Gold’s Gains Limited To US Dollar

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This story features NEWCREST MINING LIMITED.
For more info SHARE ANALYSIS: NCM

By Chris Shaw

As the market speculates over a likely rate cut this week by the US Federal Reserve the gold price has risen to 27-year highs, but lost in the headlines according to National Australia Bank’s report ‘Gold Market Outlook October 2007’ is the fact the gains in the metal’s price are almost all linked to the weaker US dollar.

As evidence the bank’s minerals and energy economist Gerard Burg points out gold in both euro and Australian dollar terms remains below the peak levels seen in May of last year.

The underperformance has been relatively significant as Burg notes in September the gold price rose 6.9% in US dollar terms to an average of US$712 per ounce, but in euro and Australian dollar terms the gains were just 4.8% and 4.6% respectively.

He expects this trend will continue and estimates for 2008 gold in US dollar terms will gain a further 8% to an average of US$740 per ounce, compared to a 3.1% gain in euro terms and a fall of 1.9% in Australian dollar terms.

His forecast gains for next year are predicated on the expectation of further rate cuts in the US, as this will provide additional incentive to invest in the yellow metal as returns on fixed interest assets will decline as interest rates come down.

This would indicate something of a change from recent trends as Burg points out investment demand has not played a major role in gold’s recent strength. Figures show identifiable investment inflows in the first half of 2007 were down 17% from levels of a year ago, with the June quarter actually recording a net outflow of gold from ETFs (exchange traded funds) for the first time since 2005.

Luckily for the gold price fabrication demand remains more solid, thanks in some part to less volatility in gold prices than among the base metals. This has supported demand in price sensitive markets such as India where demand increased by 72% in the first half of 2007 and accounted for more than a third of global consumption in the period.

China also played a major role as the country lifted demand by more than 30% in the first half of the year as consumers enjoy greater wealth on the back of continued strong growth in the Chinese economy.

Gold industry consultant GFMS’s figures for the first half of this year show total end user consumption of gold rose by 25% to 1,480 tonnes, while total gold fabrication is expected to rise by around 12% for the full year. Burg expects this rate of increase to slow next year but is still forecasting a 4.3% increase in total gold fabrication demand in 2008.

The supply side has also helped improve the fundamentals of the gold market as gold production in recent years has grown slowly despite the stronger spot prices. South African production is a major factor in this as operations in that country are experiencing continued higher costs as operators have to go deeper and deeper underground to access ore.

Burg notes average cash costs for gold production have risen by 20% year on year in the first half of 2007 and now stand at US$371 an ounce according to GFMS figures, while Australian miner Newcrest ((NCM)) estimates total costs of production for the industry are now more than US$500 per ounce.

Offsetting the lower South African output over the first half of 2007 was increased production from China and Indonesia in particular, while output in Australia was essentially flat for the first half when compared to 2006.

In 2008 production is expected to increase by just 2.8% to 2,580 tonnes, though the support offered to spot prices from producer de-hedging is likely to decline over the next couple of years in Burg’s view as those with major hedged positions such as Barrick Gold and AngloGold Ashanti have committed to delivering gold in line with expiring hedge contracts.

While de-hedging appears to be declining official sector sales by central banks were a little higher than expected for the year to the end of September, these sales playing an important role as mine supply remains lower than fabrication demand.

In quarterly terms Burg is forecasting an average gold price of US$740.40 per ounce in the December quarter this year, then US$750 per ounce in the March quarter of 2008 and US$730 per ounce in the June quarter. This suggests an annual average price for 2008 of US$740 per ounce, up from the US$685 per ounce expected for 2007.

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