The 2015 Metals Outlook Series: Gold

Gold has peaked, but the current price schizophrenia of spikes and troughs that have been experienced over the last six months will soon be at an end.

However there is still likely to be pain for a number of unproductive gold miners as the commodity price goes through a rationalisation phase operations with high costs per ounce are likely to fall as the market becomes tighter.

But how did we get to this point, and how did the great decade long Bull Run get to its current state, and where will it head in 2015?

The rise and fall of the gold market did not happen overnight; and it is not the first time this market has moved this frenetically either.

The first time gold made massive leaps was in the late 1970s, due to the end of the Bretton Woods accords – which had codified the strength of the US dollar in the global financial markets – and the US moving off the gold standard, which removed international mechanisms tying the US dollar to gold via fixed exchange rates.

This drove the US dollar down as it become a fiat currency and fell in its free market exchange price versus gold.

In the wake of this decision prices gradually skyrocketed from US$35 per ounce in 1969 prior to the US currency float, to close to US$500 per ounce in 1980, but a period of rationalisation saw the price fall and then stabilise.

Gold was driven to its most recent historic highs following the Global Financial Crisis, after investors flocked to the metal as a safe bet in the wake of the extreme volatility in the financial markets and ongoing uncertainty over economic growth prospects.

From its average rate of US$ 1200 in 2009/10, a point which it currently languishes below, gold soared over the US and European debt crisis, but as these markets' economic conditions have improved the price of the metal has swiftly decreased.

Gold, as a commodity, is often inflated due to fear or uncertainty in the market, with investors flocking to it and pushing up the price in the face of weak economic outlooks.

ANZ's head of Australian economics – corporate and commercial Justin Fabo explained, "geopolitical tensions have taken centre-stage for the precious metals markets."

The crisis in the Ukraine is a key example of this factor affecting the gold price, and is believed to have carried the inflated gold price, allowing it to stay higher than it should have in the face of economic improvement in the US and Europe.

It turned gold back into a safe haven metal, however it has not attributed to another spike in price nor will it in the future, as the price will be dampened by a bullion banking sector that may face default if the commodity rapidly heads north once more.

BNP Paribas's head of energy and natural resources investment banking Asia-Pacific, David McCombe, told Australian Mining "gold was a haven for certain banks, but the nexus just is not there at the moment".

Resources industry finance site Mineweb's journalist Lawrence Williams explained the situation best.

"If some of the analysts on the bullish side of the gold equation are correct in their assumptions that many Western central banks (with the approval of their governments whether they are deemed independent or not) have leased out much of their gold reserves, and that the banks to which they have leased them are in no position to return the bullion, then the proverbial could well be set to hit the fan as banks default in their commitments."

If investors call on their banks to repay their physical gold then the market may find a run on banks.

Ignoring this however, most of the global demand for physical gold comes from China and India.

While Indian demand con­tinues to fluctuate on the back of its wedding season expectations on Chinese demand are grimmer.

"Chinese demand for physical gold remains largely on the sidelines and we see further weakness in coming months," ANZ's head of Australian economics – corporate and commer-cial, Justin Fabo said.

"What was a key supportive factor for the gold market in 2013 is proving to be a benign one currently.

"China's weak gold import volumes, down 14 per cent year on year in the first half of 2014, confirm the softening demand.

"An onshore stock build in China of over 100 tonnes in Q1 2014 is also having a dampening effect on fresh imports," he added.

Fabo went on to state that "in India, the lull in the festival/wedding season until November will also see physical premiums subdued".

McCombe added: "Demand for gold in Asia is down."

CURRENT PRICE

Gold is continuing its downwards slide, dropping to a new four year low of US$1160 per ounce at the time of writing.

This new drop is the latest blow for the metal, which has seen a consistent slide from its high point of almost US$1800 per troy ounce to its new low point.

Overall gold prices fell close to five per cent last in early November.

McCombe said he expects the price to continue to fall in the short term to south of the US$1100 mark.

According to IBISWorld research the price of gold will rise again, however, stabilising above current rates and "is expected to increase in 2014/15 to an average of US$1411 per troy ounce as the global economy improves and inflationary pressures ease with higher interest rates in the United States and Europe".

However this is having a flow on effect for the aforementioned gold producers, who will see their profit slashed in the wake of this price righting combined with the increased cost of actual production.

"Overall industry profit is estimated to have decreased from 12.6 per cent of industry revenue in 2009/10 to 8.7 per cent in 2014/15," IBISWorld stated.

It went on to forecast these rates to decline even further over the next five years "with higher costs contributing to profit declining to a forecast 7.6 per cent of revenue in 2019/20".

The head of precious metals at the Bank of Nova Scotia told Reuters the market is vulnerable, adding that it is unlikely to increase soon, and will continue on a similar trajectory throughout the year.

The $US1170 mark seems set to stay.

Unfortunately for many miners these current prices sit below their production costs.

CEO of brokerage firm Maison Placements Canada, John Ing, told Bloomberg that this situation is creating a new two tier market, with top tier companies operating good assets with lower costs, while others are saddled with low grade, high costs assets that began during the boom times for gold.

This is creating a new crisis point for the industry, as according to Fidelity Select Gold, up to a third of worldwide output will be pushed into a cash-flow negative position now gold has fallen below the US$1250 mark.

Speaking to Grant Thornton's Brock Mackenzie a new cost per ounce matrix is being developed, with the likelihood that if prices fall below US$1100 per ounce Standards & Poor will begin looking at credit ratings.

"The reality was that many companies were chasing production without focusing on their costs as prices were still too high to support this action, but while the price of gold increased gold stocks themselves underperformed massively," he said.

"At this US$1100 per ounce mark a lot of mines will become very marginal operations, so they are likely to close and supply will diminish and we will see likely see an upwards movement in price again, although it does depend on the US dollar."

Lower price have already hit some miners, such as Barrick Gold which earlier this year recorded a net profit drop of 90 per cent, after its Q1 2014 net earnings fell to only US$88 million from the previous corresponding period's earnings of US$847 million.

However the need for miners to re-examine their costs and push them below $1000 has long been on the table.

Earlier this year gold producers gathered at the 2014 Paydirt Australian Gold Conference to discuss the future of the industry in a worsening market.

Northern Star Resources managing director Bill Beament said at the event that although the company has a good record for maximising productivity and efficiency, the overall sector needs to address the expectation for improved cost performance in the upcoming market climate.

"We are aiming to achieve an all-in sustainable cost of $1050 per ounce on average across our four mines and this now includes reviewing all supply contracts and leveraging off the company's buying power so that we reduce the total site cost per ounce," Beament said.

Miners sitting at lower costs per ounce like this have a better chance of weathering what will definitely be a stormy market ahead.

Most that fit criteria will prob-ably reduce output to solve the supply issue.

Added to this is the fact "2015 will be the peak in world gold production," Mackenzie said, "so every year after that there will be less gold produced, which will have a positive effect on the price."

McCombe went on to state that "this run-off in gold production is expected to sustain the price in the forecast period".

These immediate significant contributions next year will be made by the Tropicana mine ramping up, Newcrest's Cadia East mine moving to full production, and Mungana Goldmines Chillagoe and Tanami Gold's Central Tanami project moving ahead.

A SHINING FUTURE?

In terms of Australian producers, much of their future depends on the vagaries of the movement of the Australian dollar against the US greenback.

According to Beyond the Boom, a Lowy Institute Paper developed by John Edwards, a board member of the Reserve Bank of Australia and former senior economic advisor for prime minister Paul Keating, "a declining dollar would help."

The drop will help strengthen Australian gold miners and to a degree inure them against the downturn.

"Just as the appreciation of the Australian dollar to some extent moderated the rise in US dollar commodity prices on the way up, so too a sustained decline in the Australian dollar would moderate the fall in commodity prices on the way down," Edwards said.

Fabo added: "Gold may find near term support, though the state of physical demand suggests prices are likely to retrace lower over the medium term."

However, much of this depends on the movements of the US Federal Reserve.

"Over the next five years industry revenue and profit will reflect trends in production, US dollar gold prices, and the exchange rate," IBISWorld explained.

"The US dollar gold price is expected to rise slightly over the next five years and that gain, combined with a marginally weaker Australian dollar will push up gold prices slightly in local currency," it said.

"Once inflation is taken into account the forecast price increase will be relatively small."

Mackenzie delved deeper into how the future of gold prices will be affected in the short term by variations in US economic policy.

"There are indications in the new year that the US will increase interest rates, and the appeal of the US dollar increases: the gold price typically moves in opposition to the US dollar," he said.

"That is why we'll expect some shifting, so with quantitative easing ceasing the US is likely to increase its interest rates, so the US dollar will have more appeal."

However Mackenzie stated the gold price has already taken into account this forecast quantitative easing, adding "it is partly behind what is driving the price down now".

IBISWorld has forecast next year to be the first for revenue growth in the gold sector since 2011/12, with the 2015/16 period seeing a 1.8 per cent increase, after the 2.4 per cent decline expected for the 2014/15 period.

Following that the sector is predicted to grow at a rate of 2.3 per cent the following year, and then 3.5 per cent for the 2017/19 financial year, before once more entering a period of decline as an era of consolidation takes hold and more mergers and acquisitions are seen in the market.

However, despite it all the story next year will be brighter for gold on the back of these IBISWorld growth forecasts, as the rationalisation takes hold and smaller less cost efficient gold miners are priced out of the market due to unproductive operations and higher costs per ounce, leaving only the more labour efficient businesses.

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