From net gold demand of around 1,300 tonnes in 2012, investment demand has turned into a source of net supply this year and could reach as much as 400 tonnes or more as ETP sales far outweigh new investment in gold bars, Natixis Economic Research suggests.
“Even if ETP investors stop selling, it will be difficult to see net demand turning positive for the year as a whole,” said precious metals analysts.
“At current prices, jewelry demand is rising strongly and scrap supply is diminishing, but even alongside solid demand from central banks the overall effect is insufficient to redress the enormous decrease in net investment demand,” the analysts observed. “The market therefore requires a fall in mined gold output, which implies that prices should drop to the point at which mining companies close their more marginally profitable operations.”
Noting that much has been made of the importance of all-in sustaining costs in the gold industry, Natixis cautioned that, “in the short-run these are not the right costs to be focusing on. Instead of long-run average costs, which determine whether mining companies will undertake investment in new ventures, we need to consider the marginal costs for each mine (cash costs, net of by-products). It is these lower marginal costs that will determine—in the short-run—whether individual shafts or mines are closed.”
“Our estimates suggest that, at current prices, the rise in jewelry demand and fall in scrap supply will be able to absorb around 750 tonnes of the decrease in investment in gold,” said the analysts. “This leaves an imbalance of as much as 830 tonnes. To reduce this through lower mine output alone would require prices to fall as low as $800/oz.”
“Our best guess is that, if selling by investors persists, short-term equilibrium would be reached somewhere between $1,000/oz and $900/oz,” Natixis advised.
However, the analysts suggests that once investment demand returns to its long-term “normal” of around 6-9% of the global market, “so we should return to a price level that compensates mining companies for their continued participation in the gold market.”
“We do not expect all of the higher cost mines to reopen, but it would be reasonable to think that prices should stabilize at or around the long-run costs of production for the vast majority of the gold industry. This suggests that a reasonable medium-term target for gold prices would be somewhere in the vicinity of $1,150-$1,250/oz.”
The analysts suggest that gold will average $1,180/oz for the last quarter of the year to give a yearly average of $1,370/oz. “As 2014 progresses, the gradual return of net investment demand should offer increasing support to gold prices, giving an average price somewhere in the region of $1,200/oz.”
Natixis expects silver prices to continue to closely follow gold prices throughout 2013 and 2014.
Since the year’s high in March, silver backed ETPs have dropped by 1,000 tonnes, according to the analysts. The amount being held in physically backed silver ETPs is proportionally higher than gold.
“In our base case scenario we expect silver prices to drop to around $17.75/oz over the remainder of the year, giving an average of $22.25/oz for the year as a whole. In 2014, prices are expected to remain broadly constant at around $16.75/oz,” the analysts advised.
Natixis remain bullish on platinum and palladium with platinum prices averaging $1,500 per ounce, rising to an average of $1,610/oz in 2014. The analysts’ forecast for palladium for this year is an average price of $725/oz, rising to an average of $760/oz in 2014.