LONDON (ResourceInvestor.com) -- Investment money will probably drive the gold price higher, and all fundamental bets are currently off, according to Jessica Cross, CEO of Virtual Metals. While the price must eventually realign with the fundamentals, the new base price appears to be higher than previously thought, as the physical market now appears to be accepting higher prices.
Virtual Metals, a London-based commodity consultancy, publishes forecasts of the supply-demand balance for gold twice yearly in the open-access Yellow Book. In the November 2005 issue, the focus was on the degree of confidence that could be attached to each estimate in the supply-demand balance looking at the known knowns, known unknowns and unknown unknowns! The April 2006 issue cut the market a different way, examining the price sensitivity of each sector of the gold market, and the continuum of the gold investment market.
Here Cross talks on these themes to Resource Investor.
RESOURCE INVESTOR: The last issue of the Yellow Book was published on April 3 when gold closed at $587/oz. Since then the price has soared $89 (15%) in just one month to $676. What do you see as the main factors underlying the latest hike?
JESSICA CROSS: There appears to be a huge amount of investment money moving into all the commodities at the moment and gold is one of them. This has given rise to real momentum behind the price. From what we can see this investment is a combination of hedge funds, institutional money and retail investors and thus the inflows have a broad base of market participants.
Supply
RESOURCE INVESTOR: The supply side falls mostly into the category of known knowns – it’s the easier side of the supply-demand balance to project. In early April, you were suggesting that the supply of gold will rise just 1% this year. Have you revised your view since then?
JESSICA CROSS: The supply side is easier to project than demand, save perhaps for scrap recycling which is price sensitive. I am comfortable with our supply projections with respect to primary supply, hedging and central bank sales. Our scrap figures may have to be adjusted upwards to account for the very recent price appreciation. All the indications are that the gold refineries are busy at the moment. With the other sources of refining material looking stable we have to deduce that secondary recycling is continuing at high rates.
Demand
RESOURCE INVESTOR: The demand side meanwhile lies more in the category of known unknowns; its diversity makes it far harder than supply to pin down and measure. The estimates for physical demand published in April were based on a first quarter average of $554. At that stage you were anticipating that demand would fall 16% primarily because of the price sensitivity of the investment jewellery market. How do you see this changing given the current price trajectory?
JESSICA CROSS: Very interestingly, while demand has certainly been disrupted by the higher prices it seems as though there is some acceptance of the higher trading ranges on the part of the major consumers. Indian imports, while still weak compared to this time say two years ago are showing some signs of stabilising and not continuing to implode as they did in January this year. This might be a sign that Indian jewellery buyers are resigning themselves to a higher trading range which certainly augurs well for price consolidation at higher levels.
RESOURCE INVESTOR: You argue in an article “(Not) the China syndrome” in the latest Yellow Book that you do not expect Chinese demand for gold to mirror the exponential growth seen in other raw materials. Chinese demand for gold grew by just 3.5% in 2005. What do you see happening to this sector in the future, especially now that prices are so high?
JESSICA CROSS: We believe the Chinese will continue to buy gold without excessive substitution to other precious metals, bearing in mind that the prices of platinum, palladium and silver have shown similar strength. But the growth rates will be unsensational.
The Chinese like white metal, and their first preference has been platinum, though recently, with the widening differential between platinum and palladium prices, they have partially substituted to palladium jewellery. Their preference for the PGMs appears to be rooted in their desire for high purity alloys (995). For this reason, white gold (750) is still not the preferred option, being perceived as less pure than the PGMs.
More broadly, jewellery is still considered as luxury spending. China’s massive demand for other commodities reflects the infra-structural development going on in the country and demand for white and domestic goods associated with swift urbanisation of many millions of people. The fridge and TV come first, and only then the luxury spending like travel and jewellery.
Supply-Demand Balance and Price Outlook
RESOURCE INVESTOR: Your April forecast suggested that the market would move from a supply deficit of 310 tonnes (equivalent to 7% of supply) to a surplus of 422 tonnes (10% of supply). What is the significance of this and how might it change given the current price level?
JESSICA CROSS: I think while there is this massive flow of investment money into precious metals in general and gold specifically, the supply/demand imbalance reflecting a market moving into surplus will not impinge on the positive market sentiment. But to maintain the price momentum, the flow of investment money must continue. Should this flow slow down or reverse and the price correct downwards, then fundamentals of the market will come back into play.
RESOURCE INVESTOR: Now to the impossible questions. What will happen in the pure investment markets?
JESSICA CROSS: I guess they must eventually come full circle. Investment money flows in and out of financial sectors depending on how the managers of those funds perceive the world. They will be looking for an optimal combination of maximising potential returns on their money at the minimal risk to their investments. I think of them as that swarm of midges on a cricket field on a hot summer afternoon. One minute they are concentrating in one area - usually around the bowler as he is about to deliver the next ball. Then they suddenly seem to evaporate and re-consolidate somewhere else on the field. Their movement is unpredictable, their reasons for moving opaque and apparently random.
RESOURCE INVESTOR: And what are the “unknown unknowns”? What spanners in the works might we see in the short to medium term?
JESSICA CROSS: The big unknown is what is going to trigger a change in thinking on the part of the investors or equally pertinent what will continue to convince the investor that commodities in the place to remain? Will it be a Fed interest rate hike and possible reversal of the current dollar weakness? Will it have something to do with the oil price and standoff in Iran? Might it be continued developments in Iraq? Rest assured it is most likely to be something not especially obvious but with hindsight we will say: we should have we seen that coming! The knowledge of hindsight is an amazing thing.
RESOURCE INVESTOR: And the bottom line? Where do you see the gold price going in the short, the medium and the long term?
JESSICA CROSS: Short term there certainly appears to be room for it to go higher and we accept that all fundamental bets are currently off. How far? Impossible to tell, save to say the faster it goes up the greater the chance of a correction and the higher it goes the greater the size of the correction. Where is the base? That will be decided by the buyers of physical metal and we need to watch closely where the buying comes back in volume and the recycling of scrap slows down.
