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Gold Not Yet Bottomed in Dollar

By Commodities Now

Demand and dollar prices continue to build a base
Like most markets, gold takes time to recover from periods of turbulence and in early 2015 it is continuing the stabilization of 2014 following the hurricane that swept through it in the previous year.  Demand contracted sharply in 2014 as some key regions, notably China, suffered from over-purchasing in 2013, while lack of confidence in any near-term price recovery deterred investment purchases elsewhere. There are signs that confidence is starting to return, however, as the physical market adjusts and takes comfort from the price stabilization since November 2014. 

Western investors are likely to return in 2015 – but not yet

In the western markets in particular, dollar strength and the focus on FOMC policy has remained to the fore.  While US monetary policy will remain a central focus over the course of 2015, investors are already discounting a return to a rising interest rate cycle (albeit gradual) and it is arguable that loose-handed holders are out of the market. This does not automatically signal higher prices however, as these require fresh investment activity; indeed there is still the possibility of short-side sales in response to any unsettling news or economic development.  Once the new rate cycle is in place (or signaled), asset reallocation is likely to commence and we expect gold to benefit accordingly.

Further short-term weakness to ensue in dollar terms, while local prices have already bottomed

The dollar is likely to retain currency supremacy, given monetary policy elsewhere in the world, and non dollar-denominated gold prices are believed to have bottomed.  In dollar terms, however, the GFMS team at Thomson Reuters is looking for further slippage towards $1,100/ounce during 2015, with an annual average of $1,170/ounce in 2015, with prices rising towards year-end; this should lead to an average of $1,250/ounce in 2016 as buying picks up in Asian markets and institutional investment in these markets offsets the recent decline in Over-the-Counter demand in the West.

Official sector purchases the second highest total since the end of the gold standard

Official sector gold transactions in 2014 amounted to an estimated net purchase of 466 tonnes, up 14% from 2013 and the second highest level since the end of the gold standard. Heightened political tensions in 2014 saw Russian central bank reported gold purchases reach record levels at 173 tonnes, while several CIS countries increased their gold holdings. Sales remained muted.  The sector is expected to remain a source of demand for gold over the medium term.

The structural shift in the market points to increase price stability

The renewed eastward shift in physical gold demand (following the westward lurch following the start of the financial crisis) stalled last year, but is expected to resume as the markets continue to stabilise. This will, in GFMS’ view, give the gold market fresh stability in the near to medium term. The appetite for gold in the East was well-illustrated in 2013 and, as stocks are worked off and confidence returns, we expect the Asian markets to reassert their power in terms of price support.

Jewelry demand – excluding China – has remained robust

World jewelry fabrication– excluding China – actually increased by 6% in 2014.  The result of the massive surge in jewellery demand in China in 2013 was a fall of 35% in Chinese jewellery consumption and 31% in local jewellery fabrication last year. Even so, Chinese jewelry fabrication in 2014 was 7% higher than in 2012 and the second highest on record. Heavy leasing activity in the local market has led to suggestions that retail demand was much higher than was actually the case.  India, despite import restrictions, reached another record in both fabrication and consumption terms, reflecting the determined affinity of the Indian people for gold.  China and India between them accounted for 54% of the world’s jewellery, bar and medal demand in 2014. 

Investment was cramped by the Asian markets in 2014, but is expect to recover

Overall investment demand was the fifth highest on record, despite year-on-year contractions.  The retail coin and bar market was the one that really suffered in 2014, slumping by 40% year-on year, driven particularly by the Asian markets, reflecting the action of 2013 and unease over the price outlook.  Elsewhere in the investment sector, ETF holdings continued their erosion, albeit at a much slower rate than in the previous year.

The mining sector continues to struggle

The gold mining sector remains in a precarious condition.  While production expanded in 2014, to 3,133 tonnes, this reflected a ramp up of previously commissioned projects.  Output is expected to be flat in 2015 as this impact wanes, before starting a palpable decline.  All-in-Costs dropped by 25% to $1,314/ounce in 2014 (the average spot price over the year was $1,266.40), although this fall was distorted by the large number of impairments incurred in 2013.  If these are stripped out then the fall was much more modest at 3%.  Average total cash costs decreased by 3% to $749/ounce, reflecting advantageous foreign exchange rate movements and higher processed grades, while labor costs and lower by-product credits were adverse factors.

Corporate activity also reflects the parlous state of the sector

Corporate activity in the gold mining industry continued to decline in 2014, with aggregated deals amounting to just $7.3 Bn, approximately 9% lower than in 2013 (data from ThomsonOne Investment Banking). Miners’ priorities focused largely on rationalizing existing portfolio and strengthening balance sheets by reducing debt levels while deteriorating sentiment drove the determination to increase efficiency.  Hedging, at 103 tonnes, was the highest since 1999, but the GFMS team does not believe that this is a turning point to widespread hedging activity, as it remains confined to a small subset of producers.  This year may see net hedging, but it is likely to be of a comparable scale to that of 2014.

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