GOLD ANALYSIS

‘Structural deficit’ in gold supply could send prices higher

Wellington West Capital Markets analysts suggest that investors “revisit investing in the junior and intermediate gold producers.”

RENO, NV - 

Based on the assumption that current strong physical gold demand highlights an existing supply deficit, Toronto's Wellington West Capital Markets forecasts that, "if the increased structural deficit in gold supply continues, gold prices should adjust higher."

Wellington metals analysts also advised, "Given the potential change in market fundamentals, we believe it is time investors revisit investing in the junior and intermediate gold producers."

The analysts said their data indicates that a Central Bank Gold Agreement (CBGA) signatory "has become a gold buyer, putting further pressure on the existing supply deficit in the bullion market." In their analysis, Wellington suggests that China is building a strategic gold reserve.

Meanwhile, possible Russian, Ecuadorian and Iranian gold liquidation in the face of internal credit woes "has not fazed the market," the analysts advised.

Analysts Catherine Gignac, Paolo Lostritto, John Miniotis, and Ryan Walker also noted that investment demand for physical gold increased by 179% in the third quarter of this year.

"Severe stock shortages of bars and coins were reported among bullion dealers in many parts of the world. A continuation of strong gold investment demand has been seen so far in Q4/08, leading to the Perth Mint being forced to suspend orders until January," they said.  

Wellington also urged precious metals investors, who "are expected to initially focus on large, capitalized liquid producers" to consider coming down the food chain. "If the market starts to regain confidence and applies higher future gold prices, we would expect more speculative funds to invest in intermediate and junior gold producers."

"Funds should continue to focus on well-managed senior producers but we believe it prudent to start considering the junior and intermediate gold space," the analysts advised.

In their research for the third quarter of this year, Wellington's analysis found that, despite a 19% increase in gold average gold price, gold mining production fell 2%, costs rose 37%, and margins declined by 13%, resulting in operating cash flows declining an average 29% for the group. "We note that debt levels are rising for most of the companies, in comparison to previous years when equity financing was more common."

The analysts also discovered that the relationship with the price of gold relative to the price of oil began to break down in October, resulting in the price of gold only decreasing by 8.1% since the end of September while the price of WTI crude oil decreased 51%.