May 2, 2005
Mine Site
At the time when so many analysts are moving in favour of a significant rise in the price of gold over the rest of this year, it is amusing to read the Financial Times. The Pinker That Pink ‘Un, it has to be admitted, did find space in the middle of an election to mention such a subject, but judging by other commodity stories it was more a matter of luck than judgement. Readers seeking information on commodities at the end of last week were probably riveted to know that oil prices were falling and we were in for a record wheat harvest. The big story about iron ore, ‘Rio Tinto, BHP Gear Up To Expand’, appeared elsewhere under Companies Asia-Pacific and was not easy to find.
In the old days the FT had a specialist writer on oil and on mining. They knew a lot about their subjects and had the respect of readers. We have been in a resources boom for sometime now, but when writing about Philip Klapwijk, executive chairman of the prestigious Gold Fields Mineral Services precious metals consultancy, who has just said that gold could reach US$500 this year, the FT journalist offered the following non-sequitor. “Gold last hit US$500/oz in 1987, but it may struggle to reach that level this year because of its flat performance so far in 2005.”
A clear case of ‘get an FT: get no comment’. Presumably this poor chap has never traded anything in his life and possibly did not even realise what a crass comment this was. Once opinion and other factors fall in line behind a commodity, particularly when demand is putting pressure on supply, its price will tend to move. Previous performance is of little concern and the market usually anticipates the publication of figures which prove the point. Thus the importance of Mr Klawiijk’s remarks, which were based mostly on the fact that the dollar was likely to be forced down by concerns about the twin US deficits, were beaten out of sight by a statement from Peter Munk, founder and chairman of Barrick Gold, one of the world’s biggest producers..
He took the lid off the box with his forecast that the price would rise as few major gold projects were coming on stream to meet demand which was actually rising as a result of China and paper gold investment to name but two. He also went out of his way to name at least four countries where it had been virtually impossible to obtain permission to develop mines in areas where deposits had already been found . He named Argentina, Romania, Turkey and Spain as being particularly difficult, which may not be entirely fair. Big companies such as Barrick tend to be inflexible and this generates problems of its own. They do not use local talent and goods in the way their smaller peers do and this goes some way down the line. The US company Meridian Gold bought the Esquel project in Argentina four years ago from the British company Brancote Holdings and then made a complete nonsense of the local relationships which had been fostered so carefully. As a result the project is still not in production.
Statements from the bosses of major companies at the time of quarterly results should be taken with a pinch of salt as Peter Munk clearly wanted to make the point that Barrick itself has four big new projects on the go that will increase annual production by 40 per cent in 2007. The company's Tulawaka mine in Tanzania began production in March, its Laguna Norte gold project in Peru will follow suit in mid-June, while the Veladero mine in Argentina (see what I mean) and the Cowal project in Australia will start production at the end of 2005 and early 2006 respectively.
In essence, however, he was making three points, all of which are important. First he did his job by claiming that Barrick was outpacing its rivals. Second he made the unarguable point that when mines are actually permitted they take four or five times longer to develop than they used to and costs are increasingly making the average mine non-viable. Thirdly he said , “"Mines, every one of them, have a finite amount of reserves ... the mine ceases to produce and they need replacement. If the supply side is impossible to replace then you can draw your own conclusions in terms of the gold price.” Behind this point is the fact that gold production dropped 5 per cent to 2,464 tonnes last year which is the lowest since 1996.
At this stage it will be best if we enumerate the other factors affecting the price of gold, US finances apart, for the sake of our friend at the Financial Times. For a start the gold price tends to be geared to the oil price. As oil prices have risen, the value of gold has also increased on fears of inflationary pressure. Gold hit its highest level of US$825/oz back in 1980 when the oil price rose after the Arab-Israeli conflict. Second, there is little selling pressure from the central banks as most are signatories of the agreement which governs sales of the precious metal. So far this year they are thought to have offloaded 250 tonnes, which was accepted with ease, and they have another 300 tones to go to reach 550 tonnes which is seen as the upper limit.
What other factors have been missed. Well, hedging for one. Last week Virtual Metals and Halliburton produced a foretaste of their upcoming “The Hedge Book” which is sponsored by Mitsui and the main finding is that de-hedging by the majors is increasing. Two useful bits of information can be gleaned from this. First, the big producers clearly do not see the gold price falling to earlier levels or they would leave the hedging in place. Second, as there are fewer new projects coming on stream which will have to be hedged , pace Munk, the impact will be limited.
Two new exchange traded funds came into existence in the States towards the end of last year to add to the Gold Bullion Securities funds already in existence in London and Australia. The Americans started at a great pace and GFMS reckoned that investment in these funds equated to 250 tonnes at the end of January - 10 per cent of production, don’t forget - as physical gold backing for the paper has to be retained in bank vaults.
Last, but not least, there is the impact of China where the gold market has been opened up to investors over the past couple of years since the Shangai Gold Market started trading again for the first time in 50 years. The World Gold Council reckoned that holdings of gold per capita by Chinese people in 2002, before the market opened up, was approximately 0.16 grammes against a world average of 0.7 grammes. Compare this with Hong Kong where the offtake was recorded as 2.7 grammes and it starts to get interesting as there are only 8 million people in Hong Kong compared with 1,288 million on the Chinese mainland.
If all the Chinese bought 2 grammes of gold during the next five years it would amount to 82 million ounces which is equivalent to 2,645 tonnes of gold. By coincidence this is exactly in line with world annual gold production so the question that has to be asked is what would this do to the demand/supply situation? We may not have to wait too long for the answer judging by an article in Asia Pulse last December which was entitled “Gold Rush Reaches Fever Pitch In China.” Apparently in seven hours on November 19th a single store in Beijing sold 300 kgs of gold bars minted by the China Gold Coin Company to commemorate the Year of the Rooster. Quite something as that would be worth US$4.2 million at the current price of gold and worthy of a little more quiet thought by the Financial Times.
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