GOLD ANALYSIS

Gold to the rescue as financial forces overwhelm challenging fundamentals - GFMS

GFMS Ltd expects gold to help safeguard investors against government profligacy in 2009; prices to remain volatile and dips are possible, but followed by a strong bull run. The US jewellery industry has been hard hit.

Author: Rhona O'Connell
Posted: Friday , 16 Jan 2009

LONDON - 

The second interim update for the GFMS Ltd annual gold survey highlights gold's highly individual nature, arguing that while recessionary conditions undermine the outlook for physical fabrication of the metal this year, the prospects for investment demand are robust and that an investor-led breach of the March 2008 high of $1,023.50 is quite feasible during the first half of this year. 

This argument is based primarily upon the main reasons for the current economic crisis and "in particular, the nature of the authorities' response to it, especially in the United States".  The combined level of the commitments already made by the outgoing Administration plus the new fiscal and monetary package proposed by President-elect Obama means that they are too large to be financed by orthodox means (especially as tax cuts are on the horizon) and the Fed has already suggested that it will be prepared to do so through "quantitative easing". This looks likely to weaken the dollar, perhaps substantially, as well as risking igniting major inflation in the future.  With the euro and the yen also facing problems of their own, gold is likely to "benefit handsomely". 

As well as these overtly supportive factors for gold, another key feature emerges in the form of serious concerns over the security of many alternative forms of investment.  Deep recession, for example, is hardly the environment for equity investment.   From a fundamental standpoint, though, there is little support to be expected from fabrication demand as economic stagnation will undermine jewellery offtake; furthermore the bulk of dehedging from the mining sector is now complete.  Mine output will be relatively flat and central bank sales are expected to be similarly so; also unless prices go to at least $950 there is little increase in prospect from the scrap sector. 

The study, as always, includes a preliminary schedule for last year's market balance, along with a comprehensive analysis thereof.  The essential conclusions from this work are that Central Bank sales were down by more than 42% last year; scrap was up by over 13% and mine production slipped by almost 4%.  Total fabrication was down by 8%, driven by an 11% fall in jewellery demand and contraction in all other areas of physical demand apart from the boom in coin offtake.  Separate from this, bar hoarding rose by more than 60%. 

This latter change has revolved in some part around a change in trend in Japan, with the group noting that 2008 marked "the end of what has been a remarkable episode in the history of Japanese bar hoarding".  After twenty years of net hoarding of gold investment bars, Japan has just witnessed eleven consecutive quarters of net dishoarding of gold - which came to a close in the second half of last year.  Positive net hoarding returned to the Japanese market in the fourth quarter of last year, in good volume, as Japanese investors looked balefully at the prospects for the global financial position. Heavy increases were also recorded in China, Thailand and Vietnam.  The Chinese increases may yet prove to be significant as they reflect not only the changing investment patterns of the local populace in the light of the economic environment but also increased access to investment bars due to the market's deregulation. 

While the rise in bar demand was driven primarily by the Eastern hemisphere, the massive surge in coin demand hit a 40% increase in minting to a 21-year high, reflecting the sharp growth in investment in the United States and Europe in particular.  The increase was concentrated in the second half of the year, which accounted for roughly two-thirds of the total against an average of 45% from 2000 - 2007.  An interesting development within this overall increase was that, as well as the natural increase in coin premia (particularly towards the end of the year when blanks became scarce), higher premia also became commonplace in the secondary market and minting dates of existing coins became irrelevant. Furthermore, "old" coins, i.e. those no longer in mass production, also started to trade at close to parity with some of the major bullion coins, rather than at lower prices, as hitherto.  There was also a shift in minting patterns, with excess capacity that belonged to private manufacturers often being used to produce investment-grade products and thus partially to ease the supply bottleneck that had developed. 

While coins and bars were the bright spot on the demand side of the market, jewellery suffered.  Overall demand fell by 11% last year, but if scrap return is stripped out to give "new" gold jewellery, then demand in the sector fell by 17%.  The largest manufacturing losses were sustained in India, Turkey, Italy and the United States.  Further losses are expected in the first half of this year at least.  

One of the most interesting points to emerge from within the detail of this study is the state of the US jewellery industry.  Within the global jewellery industry the percentage fabrication falls were the largest in North America, with a fall of 25%, followed by 16% in India (a combined tonnage fall of 131 tonnes, or 50% of the global fall).  The North American position was worse than the fabrication figure suggests, as imports were also sharply reduced (especially from Italy) and GFMS estimates that US jewellery demand in 2008 was down by approximately one-third against 2007.  The study reports industry figures showing that in the first eleven months of last year 1,069 jewellery-related businesses either ceased operations or were declared bankrupt - and there is a raft of other manufacturers, generally with a regional focus, who are under threat.  The study cites a series of interlinked factors that have led to this position.  Demand is expected to recover, although this is more likely to be in 2010 than this year; in the mean time, however, the US jewellery supply chain has been hard hit.