is upwards for the next year at least, and possibly beyond, but the upwards trajectory may have slowed somewhat through perhaps misplaced sentiment over the vaccine situation and the likely speed and overall effect of rollout.
Precious metals prices currently seem to be slipping sharply at present and investors in them. And associated companies, may be in for a difficult ride until the year end and perhaps beyond. However we believe that a settlement of the current U.S. Presidential election impasse, together with a somewhat delayed economic stimulus package will see precious metals prices settle down again, and move up to higher levels.
Equity market valuations in general look to be excessive in terms of earnings levels for many players, although these have been hugely boosted by tech sector companies which have tended to do well in the light of coronavirus strictures. However, it is also apparent that many companies, including a number of household names, have seen earnings decimated to such an extent that they may never recover – particularly as the post-virus world will perhaps never be the same again. Gold, in particular, should thrive in such an environment. But as a sentiment-driven commodity its revived upwards path may be anything but smooth.
19 Nov 2020