After the Gold Rush, with Richard Davis
What are the factors that will result in a steady decline or rise in the price of gold, outside of dollar strength/weakness over the coming months?
RD: One of the key factors will be investment demand. This is important because investment demand is really the only factor that can drive a long-term bull market in gold. In fact, every bull market has been driven by investment demand.
There are many reasons why people today buy gold as an investment. Some people are worried about inflation, US dollar weakness or geopolitics for example. Buying gold as an investment is not something we tend to do in the UK, but it is common practice in many countries in Asia and the Middle East for example. Importantly, these countries are becoming wealthier, so investment demand could continue to grow strongly in these regions. ............................................................................................................................................
Do you think the current trend down is more of a short term correction or a long term trend as liquidity constraints are being resolved?
RD: The fall from US$1,030 per ounce to current levels is a short term correction in a long-term bull market. The factors that have been driving prices higher for the past 7-8 years remain very much intact. These factors include, amongst others, rising investment demand and shrinking mine production.
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How serious are the likely effects of the potential electricity rationing in South Africa for gold supply? How will this affect gold stocks?
RD: South Africa is the world’s second largest producer, supplying 270 tonnes or roughly 11 per cent of global mine production. The power shortages in South Africa can only have a negative impact on supply. There is no quick fix to the problems, which stem from underinvestment in new generating capacity. It is estimated that it could take Eskom, the power utility, until 2011-12 to redress the problems.
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In the long term and once we are over the current credit crisis, what are the prospects for physical demand for gold? As India and China become richer and global growth rates rise, will prices recapture recent highs?
RD:Physical demand for gold will grow in the long term. India is already a substantial buyer of gold, accounting for 555 tonnes, or 23 per cent, of total jewellery demand.
China is less important at 302 tonnes but has greater scope for growth. Per capita consumption of gold in China is extremely low – just 0.2g per capita per year compared with 2g per capita per year in Hong Kong, for example. As incomes grow, consumption should increase. This will be positive for gold prices.
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Central banks around the world have been net sellers of gold for many years now. With investors driving the price of gold to new highs should central banks re-evaluate the role of gold in their reserves?
RD:European central banks have been net sellers of gold for many years. Arguably, they should re-evaluate the merits of selling. In recent years, gold has been the best performing currency – prices have risen in every major currency – so central bankers should ask themselves if it’s a good decision to keep selling their best performing asset.
Another interesting question is when they sell gold, what do they buy? Do they really want more US dollars? Outside Europe, central banks are now net buyers of gold for the first time in many years. My view is that any re-evaluation of gold will be made by central banks that don’t own enough and they could make a decision to buy some more.
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What impact could further gold sales by central banks and the IMF have on physical supply of gold - as a high gold price, combined with growing budget problems worldwide, could increase their incentive to raise money from gold sales?
RD: European central banks are the main sellers of gold. Their sales are part of the Central Bank Gold Agreement (CBGA) which sets a limit of 500 tonnes per year. Any IMF sales will also be part of the CBGA. As the USA and Japan have stated they will adhere to the spirit of the CBGA, no other central bank owns enough gold to have much of an impact on the market.
China is the ninth largest holder, but with only 1-2 per cent of its reserves in gold, China is more likely to be a buyer. Going forward, we may see an increase in net buying by countries outside of the CBGA.
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The US Federal Reserve has a dual goal: to fight recession and to fight inflation. If it is pumping dollars into banks and credit markets to fight recession, is there any evidence it has also been shorting gold to fight perceived inflation?
RD:There is no evidence to suggest that the Fed is shorting gold.
............................................................................................................................................Has central bank intervention in the precious metals market actually been helpful to world economies?
RD: One example of intervention was the signing of the Central Bank Gold Agreement (CBGA) in the late 1990s. This limited the amount of gold that the European central banks could sell. This was a very positive step for gold prices because the market now had clarity on the volume of gold that would come onto the market.
Rising gold prices have been positive for gold exporting nations, many of which are emerging economies. In fact, many of these countries lobbied hard against IMF sales in the 1990s because of the potential adverse impact they would have had on their economies.
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When the central banks sell, who are the primary buyers? I’ve read that there has been a major shift in the ownership of gold from the central banks and the governments they represent to the public, with the public now owning somewhere near 70 percent. Is this correct?
RD:When central banks sell, the main buyers are jewellers and investors. It is worth pointing out that jewellery demand alone is roughly equal to the amount of gold supplied by the mining industry.
The amount of gold that has ever been mined is 161,000 tonnes. The bulk of this - 83,000 tonnes - is in the form of jewellery. Only 29,000 tonnes, or 18 per cent of total stocks, is currently held by the world’s central banks.
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Most of the recent gold investors never take possession of physical gold but instead invest in a claim to gold. Does this mean that gold rally of recent years is yet another asset price bubble?
RD:My view is that gold’s rally is not an asset price bubble, but is part of a long-term bullish trend driven by supply-demand fundamentals. A lot of demand for gold has made through exchange traded funds (ETFs), which is tantamount to buying the physical metal.
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My purchase of gold mining stocks last year (Barrick and Kinross as well as Ishares) has not performed as well as the actual price of gold. What would you recommend as the best vehicle to take advantage of gold price movements?
RD: Gold shares have been disappointing given the movement in gold bullion.
Historically, gold equities have provided decent leverage to the gold price, but in last couple of years or so the benefits from rising bullion prices have been eroded by higher costs, so their margin expansion has been poor and this is reflected in their share price performance.
I think that the rate of increase in costs will taper off and that the producers will succeed in growing margins as gold prices rise. In fact, we saw this in the quarterly results of Newmont Mining released last week. So in answer to your question, I think you can make money by holding on to your gold equities
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I’ve read that 75 per cent of the world’s gold has already been mined and the remainder is expensive and difficult to obtain... Will increasing wealth in the Brazil, India and China leave demand outstripping supply, or is there something that could cause a real gold crash sometime in the future, with prices dropping back to say half of today’s levels?
RD:Total demand for gold already significantly exceeds mine supply. The market needs central bank selling and scrap sales in order to fill the gap. Demand will continue to grow as emerging economies, especially Brazil, India and China become wealthier, while mine supply will struggle to grow – so this gap could rise, which would lift prices in the long term.
What could send prices sharply lower would be the dissolution of the Central Bank Gold Agreement and a return to unlimited gold sales by the European central banks. Any sales by the US would also be negative. These scenarios are unlikely in my view.
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Would you agree that many of the mining majors are exhausting their reserve base, especially in light of high-grade production in recent years? And do you anticipate increased mergers and takeovers among junior miners & mid-tier producers with resource positions, in order for the majors to replenish their reserve bases?RD: Gold reserves are being exhausted. Barrick Gold, one of the world’s biggest gold producers, estimates that around 15 million ounces of new discoveries were made last year by the gold mining industry. This compares to production of 80 million ounces.
According to Barrick’s analysis, global mine production will fall 10-15 per cent in the next 5 years. This poor success rate in exploration is not due to under funding. Indeed, budgets today are at record levels.
The key issue is that all the big, easy-to-find orebodies have already been found. There is no short term solution to the problem. The average time taken from discovery to production is around 10 years.
This is why M&A activity has been and will continue to be a feature of the equity market. The most efficient way to increase reserves and production is by buying another company. This gives instantaneous growth to reserves, production and sometimes earnings per share. The alternative is to grow organically through the drill bit which could take years and may even be completely fruitless.
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