abare.gov.au - Australian commodities – March quarter . volume 16 . number 1 2009

Gold

Outlook to 2013-14

Andrew Schultz

In 2008, the gold price averaged US$873 an ounce, representing a 25 per cent increase on the 2007 average of US$697 an ounce. In real terms, the annual gold price has risen for the past seven years and in 2008 was worth greater than US$550 more than in 2001. While the average gold price in 2008 remained well short of the historical peak of US$1580 an ounce (in 2008 US dollars) reached in 1980, it was the highest annual price since 1983.

During the first half of 2008, the price of gold rose sharply, rising briefly above US$1000 an ounce and averaging US$912 an ounce. This price rise mainly reflected investor interest in response to the high level of instability in global financial markets as conditions worsened in the US subprime mortgage market.

During the second half of 2008, the global financial crisis began to have a severe impact on global equity markets and world economic activity. Over this period, the gold price fell to an average of US$833 an ounce. There were two reasons behind this decline in the gold price. Firstly, the sharp decline in global equity markets resulted in many investors selling liquid assets and commodity holdings, including gold. Secondly, the US dollar appreciated as institutional investors turned to US dollar denominated assets, such as US treasury bonds, for their perceived lower risk profile. This resulted in lower investment demand for gold, causing the gold price to fall over this period.

Since late 2008, however, strong demand for gold bars, coins and other physical gold products following a sharp worsening in the world economic outlook has led to the price of gold rising to more than US$900 an ounce by mid-February 2009.

In 2009 the gold price is forecast to rise by 4 per cent to average US$910 an ounce. This rise is expected to stem from growth in retail investment demand, in the form of gold bars, coins and other products, which has grown in popularity in some countries as global economic and financial market uncertainty intensifies. Partially offsetting this upward pressure on the gold price will be expected lower inflationary pressure in the short term, as gold is commonly used as a hedge against inflation. Furthermore, assumed ongoing strength in the value of the US dollar throughout much of 2009 is likely to place downward pressure on the gold price, which is denominated in US dollars.

Gold price to fall in the medium term

In 2010, the gold price is forecast to rise by more than 3 per cent to around US$940 an ounce. This rise is based on the assessment that, by this time, an assumed recovery in world economic growth will lead to an increase in investment demand for commodities, including gold. In contrast, a strengthening in world economic growth from 2010 onwards could also lead to a reduction in retail investment demand for physical gold, such as gold bars and coins, as the risk of a prolonged and deep world economic recession subsides.

Toward the end of the outlook period, the gold price in real terms is expected to fall gradually as world economic growth increases to levels which are more consistent with its longer term potential. Under this scenario, investors are expected to increase their appetite for more risky assets, such as shares and real estate, and reduce their interest in gold. Nevertheless, the decline in the gold price is projected to be relatively limited because of higher demand for gold in some fast-growing emerging economies, especially China and India, and an expected continuation of the downward trend in global mine production.

There are significant risks associated with the price outlook for gold, especially in light of the current global financial crisis. An extended period of financial market instability could place further upward pressure on the gold price, leading to a significantly higher gold price than the current forecast, at least in the short term. On the other hand, if income growth in developing countries were to be more significantly affected by the current economic downturn, downward pressure on the price of gold could be more severe as a result of a sharper decline in jewellery and other investment demand.

Production to rise in 2009

World gold mine production is estimated to have fallen by 3 per cent to 2392 tonnes in 2008. This follows the downward trend evident in global mine production since the production peak of 2640 tonnes in 2001. While South Africa, Australia and Indonesia recorded the most significant falls, production also declined in other producing countries.

In South Africa, production disruptions, including electricity shortfalls and mine maintenance activities combined with the introduction of new mine safety provisions, led gold production to fall by an estimated 14 per cent in 2008. In Indonesia, the scheduled mining of lower grade ores at Freeport-McMoran’s Grasberg mine contributed to a decline in production of around 47 per cent or 32 tonnes during the year.

In 2009, world gold mine production is forecast to rise by around 3 per cent to 2464 tonnes, supported by expected higher production in South Africa, Australia, Indonesia, China and the Russian Federation. In South Africa, while electricity rationing by the state-owned power generator Eskom is expected to continue, the adverse effect on production is expected to weaken as producers modify their operations to accommodate the disruption. Production from mines such as the Gold Fields’ Kloof and Driefontein mines is expected to increase in response to the completion of maintenance and upgrades. In Indonesia, the mining of higher grade ores from the Grasberg mine is forecast to increase production by around 28 tonnes in 2009.

In the medium term, global gold mine production is projected to grow at an annual average of 1 per cent. The significant tightening in global credit markets could adversely impact on the start up of some development projects in the short term. China is expected to remain the world’s largest gold producer, as production expands from new mines in the more remote provinces of Inner Mongolia, Xinjiang and Guangxi. The Russian Federation is expected to be the fastest growing gold producer over the outlook period, with a forecast average growth rate of around 3 per cent a year. Africa (excluding South Africa) and Latin America are also expected to increase gold production over the outlook period.

In contrast, production in mature gold producing countries, such as Australia, South Africa, the United States and Canada, is expected to decline over the medium term as ore grades continue to fall and reserves are not replenished by the discovery of new gold deposits.

Sales of gold scrap to reflect gold price movements

The supply of gold scrap, largely sourced from recycled jewellery, is estimated to have risen by 13 per cent to 1108 tonnes in 2008, reflecting the effect of a higher gold price. With the forecast of strong demand for physical gold, high volumes of gold scrap, averaging around 1000 tonnes a year, are expected to be available in the next few years. Over the medium term, gold scrap sales are projected to decline, as demand for physical gold moderates.

Official sector sales to contribute to supply over the outlook period

Net sales of gold by the official sector are estimated to have fallen by 42 per cent to around 280 tonnes in 2008. More than 95 per cent of the net sales came from the central banks which are signatories to the European Central Bank Gold Agreement (CBGA).

The CBGA places a collective limit of 500 tonnes a year on the quantity of gold which signatories, comprising 18 European central banks including the European Central Bank, are permitted to sell from their reserves. The current CBGA began in 2004 and is set to expire in September 2009.

The central banks of France and Switzerland were the biggest sellers of gold in 2008, selling an estimated 111 tonnes and 105 tonnes respectively. Together with the central banks of Germany and Italy, these banks hold the bulk of existing European gold stocks. The German and Swiss central banks have both indicated that gold sales are unlikely in the short to medium term. Central bank sales are forecast to be around 220 tonnes in 2009.

Under the assumption a similar agreement will be reached to replace the expired CBGA, sales by the signatories are expected to continue, although at reduced volumes annually. While considerable uncertainty remains in the outlook for gold sales from the central banks, the reduced gold stocks of many European central banks and the perception that gold is a relatively safe asset, is likely to dampen official sector sales, especially in the short term as the global financial crisis continues.

Gold fabrication demand to rise in 2009

Gold fabrication consists of gold used in jewellery, electronics, dental applications, medals, coins and other industrial uses. In 2008, gold for use in jewellery, the largest component of gold fabrication, is estimated to have fallen by around 11 per cent. Falling jewellery demand was recorded in all major consuming countries except China, where fabrication rose above 300 tonnes for the first time. World fabrication use of gold is estimated to have fallen by 8 per cent to 2824 tonnes in 2008.

In response to the assumed significant slowdown in global economic activity and ongoing strength in the gold price, demand for gold jewellery is forecast to decline in 2009. Within developed economies, including North America and Europe, assumed economic contractions are expected to lead to substantial declines in jewellery consumption. In the more price sensitive jewellery markets of the Middle East and the Indian sub-continent, the higher gold price is forecast to reduce demand for gold jewellery. Taking into account falls in demand for gold used in electronics, dentistry and other industrial uses, world consumption of gold for fabrication is forecast to fall by 5 per cent to 2683 tonnes in 2009.

Over the medium term, fabrication demand is projected to rise moderately. In 2010, jewellery fabrication is expected to recover by around 1 per cent in response to a partial recovery in world economic growth. Over the remainder of the outlook period, gold consumption for fabrication is projected to rise by around 2.5 per cent a year, with increasing demand in emerging markets expected to more than offset the decline in developed economies.

Producer dehedging to diminish in importance

Producer hedging involves gold producers borrowing gold from central banks and selling it on the spot market in order to reduce exposure to the risk of lower gold prices at the time of actual production. As a result, the value of future mine production of gold is effectively brought forward.

Dehedging, through the buying back or unwinding of these hedged positions, has largely occurred because of producers’ expectations of an increasing gold price. Net dehedging, occurring when gold repayments to central banks exceeds new producer hedging, imposes upward pressure on the gold price through the reduction of gold supplies to the spot market.

An estimated 346 tonnes of gold was cut from the outstanding hedge positions of global gold producers in 2008, with Anglogold Ashanti and Barrick Gold the main contributors to dehedging activity.

Future substantial dehedging is limited by the reduced size of the remaining hedge book, with Anglogold Ashanti and Barrick Gold the only gold producers with significant outstanding hedge positions. Consequently, net dehedging is forecast to fall to 130 tonnes in 2009.

Australian gold production to fall in 2008-09…

Australian gold mine production is forecast to fall by 1 per cent to 225 tonnes in 2008-09. While many of the larger mines in Australia are forecast to increase production modestly in 2008-09, as higher grade ores are processed, this is expected to be more than offset by declines in production by Newcrest’s Ridgeway project and Anglogold Ashanti’s Sunrise Dam. Together, the production decrease from these two mines is forecast to be more than 7 tonnes compared with the previous year.

With a number of small to medium sized producers deferring operations or entering administration, unscheduled mine closures are forecast to result in production losses of 7 tonnes in 2008-09, compared with 2007-08. The largest affected operation has been GBS Gold Australia’s Union Reefs project in the Northern Territory, which was placed into voluntary administration in September 2008 after producing 3.5 tonnes of gold in 2007-08.

Several new projects are expected to approach commercial production. These include Apex Minerals’ Wiluna redevelopment (averaging 6.2 tonnes a year), Avoca’s Higginsville project (5 to 6 tonnes a year) and St Barbara’s Leonora operations (6.2 tonnes a year).

…before rising until 2012

Australian gold mine production is projected to rise by 21 tonnes to 246 tonnes in 2009-10. Gold production from a number of new projects is expected to increase as they approach full production potential. Additionally, several larger projects are expected to begin production during the year. These include the Boddington joint venture (averaging 28 to 31 tonnes a year for the first five years), Newcrest’s Ridgeway Deeps (5.6 tonnes a year) and OzMineral’s Prominent Hill (3.6 tonnes a year).

The rising trend in gold production is projected to continue until 2011-12, peaking at 264 tonnes and then declining to 248 tonnes by 2013-14. The projected decline in gold production by the end of the outlook period reflects expected production falls in numerous mines which will be nearing the end of their estimated mine life. Partially offsetting these declines will be output from new mines such as Anglogold Ashanti/Independence Group’s Tropicana project (9.3 to 12.4 tonnes a year).

Expected historical highs for export volumes and values

The volume of Australian gold exports is forecast to rise by 14 per cent to 434 tonnes in 2008-09. This forecast export volume is higher than Australian gold mine production, reflecting imports of gold dore (impure gold) and scrap which are shipped from overseas, refined into gold bullion, and then re-exported. With world demand for gold bars and coins expected to ease, export volumes are projected to fall to 422 tonnes in 2009-10. Reflecting projected movements in Australian mine production, gold exports are projected to peak at 440 tonnes in 2011-12 before declining to 424 tonnes by 2013-14.

The value of Australian gold exports is forecast to rise by 59 per cent to $17.3 billion in 2008-09 in response to both higher export volumes and a considerably higher Australian dollar denominated gold price. Export values are projected to grow by a further 7 per cent to around $18.6 billion in 2009-10.

Over the medium term, export earnings from gold are projected to ease gradually, to around $12.7 billion (in 2008-09 dollars) by 2013-14. The projected decline in export earnings from gold over the medium term reflects the combined effect of a projected lower gold price and an assumed strengthening in the Australian exchange rate against the US dollar.