GOLD - WHAT'S DRIVING IT HIGHER?
Excerpts from GLOBAL WATCH:
THE GOLD FORECASTER
by Julian D.W. Phillips
December 21, 2007

As we approach the end of 2007 and a time when gold looks poised to move through its record high, and a time when global financial volatility and uncertainty have never been higher, it is time to look at what’s driving the gold market now and what lies ahead in 2008.

There is no doubt that during 2007 the gold market has evolved from one suffering persistent undermining attack by global monetary authorities over the last 25 years [through sales and accelerated supply] began to fade noticeably, as the credibility of its replacement, the U.S. $ began to decay visibly, to one that garnered a new respect, if only amongst both private and fund investors. And by funds, we are not referring to the short-term speculators but to long-term holders, primarily of gold Exchange Traded Fund shares. It is primarily Investor demand that will drive the demand for gold in 2008 because of the enviable position it holds, which we describe below. 

Add to the above the meteoric rise of the oil price and we saw gold beginning to act as a counter for dropping confidence in the monetary system attracting more investment demand. Such decay was amply described by and ex-Treasury Official in an essay, in which he pre-ambled as follows.

More than a confidence crisis!

“Many $ holders, including central banks and sovereign wealth funds as well as private investors, clearly want to diversify into other currencies. Since foreign $ holdings total at least $20,000 billion, even a modest realization of these desires could produce a free fall of the U.S. currency and huge disruptions to markets and the world economy. Fears of such an outcome have risen sharply in both official circles and the markets.

However, none of the countries into whose currencies the diversification would take place want to receive these inflows. The Eurozone, the UK, Canada, and Australia among others believe that their exchange rates are already substantially overvalued. But China and most of the other Asian countries continue to intervene heavily to keep their currencies from rising significantly. Hence, further large shifts out of the $ could indeed push the floating currencies far above their equilibrium levels, generating new imbalances and a possibly severe slowdown in global growth.”

This is the atmosphere that has driven investment demand for gold and in turn the gold price. We expect that in the year ahead, this climate will deteriorate substantially driving investment demand to new record levels. But let’s be clear about this, we are not talking of a simple rising of investment demand, we believe we will see a large acceleration in that demand taking it well through four figures in tonnage terms as well as in price terms. 

At each stage of its growth it will attract bigger players as the liquidity of these shares gives comfort to the larger players. Indeed, the total holdings of such funds are already equal to the holding of the top echelon of Central Bank holdings, even above that of China having moved into the equivalent of seventh place and likely to move into sixth place next year ahead of Switzerland. 

We have said in the past that a level of 3,000 tonnes holdings by the gold E.T.F.’s is possible and will attract the biggest players. At the time many thought it was far fetched, but as total holdings by such funds [including the Canadian equivalent] crosses the 860 tonne level, such forecasts are proving more than credible. 

Bear in mind that the huge financial power of the Mutual / Pension etc funds is now able to invest almost directly in gold [via these shares]. This buying power was just not present before the creation of the gold E.T.F.’s. Each day this demand grows as new gold Investors come into this market and there is a massive amount out there still to come in. Funds before the Exchange Traded Fund concept were just not permitted to hold gold. The nearest they could come to that was to own gold shares with all their inherent risks. Now that investing power is unleashed needing only the education that gold in share form is now available to them. It is this power that is becoming the main driving force behind the rise in gold.

As you can see in the Table below [thanks to Fortis Bank] investment demand just has to exceed 123 tonnes for the year [last week saw 17 tonnes added to the funds] for the gold market to be in deficit. 

We want you to note well supply less demand and the change in Dehedging expected.

World total       2003     2004    2005     2006     2007e   2008f

Supply

Mine supply                         2,512     2,351   2,411    2,367    2,413    2,414 

Scrap recycling                     900       1,100    836      1,057     981       817 

Hedging                               188       68         84         40         42         25 

Central Bank sales                571       464       616       379       583       495 

Total supply                        4,171    3,983    3,947    3,845    4,018    3,751

Demand

Jewelry fabrication    2,808    2,878    2,996    2,276    2,257    2,334 

Jewelry consumption            2,808    2,878    2,996    2,276    2,257    2,334 

Legal tender coins                 85         91         101       102       80         92 

Electronics                           310       332       357       372       403       416 

Other end uses                     315 350             393       315       311       313 

Gold E.T.F.’s                        33         125       192       253       241       178 

Central Bank purchases        39         61         39         132       64         61 

Dehedging                            529       524       223       462       442       235 

Total demand                    4,118    4,362    4,304    3,912    3,798    3,628 

Supply less demand           52        (378)     (357)      (70)       220       123

The only danger in the next two years to the power of the gold E.T.F.’s is that the demand engendered by Dehedging will slow down to stop in the next year and more. In 2007 it will be 400 tonnes, but in 2008 it could drop as low as 210 tonnes or thereabouts. 

The only counter to this demand, apart from investment demand is the strong chance that Central Banks gold sales will pull back in the face of the much lower level of announced sales. If no new announcements are made then these sales if evened out over the remaining years of the agreement could drop to 250 tonnes, down from nearly 500 tonnes, in the last year of the agreement. 

So what’s driving gold? Primarily, investment demand and dropping supply. 

© 2007 Julian D. W. Phillips
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