Shifting trade patterns in gold suggest higher prices likely

13 Sep

The latest data show that investment demand for gold bar and coin in Asia increased significantly in 1H2013. Investment demand in Europe and the Americas—which fell in late 2012 and early 2013—is also picking up from its recent trough, but remains lower than Asia, extending a trend that emerged in 2010. The gap between bar and coin demand in Asia relative to the Americas and Europe has nearly doubled to about 11.1 million ounces as of 1H2013 from 5.8 million ounces in the first half of 2012. At the same time, institutional investor interest in owning gold declined over the first half of this year, shifting ounces toward individual investors. According to data from the World Gold Council, Central Banks reduced their purchases in 2Q2013 by 35% from the prior quarter and by 57% relative to last year. Liquidations from gold ETF holdings over 1H2013 have slowed, and given the upward trajectory of inflation, recent EM interest rate hikes (Brazil, Indonesia), and a resurgence of geopolitical risk, we expect to see renewed interest in owning gold in the fourth quarter. Overall, the pendulum is moving away from buyers in developed markets—the main drivers of demand growth during the 2008-2009 window—toward the Asian investor and consumer.

Recent data from a number of mints point toward a sharp drop in physical bar and coin demand in the US and in Europe, after strong growth in the first half of the year. The US Mint report a 69% drop in combined American Eagle and Buffalo coin sales in August from the prior month. August sales mark a 55% decline relative to a year ago and the fourth consecutive monthly sales decline from the recent peak in April. For the first eight months of this year, US coin sales increased by 76% yoy, propelled by the April surge. In Australia, coin sales at the Perth Mint fell in August by 46% from July, and remains on a declining trend. The Perth Mint refines nearly all of the bullion mined in Australia—the world’s second-largest gold producer after China—with the majority of sales headed toward the US and Europe. In Turkey, Europe’s leading gold producer, coins sales at the Turkish State Mint were almost zero in August, due to a strike at the facility. Industry sources report only limited replacement of lost coin demand with bars.

In contrast, Asian consumers continue to make purchases. The latest trade data released by the US Department of Commerce reveal strong external demand for US gold. US gold exports reached 15.5 million ounces in the first seven months of the year, an increase of 16% relative to the same period last year. This performance is especially noteworthy given that gold exports in 2012 were at the highest level since 1996—the year our data set begins. US gold shipments to China and Hong Kong increased by 88% year-to-date through July. At 900 thousand ounces, July’s export figure was the second-largest to China and Hong Kong since 1996 (the December 2012 figure was 1.2 million ounces). For reference, the US exported 4.7 million ounces of gold to China and Hong Kong in the first seven months of the year, or more than the 4.2 million ounces exported during all of 2012. Indirect shipments to Asia from the US via Switzerland, with most of these ounces also making their way into Asian markets in kilobar form, increased by 17% in the first seven months of the year. Of the 15.5 million ounces the US exported during the January through July period, Switzerland received 6.7 million ounces—which, when combined with China and Hong Kong, tallies to a 73% share of total US gold exports.

Our baseline forecast is Asian gold demand will remain strong for the remainder of the year, with the likely result that US trade remains on track to export a record amount of gold. However, the primary question is: where will this gold come from? We estimate that US mined gold production in 2013 will be 8.1 million ounces. After adjusting for scrap, we estimate total US gold supply of 15.4 million ounces this year. Accounting for imports and exports and subtracting domestic demand, we estimate the US market will record a deficit of over 6.7 million ounces in 2013. Since the beginning of the year, Comex gold inventories have drawn by 36%, or 4.0 million ounces.

India’s May 2013 introduction of additional restrictions on payment terms for gold imports and the third consecutive annual increase in import duties has had only a limited impact on consumer demand, so far. End-use demand has been largely met by stocks that had accumulated as a result of very strong imports during the April and May period. A sharp drop in Indian gold imports in June was mainly due to the seasonally-quiet demand period, but July gold imports increased by 54% from June. The move by the RBI on July 22 to link the gold import quotas to exports will likely result in weaker August and September import numbers, and we estimate this weakness will persist into October. As domestic jewelry demand comprises the larger part of Indian gold imports, jewelry producers are reportedly running down their inventories accumulated earlier in the year.

With the seasonally-strong 4Q approaching, combined with weaker imports in August and September, we estimate that the Indian jewelers will start experiencing greater, customer-driven pressure to import additional supplies. In India, the average annual gold demand for jewelry has trended in the 16-to-21 million ounce range. In contrast, over the past few years there has been a sharp rise in gold bars and coins investment in India. Similar to India, China’s gold imports dropped during the month of June (by 11% from May). However, imports picked up again in July and year-to-date imports are 89% higher than last year, according to NBS figures. China’s retail sales of gold and silver jewelry reportedly increased by 43% yoy in the first eight months of 2013.

Implications for risk and valuation

Incorporating the latest industry data into our global gold supply-demand balance leads us to reduce our 2013 mine production forecast to 94.9 million ounces from our July estimate of 97.2 million ounces. According to the World Gold Council, gold scrap supply in the first half of 2013 was 21.6 million oz—the lowest half-year print since 2007. Although our forecasts already incorporate the assumption that elevated gold prices in local currencies will attract additional scrap, a weaker-than-expected 2Q and 3Q result in a lower full-year scrap projection of 46.0 million oz versus our prior estimate of 48.2 million oz (July 2013). In the first three weeks of August, premiums in India were reportedly trading as high as $40-$50/oz from $5-$10/oz in July. Anecdotal evidence suggests that scrap gold selling in India has increased to about 100 to 150 kg per day from 5 to 10 kg per day in the last week of August, as gold owners sell into higher local prices. Since August, as scrap has made its way into the market, gold premiums have reportedly retraced. Our analysis concludes that an increase in scrap supply will not offset the likely sharp drop in Indian gold imports registered this quarter, and the Indian domestic gold market will most likely be in deficit in 3Q13 and 4Q13.

On the demand side, we increase forecast 2013 global jewelry use to 73.2 million oz, compared to our previous estimate of 65.4 million oz. We also raise our expectation for other fabrication use to 27.5 million oz (25.6 million oz previously) and physical bar and coin investment to 47.2 million oz (45.5 million oz previously). Data for the first half of the year show jewelry purchases increased by 21% yoy, with the most notable increases in India, China, the Middle East, and other Asian countries. Global bar and coin purchases in 1H2013 also increased by 20% yoy. Strong purchases by individuals were offset to some extent by a drop in official sector purchases, which fell by 35% yoy in the first six months of the year. This was lower than we expected and leads us to reduce our estimate for official sector purchases by 4.5 million oz to 11.6 million oz. ETF outflows have slowed and we expect to see net inflows trickle in during the fourth quarter. The changes to the balance described above reduce our gold supply estimate by 4.5 million oz and increase demand by 6.9 million oz, pointing toward a tighter physical gold market entering the 4Q. This development will likely necessitate higher prices to pull in additional scrap sales and to ration the current pace of demand.

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Posted by on September 13, 2013 in Investments


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