Precious Metals Watch – Improvement in the balance

by: Georgette Boele

In this publication: A modest rise in mine supply is expected in 2017 but demand is likely to rise more sharply, reducing the excess supply in 2017 and eliminating it in 2018. Overall, we expect a modest rise in gold prices in 2017 and 2018.

170320-Balance-to-improve.pdf (288 KB)


Recently gold prices have bounced off the USD 1,200 per ounce level to just above USD 1,230 per ounce. We usually focus on investor behaviour to explain gold prices because of our conviction that this factor is driving gold prices.  In this report we decided to take a helicopter approach including the supply dynamics (mine supply, scrap supply, all-in-costs) and total demand as well (per category).

Mine supply to rise at a modest pace in 2017…

Mine supply has been on an upward trajectory since 2008. For 2016 and 2017 we expect mine supply to be around 3,200 metric tonnes per year (slightly above of the 2016 level) partly because of lower all-in-costs to mine gold. Mine supply depends on several dynamics. First, the availability of gold ore in the ground and the ore grade. Second, the margin that can be made on mining an ounce of gold. The mining companies’ margins are calculated by taking the difference between the total cash costs or all-including cash costs on the one hand and the gold price on the other.

For 2016 total cash costs[1] will probably be around USD 725 per ounce[2] and all-in cash costs[3] around USD 1,160 per ounce[4]. The largest part of direct mining costs is wages (around 50%), energy (around 10%), parts & supply (12%) and utilities (10%) and interest (source CPM Group). Wages are often paid in local currency so if currencies of gold producing countries rise, direct mining costs and all-in cash costs will also rise. Energy is another important input cost for gold mining. For 2017 we expect currencies of gold producing countries to come under some pressure. In addition, we expect lower oil prices in the coming six months. These forces should result in some downward pressure on all-in cash costs for 2017 before rising again in 2018 as we expect currencies of gold producing countries and oil prices to rise again.

…but demand will rise more strongly…

In the coming quarters, it is likely that investors will hesitate to aggressively buy gold given the prospect of the Fed further normalising official rates. However, as long as US real yields don’t rise sharply as we expect, gold prices will probably be very resilient. Meanwhile, we expect global jewellery demand to pick up in line with the overall improvement in the global economy and in gold demand centres in particular. We expect demand from China and India to increase; the latter only at a modest pace. We also expect jewellery demand to pick up in the US in line with the increase net-worth and disposable income. So the pick-up in jewellery demand will protect the downside in gold prices in the coming quarters. Later in the year, we expect US real yields to peak and to start to edge lower. This will also weigh on the US dollar, which we expect to weaken later in the year. The peaking of US real yields (based on 5 and 10y US Treasury yields) and the downward pressure building on the US dollar are positives for gold prices.

…leading to a modest rise in gold prices

In the coming quarters we expect gold prices to stabilise in the USD 1,200 to 1,250 per ounce range. This is because we expect the improvement in jewellery demand and investor demand to balance out the rise in supply. Later in the year, we expect the balance to improve because of higher jewellery and investor demand resulting in gold prices rallying towards USD 1,300 per ounce. Next year, it is likely that demand will outpace supply mainly because of higher investor and jewellery demand. We expect gold prices to rally to USD 1,400 per ounce.  It would be the first time in five years that demand will be higher than supply. However, this “supply-shortage” will unlikely persist for a long time as scrap supply will probably increase as well (reaction to higher gold prices). If gold prices rise sharply, a part of the jewellery stock will come to the market as scrap supply. Jewellery stocks account for the largest share of above-ground stocks (see graphs below). Based on data from Bloomberg, Thomson Reuters GFMS and own calculations these above-ground stocks are between 187,000-189,000 tonnes of gold at the end of 2016 which is roughly 59 years of annual gold mine production.

[1] Cash costs plus off-site costs, head office costs  and sometimes interest
[2] Based on weighted average of roughly 47% of annual gold production (company reports Bloomberg, Thomson Reuters GFMS, own calculations)
[3] Cash costs plus exploration expense, head office costs and sustaining capital
[4] Based on weighted average of roughly 47% of annual gold production (Thomson Reuters GFMS mine economics, own calculations)