Gold Market
For the week, spot gold closed at $1,296.00, up $10.30 per ounce, or 0.80 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 6.06 percent. The U.S. Trade-Weighted Dollar Index lost 0.49 percent for the week.
Strengths
- Gold deliveries in Shanghai jumped as physical gold delivered in the first six months of this year approached the entire delivered in 2012, and was more than double China’s annual production. The Shanghai Gold Exchange supplied 1,098 metric tons in the six months through June, compared with 1,139 tons for the whole of last year, according to official data from the bourse. Total Chinese gold production for 2012 stood at 430 metric tons. Comparatively, total known ETF holdings of gold have decreased by approximately 500 tons year to date. In essence, during the first half of this year, Chinese buyers have taken delivery of the equivalent of all ETF holding redemptions, the Chinese full year domestic production, and then some more.
- Despite a recent wave of new restrictions by the Reserve Bank of India on gold loans, banks and other financial institutions have reported continued growth in the sector. In fact, Mineweb reports India's largest pure gold financing player Muthoot Finance has applied for a banking license. Muthoot Finance has nationwide reach, especially in the rural markets and has 74 years experience in gold financing. The move is appealing since villagers and investors in the rural areas tend to invest their savings in gold and with their savings invested in gold, most individuals prefer to take loans against gold. As a result, credit expansion in rural India will likely force more physical gold into the country and away from international circulation, thus diminishing the available marketable physical gold supply.
- B2Gold published very encouraging drilling results for 60 holes in the Wolfshag Zone, part of the 90 percent controlled Otjikoto project in Namibia. The results, which include numerous high grade intersections, support the idea of this deposit being part of a much larger open pit resource, and could offer a longer mine life. The drilling results highlighted intersections of 5 meters at 15 grams per ton and 13 meters at 7 grams per ton, significantly above the expected grades of the overall Otjikoto project (1.42 grams per ton).
Weaknesses
- Mining executives appear to agree it is cheaper to buy gold production than to build it. However, mergers and acquisitions have declined considerably. KPMG reports mining deal flows in the first quarter of 2013 totaled $15 billion compared to $90 billion in the first quarter of last year. As billionaire resource investor Lukas Lundin describes it, the major gold producers tend to buy at the peak and sell at the bottom. Conversely, some mid-tier producers appear to be taking advantage of current depressed valuations. Alamos Gold recently acquired Esperanza Resources, which has 1.5 million gold ounces in Mexico. Agnico-Eagle Mines has spent $66 million on equity stakes in ATAC Resources, Sulliden Gold, Kootenay Silver and Probe Mines. Meanwhile Randgold Resources struck an earn-in agreement with privately-owned Taurus Gold. It appears those who buy into the current environment may emerge as the cycle's winners.
- Colossus Minerals provided an operation update stating the company is having dewatering issues and will require additional equipment which will push back the production schedule. The company also appeared to signal more funding may be required before it can enter production. New Gold Inc., despite having one of the lowest cost structures, had its analyst recommendations slashed from Buy to Hold as nearly 42 percent of the company’s net asset value estimate is tied to unpermitted development stage assets.
- A gold supply surplus could send prices plummeting, according to Natixis. The French bank believes the gold market will see a supply surplus unless there is a sustained fall in mined gold output, which in its opinion would require prices to fall as low as $800 per ounce. We disagree with Natixis’ observations on two reasons: Firstly, the demand for gold is clearly outpacing the global supply of the metal, as evident in the strengths cited above. Secondly, in one of many examples, El Dorado Gold announced this week a revised operating plan with reduced capital and exploration spending in its development assets in response to the recent decline in the gold price; the revised plan is based on a gold price of $1,250 per ounce for the foreseeable future.
Opportunities
- According to Canaccord Genuity, sustained economic growth over the longer term may continue to require some form of quantitative easing. Citing a recent White House Office of Management study, over the course of the next decade approximately $6.6 trillion will be added to the federal debt. As evident in the chart above, the current level of U.S. dollar global liquidity already supports a best-fit gold price of $1,780 per ounce, well above the current spot price. It is worth noticing this best-fit price ignores the impact of likely additional easing and funding of the anticipated $6.6 trillion deficit. While there has been a recent divergence between the gold price and U.S. dollar global liquidity, the long-term trend highlights a greater potential for an increase in gold price versus a further decline.
- Billionaire resource investor Eric Sprott is of the opinion that Western central banks are running out of gold. With many major buyers of gold adding to their stocks, while supply is flat or even decreasing, the compounding of an already vast imbalance makes for an interesting case study. The conclusion reached by Sprott is that central banks have been selling their gold to non-Western central banks and private investors over the past decade, as they replaced their holdings of physical gold with claims on gold (paper gold). As proof of this, the German Bundesbank will need seven years to repatriate 300 tons out of the 6,200 tons of the New York Fed. Also, ABN Amro told its bullion customers that redemption of physical gold from their allocated accounts would now be impossible. Later, physical delivery times at the London Metals Exchange reached 100 days – unheard of. According to Sprott, as physical demand started to get tight, Western central banks engineered a method to increase available supply and decrease demand. As such, they flooded the COMEX (paper market), only to then free up physical gold.
- This week the Gold Forward rate (GOFO) has gone negative. This has occurred only four times in the last 14 years, and each time, it signaled a trough in the gold market. The Golden Truth blog provided a simple explanation of what a negative GOFO rate implies: A negative rate implies gold in hand today is worth more than U.S. dollars in hand. It means that someone with dollars needs the short-term use of gold and is willing to pay the owner of the gold interest plus use dollars for collateral. Hence, if they are willing to pay money to get their hands on gold, it means they are placing a higher value on gold than on dollars. What it really means is that the massive shortage of good to deliver 400 oz. bars in Europe, Asia and the Middle East is true.
Threats
- Scotiabank issued its second-quarter earnings preview this week. With the gold price having averaged $1,415 for the quarter, down 13 percent from last quarter, the bank expects revenue lines to be lower and believes there will be negative base metal pricing adjustments this quarter. Furthermore, cash margins are estimated to be 27 percent lower than the first quarter, while earnings per share are forecasted to be about 50 percent lower. Due to this margin compression earnings are expected to be lower both from last quarter and from the second quarter of last year. On the other hand, Scotia believes it is too early for companies to provide new Life of Mine plans, and resource updates when second-quarter financials are reported. Companies are more likely to perform this review at year end when they normally review the carrying values relating to mine assets, inventories, and goodwill.
- India’s Finance Minister has appealed to the people once again, to moderate their demand for gold. The government is insisting it will not rule on a complete ban of gold imports, as has been speculated in some circles. However, a new study has noted that the price of gold in India is expected to surge to again in the next few months, as demand increases due to the wedding season that starts in August. The seasonal pattern for gold demand is heavily weighted towards the second half of the year, with the Indian wedding season being one of the most significant demand drivers for global bullion prices.
- Fitch Ratings Ltd. is forecasting that increased royalty sales, forward sales and gold price hedging may occur for less well-capitalized companies, as plans to trim spending, sell mines, cut staff and reduce high-cost production prove insufficient to pare their market declines. The biggest threat, however, is being forced to hedge. Companies like Barrick Gold, who are reportedly approaching covenant breakpoints, and Anglogold Ashanti, who lost its investment credit rating this week, will likely be forced by creditors to hedge part of their books if they want to secure refinancing of their outstanding debt. In essence, hedging caps the potential upside increase in profitability resulting from unexpected increases in the price of gold, a very likely event in gold investors’ minds.
