Precious metals prices in for a fall
Prices of gold, silver and palladium will deflate in coming months while platinum will remain elevated from probable supply disruptions.
By Tom Stundza -- Purchasing, 10/16/2008 6:00:00 AM
In a recent Barclays Capital report, London-based precious metals analyst Suki Cooper writes to clients that supply of gold, silver and palladium again will outpace demand in 2009 while platinum will remain tight. "Fundamentals are proving, as they always do, to be the best predictor of price dynamics in precious metals markets" she notes. "Supply-side problems have characterized these metals markets in 2008 so far." Indeed, production losses have been on a massive scale spanning several continents and have affected every metal. But, it's also true that investment demand has played a role in the 2007–2008 spike in prices. Now, heading into 2009, where purchases of these materials for investment and buying for fabrication are headed remains unclear. Purchasing recently interviewed Cooper about the 2009 outlook for the various major precious metals. Here's an edited version of the question-and-answer session.
Q: Will investment demand for gold rebound in the second half of 2008 and 2009, causing market prices to reinflate?
A: Investment demand started 2008 on a very strong note so that gold holdings by speculators hit a record high of 1,043 metric tons before falling back to a still-high 1,000 metric tons. Given that most external drivers remain broadly positive for gold, we would expect investors to continue to increase their exposure towards the metal. In our view, investors are likely to remain the key price determinant of gold prices.
Q: One of the key drivers of gold prices has been the rapid deterioration of the dollar in first-half 2008. Will the dollar's decline in value continue or become less of a factor to price trends in 2008 and 2009?
A: Gold remains positively correlated with the dollar, although this relationship is far from a perfectly linear one. Our strategists believe in the near term the dollar could strengthen further but thereafter they expect another bout of dollar weakness. We expect this correlation to hold and limit the downside risk to prices.
Q: Is the physical fabrication market for gold going to continue to be erratic?
A: Higher and volatile prices as well as slower economic growth have weighed on jewelry demand recently. But, as price volatility eases and buyers become accustomed to higher prices, we expect jewelry demand to recover over the forthcoming months in light of the wedding season and key festivals in India. A pickup in gold interest in major jewelry-buying regions should cushion the downside risk to gold prices. Note that a lower and less volatile gold price in August did trigger a revival in physical interest in the metal following the sharp drop in consumption earlier this year. Gold demand has picked up sharply in Abu Dhabi, with jewelry sales rising 300% year-over-year in August, Indian gold imports were up 45% year-over-year and gold imports into Turkey set a fresh record high.
Q: What's up with gold supply? China's output is up, South Africa's is down; does it really matter?
A: Fundamentals are unlikely to dampen investor sentiment since elevated prices are unlikely to stimulate a significant supply response this year. Constrained global mine production, in combination with capped official sector sales, have helped to underpin the uptrend over the past few years. However, a key supportive dynamic has been producer de-hedging, the unwinding by miners of their gold hedge contracts. The premature buybacks have seen the hedge-book shrink from more than 3,000 metric tons at the start of the decade to less than 1,000 metric tons now.
Q: Is it true that dollar and inflation expectations have been lifting the price of silver, rather than supply/demand trends?
A: Gold and silver prices remain closely related. However silver's supply and demand fundamentals are not supportive of continued pricing uptrend. Silver mine supply is set to increase this year by the largest absolute level since 1990. So, the level of speculative and investor interest will remain pivotal for silver's price trajectory.
Q: Do you believe silver's poor fundamentals will continue to keep the surplus high in 2009 and drive prices back at 2007 levels?
A: We do expect the market to stay in surplus in 2009. Silver prices outperformed gold on the way up this year but fell further on the way down. Thus, should gold prices ease, silver prices will lose a key pillar of support and the poor fundamentals are unlikely to cushion a downtrend in price. We believe silver prices are susceptible to the downside and could come close to 2007 levels again.
Q: Why isn't demand moving upward? Is digital photography that much of a silver killer?
A: We have seen a structural shift in demand patterns, with photography demand falling now for eight consecutive years. That's due to the photography market penetration by digital technology and lower usage of photographic paper with an increasing number of pictures being stored only in electronic form. There also has been lower jewelry demand for silver. But, there have been two areas of silver demand growth: industrial end use—which has recorded year-over-year increases for six years—and physically backed exchange traded products (ETPs). Silver held in ETPs now total 7,500 metric tons, representing 15% of total identifiable stocks.
Q: Any idea why demand from silverware, coin, medal and jewelry is so lousy? Will it continue next year?
A: We have also seen a shift in demand for silverware, jewelry, coin and medals. Demand for coins has dropped primarily from reduced minting while silverware has seen a fall in interest with fewer requests on wedding lists. Jewelry demand on the other hand has seen differing trends in different countries. Silver demand in China has grown while demand in India has fallen. Although in some regions, silver jewelry consumption has benefited from substitution—as the price of other white metal jewelry such as white gold and platinum has risen much higher—price volatility has still deterred some buyers, much the same as it has done in other precious metals markets. Silver jewelry has also had to contend with competition from branded items in steel or set with gems.
Q: Barclays Capital is forecasting platinum prices to rise more than 40% in 2008 and another 3% or so in 2009. Since the forecast suggests that growth in supply (including scrap) and demand will be flat, what's the reason for the bullishness on prices?
A: Despite the growth in supply, we expect demand to remain at historically high levels and in turn keep the market balance in deficit. Supply still has a lot of work to do to make up the shortfall. Prior to the electricity problems in South Africa, the market was anticipating growth in global supplies of platinum. Instead, the market has had to contend with just the opposite, with production forecasts being revised lower. Despite jewelry consumption falling, industrial usage and auto-catalyst demand has reached elevated levels and is relatively less price sensitive. Furthermore, above ground stocks have fallen to record lows leaving prices exposed to upside potential.
Q: Will production losses in South Africa continue to grow and keep the world supply in deficit?
A: Some producers have been able to adapt to the restricted power supply, but many producers have reiterated the impact on longer term projects and in particular planned production being pushed out by an additional 1–2 years due to the electricity issues. Next year, South African producers do not only have to contend with the ongoing limited electricity supply and escalating concerns over mine safety standards but also the biennial wage negotiations. These themes are set to continue to dominate the market. The underlying power problems are not short term in nature, but are structural, such as under-investment in infrastructure and increased demand. There is no quick-fix for these issues and power outages are expected to last at least until 2011. Subject to revisions to our base case scenario for global economic growth, output losses in South Africa are set to keep the platinum market on tenterhooks.
Q:Will demand for platinum stay robust in 2009?
A: We expect platinum demand from auto-catalysts usage to grow, albeit modestly. Tightening emissions legislation around the world combined with a pick up in vehicle sales should offset attempts at thrift and substitution. We expect jewelry demand to continue to fall but at a slower pace as this use remains the most price elastic and has shown signs of picking up as prices have eased.
Q: In 2008, Barclays Capital sees U.S. use sliding from reduced motor vehicle demand but use going up in Europe, China, Japan and rest of world from expanded production of diesel vehicles. Will this trend continue in 2009?
A: In 2009, we expect modest growth in European consumption on the back of tighter emissions legislation and a pick up in vehicle sales. Platinum demand is being led by Europe as diesel vehicles continue to capture a growing share of the European market (2007: 53%). Growth in Europe was affected by the introduction of palladium in diesel catalysts; however, tighter emissions legislation has led to increased purchasing of platinum group metals. Euro V—the acceptable limits for exhaust emissions of new vehicles sold in European Union-member states—is due to be implemented in 2008 for heavy-duty diesel vehicles and in late 2009 for light-duty vehicles. This bodes well for platinum consumption. We expect a slight recovery in demand in the U.S. next year and continued growth in demand from China and the rest of the world.
Q: Will demand trends for jewelry be important to platinum market fundamentals in 2009?
A: Jewelry demand fell for the fifth consecutive year in 2007 to its lowest level in 15 years. Given our forecast of higher prices, we expect this trend to continue in 2008 and 2009. Notably, price-sensitive jewelry use now only makes up 20% of platinum demand; a decade ago, it accounted for almost 40%. Although demand from the bridal sector has been robust, strong and volatile prices have created a challenging environment for jewelers.
Q: Why is the 2009 price outlook for palladium down 8%? Will the market continue to weaken next year?
A: In our view, palladium market fundamentals have the potential to improve over the longer term and in turn supporting prices, but in the near term we believe the underlying balance will remain less positive. Demand for palladium is likely to remain robust, however supply is set to outpace the steady demand, with the anticipated releases from Russian stock piles keeping the market well supplied.
Q: Will demand trends by investors and speculators be important factors in palladium prices in 2009?
A: Overall investor interest in palladium remains buoyant. Palladium holdings in the two physically-backed ETPs have recorded an inflow of 376,000 troy ounces, more than doubling the year-end-2007 holdings of 280,000 oz. The palladium ETPs have helped to absorb some of the excess stock, but are currently insufficient to reduce the market surplus and inventories remain high. We do believe prices could be exposed to further downside risk if speculative interest wanes given the metal's poor fundamentals.
| Gold | 2003 | 2004 | 2005 | 2006 | 2007 | 2008E | 2009F |
| * after accounting for retail investment, ETP stocks, net hedges Source: Barclays Capital from industry data |
|||||||
| Total physical supply | 4,226 | 3,850 | 4,108 | 3,982 | 3,913 | 3,846 | 3,745 |
| Total demand | 3,176 | 3,424 | 3,552 | 3,166 | 3,309 | 3,020 | 3,087 |
| Surplus/deficit * | 743 | -86 | 282 | 168 | -48 | 378 | 410 |
| Price ($/oz) | 364 | 410 | 445 | 604 | 697 | 891 | 840 |
| Silver | |||||||
| Total physical supply | 27,148 | 26,905 | 27,912 | 28,418 | 27,821 | 28,811 | 29,511 |
| Total demand | 26,172 | 25,836 | 26,356 | 26,003 | 26,241 | 26,120 | 26,360 |
| Surplus/deficit * | 325 | 1,368 | 2,415 | -1,564 | -1,345 | 541 | 1,351 |
| Price ($/oz) | 4.88 | 6.66 | 7.3 | 11.55 | 13.37 | 15.8 | 13.7 |
| Platinum | |||||||
| Total physical supply | 6,845 | 7,180 | 7,410 | 7,690 | 7,440 | 7,394 | 7,735 |
| Total demand | 7,175 | 7,230 | 7,465 | 7,335 | 7,920 | 7,987 | 7,989 |
| Surplus/deficit | -330 | -50 | -55 | 355 | -480 | -593 | -254 |
| Price ($/oz) | 692 | 844 | 896 | 1,139 | 1,304 | 2,120 | 2,300 |
| Palladium | |||||||
| Total physical supply | 6,860 | 9,110 | 9,030 | 8,755 | 9,585 | 9,560 | 9,830 |
| Total demand | 5,840 | 7,090 | 7,980 | 7,410 | 7,835 | 8,077 | 8,072 |
| Surplus/deficit | 1,020 | 2,020 | 1,050 | 1,345 | 1,750 | 1,483 | 1,758 |
| Price ($/oz) | 200 | 229 | 202 | 319 | 354 | 423 | 390 |
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