Behind Gold’s Glow.

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Behind Gold’s Glow
September 28 2007 - Australasian Investment Review – (AIR)

Gold is still trading around 27 year highs of $US739 an ounce, thanks to the twin boosts of instability in various financial markets, especially the sliding value of the US dollar.
Gold has kicked higher, like many commodities and stockmarkets, in the wake of the US Federal Reserve’s cut in rates of half a per cent.

But there are other factors at work: de-hedging by producers and rising demand from fabricators has driven a lot of the underlying demand because one has reduced the amount of gold coming onto the market and the latter has expanded purchases, even as world prices have risen this year.

That rising demand for jewellery is coming from the rising incomes in China and India, and the surge in oil income into the Middle East.
It has been enough for quite a few brokers and analysts to adjust the assumptions about the price.

Goldman Sachs JBWere said yesterday in its daily note that:
“Gold’s break through US$700/oz, and, more importantly, its surge past the US$725 high-water mark established in May 2006, adds to our confidence that price risk remains strongly positive, and we believe that an appropriate trading range for the next 18 months is US$670 - US$850/oz, and we expect the price to move progressively towards the upper end of this range.

“Please note that we have raised the lower limit of our proposed trading range, but the upper limit has not been adjusted.”
Spot gold traded around $US730 an ounce, while December gold was just over $US739 in New York last night.
Some traders believe the price of the metal might fall because the recent run up has been so quick and so strong, but few if any analysts are speculating that there would be much of a retracement.

This week’s commodity review from the Australian Bureau of Agricultural and Resource Economics was also a bit upbeat, even though it only forecast a small rise in Australian production in 2007-08.

“Gold prices are forecast to increase over the remainder of 2007 and in 2008, largely because of expected strength in investment demand,” ABARE said.
“Uncertainty over the outlook for interest rate movements in the United States, the possibility that a number of central banks may consider reducing their holdings of US dollars, and concerns about continued instability in the US debt and capital markets are all expected to encourage investment demand for gold as a hedge against a possible depreciation of the US dollar.

“Growth in world gold mine production and continued high volumes of official sector gold sales are expected to place some downward pressure on the gold price over the forecast period.
“However, this is expected to be more than offset by significant upward price pressures stemming from a recovery in global fabrication demand and ongoing strength in investment demand.

“As a result, gold prices are forecast to average around US$675 an ounce in 2007 and US$685 an ounce in 2008.
There has been one noticeable factor in the supply side of the equation in the past one to two years and that is the de-hedging by major producers such as Barrick, Newmont, Lihir and now Newcrest.

ABARE said that in the absence of announcements of further hedge book buybacks or restructures, de-hedging for the year as a whole is forecast to be around 380 tonnes.
“In the first half of 2007, gold producers reduced their outstanding hedge positions by around 300 tonnes, providing strong support for the gold price.

“The majority of this de-hedging was conducted by Barrick Gold (around 78 tonnes), Newmont (58 tonnes), Lihir Gold (44 tonnes) and AngloGold Ashanti (44 tonnes).
“De-hedging is expected to continue in the second half of 2007, albeit at lower rates than in the first half of the year. Newcrest recently announced that it would close out hedge contracts around 71 tonnes.
“In the absence of announcements of further hedge book buybacks or restructures, de-hedging for the year as a whole is forecast to be around 380 tonnes.

“In 2008, de-hedging is forecast to decline to around 200 tonnes, largely because the ability of major mining companies to further cut their outstanding hedge positions will be constrained by the reduced size of their remaining hedge books.”

“Gold producers may choose to sell forward a portion of their future output in order to reduce their exposure to the risk of lower gold prices at the time of actual production.
ABARE explained that producer hedging involves gold loaned by the official sector for producer forward sales being immediately sold on the spot market (to be later repaid to the central bank from mine production). As a result, future mine supply of gold is effectively brought forward.

When gold producers in aggregate increase their hedge positions, there is effectively an increase in gold supply on the spot market. This was the situation in much of the 1980s and 1990s, when producers responded to expectations of continued relatively low prices by hedging some of their future production.

Since 2000 however, expectations among producers of gold price increases reduced the incentive to sell forward their future production.

“This has resulted in net producer de-hedging over this period, with an effective reduction in gold supply as the rate of gold repayments to central banks exceeds new producer hedging,” ABARE said.
It forecast that a slight rise in 2007-08 gold output after 2007’s production was flat at around 251 tonnes.
“Increases in production at Newman’s Tamari operations and AngloGold Ashanti’s Sunrise Dam mine were offset by lower production at a number of Australia’s major gold mines and the mothballing of several operations.

“There has been a downward revision in the forecast for Australia’s gold production in 2007-08 since the previous edition of Australian Commodities.
“Contributing to this revision have been lower than previously expected production at a number of major mines; earlier falls in production than previously assumed at mines that are expected to close during the year; the recent mothballing of certain gold operations as a result of financial or geological constraints; and the slow buildup in production at, or delays in commencement of, mines over the remainder of 2007 and in the first half of 2008.
Australian gold production is forecast to increase by 1% to 254 tonnes in 2007- 08.
“Growth in Australian gold production in 2007-08 is expected to be supported by a buildup in output at a number of mines that have recently commenced production, or will commence gold production over the remainder of 2007-08.”

These included Crescent Gold’s Laverton mine (90 000 ounces a year), View Resources’ Bronzewing mine (50 000–70 000 ounces a year) and Citigold’s Warrior mine (40 000 ounces a year) will all build to full production in 2007-08.

Further, Avoca Resources’ Trident project (160 000–190 000 ounces a year) commenced production in July 2007 and is expected to reach full production during the course of 2007-08. Production from Straits Resources’ Hillgrove project in New South Wales (initial production of 20 000 ounces a year) is expected to commence in the final quarter of 2007.

The value of Australia’s 2006-07 gold exports rose 46% to $10.3 billion, supported by both higher export volumes and prices.
ABARE said that exports remained above domestic production in 2006-07 as significant levels of gold scrap were sourced from overseas and refined into gold bullion in Australia for export. In 2007-08, the value of gold exports is forecast to increase by 3 per cent to $10.7 billion, mainly reflecting higher export prices.

Globally ABARE forecast a 2% rise in gold mine production to 2530 tonnes.
Increased production in China and Indonesia is expected to more than offset a forecast decline in output from South Africa.
“In the first half of 2007, production from Freeport’s Grasberg mine in Indonesia more than doubled year on year (to 1.87 million ounces) as the operation continued to access ore containing higher grades of gold.

“In China, Sino Gold’s Jinfeng mine in Guizhou province started production in mid-2007 and is expected to produce 70 000 to 75 000 ounces of gold over the remainder of 2007 before reaching an annualised production rate of 180 000 ounces of gold in 2008.

“Elsewhere, a number of mines continued to move to full production in 2007. In Ghana, Newmont’s Ahafo mine commenced operation in mid-2006 and is expected to produce between 410 000 and 450 000 ounces in 2007 as the mine enters its first full year of production. In the United States, Newmont’s Leeville and Phoenix mines (combined production of around 750 000 ounces a year) both commenced commercial operation at the end of 2006 and are expected to achieve full production within the next twelve months.

“Additional production is also expected from new mines in the United States. For example, Barrick Gold’s new Ruby Hill operation in Nevada commenced in early 2007 and is expected to reach full production by next year.

Next year is expected to see world mine production increase 3% to 2606 tonnes, largely from higher output in Australia, China and the United States and a partial recovery in South Africa’s gold production.

ABARE said South African gold mine production has declined substantially over the past decade, primarily as a result of an increase in production costs and a decline in rand denominated gold prices. Production is expected to pick up from 2008 as projects to expand existing gold operations begin to come on line.

Sales from official sources, such as central banks in first half of 2007 rose by around 17% (year on year) to around 256 tonnes, mainly because of an increase in sales by signatories to the second Central Bank Gold Agreement, which expires in September 2009.

“In the first half of 2007, gold sales by signatories to the agreement amounted to around 224 tonnes, led by the central banks of Spain (gold sales of around 110 tonnes) and France (42 tonnes). In June 2007, the Central Bank of Switzerland announced it would sell a further 250 tonnes of gold before the end of the current agreement and subsequently sold 48 tonnes by the end of July.

“There is also potential for the Central Bank of Italy to sell a portion of its gold holdings in order to reduce the country’s debt levels. Considering its substantial reserves of gold (2452 tonnes), this could add significant gold supplies to the market. For 2007 as a whole, official sector sales are forecast to increase by around 28% to 420 tonnes.”
ABARE though singled out the rising demand from fabricators as a key driver behind the price strength.

“In spite of high gold prices in the first half of 2007, world fabrication demand increased substantially, largely because of strong demand for gold jewellery in India, the Middle East and China. In the six months to June 2007, world consumption of gold in jewellery increased by around 28%, year on year, a similar amount to that consumed in the first half of 2005.
“In India and the Middle East, a reduction in gold price volatility encouraged consumers that had reduced jewellery purchases in response to high gold price volatility during 2006 to reenter the market.

“For 2007 as a whole, world gold fabrication consumption is forecast to increase by around 11% to 3246 tonnes. This anticipated pickup in consumption mainly reflects continued growth in household disposable incomes and lower price volatility.

“In 2008, gold fabrication consumption is forecast to increase by over 3% to 3358 tonnes.
“Sustained economic growth and corresponding increases in household incomes in India, the Middle East and China are expected to underpin growth in gold fabrication consumption in 2008, albeit at a lower rate than in 2007.

“Also important to the growth in consumption will be lower gold price volatility in 2008 than in 2006 and further growth in consumption by consumers that re-entered the market in 2007, “ABARE said.

Copyright Australasian Investment Review.
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