Gold

Since 2005, gold has made an impressive return to the trading floors of the international financial markets. However, the jewelry industry and several other industries have lost some of their importance as consumers, in some cases significantly.
Thus it was primarily purchases by private and institutional investors that drove the price of gold in the first quarter of 2008 not only above the previous record of $850 per ounce bench mark in January 1980, but even catapulted the metal for the first time beyond the psychologically important price level of $1,000 per ounce.

The metal ultimately reached a peak price of $1,030 per ounce (31.1035 grams) before the price once again declined well below the $1,000 level.

Investors were motivated to purchase by the three-year-long weakness of the US dollar and the soaring price of oil—at times to more than $160 per barrel. The weakness of the dollar caused investors to seek out investment alternatives, and amongst others for gold. Soaring oil prices pushed on inflation, and gold benefited from its designated role since the 1970s as a hedge against inflation.

Despite the sharp price increases during 2005–2008, there has never been a danger that the world would run out of gold in any form. Analysts assume that throughout history, about 160,000 tons of the yellow metal have been mined, only a small portion of which was used up or lost. Every year about 2,500 tons of gold are added to this quantity, though the figure has been gradually declining since 2001, the year in which a record of 2,645 tons were mined. In contrast to the platinum metals, the mining of gold occurs all over the world. Since 2007, the top producing country has been China, but even its share only accounts for about 10% of the total. South Africa, which had topped the rankings of gold-producing countries since 1905, occupies second place with around 250 tons. As recently as 1970, some 1,000 tons of gold were still mined on the Cape, and the country was responsible for 80% of global production. Next on the list are Australia and the USA, both with more than 225 tons per year. Peru follows in a distant fifth place with 165 tons.

The annual supply is supplemented by central bank sales, which totaled 480 tons in 2007 but are expected to account for much less in 2008, and by the emergence of a substantial amount of scrap gold. In 2007, the latter totaled about 1,000 tons, but in 2008 the figure should be significantly higher as a result of high prices.

Neither central banks nor investors are the largest holders of gold. More than 82,500 tons, almost half of the gold that has ever been mined exists in the form of jewelry. Central banks occupy second place with almost 30,000 tons, with private investors following a close third. Currently, slightly more than 19,000 tons are used in various industrial applications.

Mining companies today face big challenges when it comes to holding new production of gold somewhat stable at the above-mentioned 2,500 tons. While old mines are increasingly approaching the ends of their life cycles, there are very few already discovered but unexploited deposits. In this context, mining engineers point out that it can take ten years from the discovery of a deposit until the beginning of exploitation. This is another reason that the production of gold can climb only very slowly, if at all.

However, expenses associated with producing gold in already existing mines continue to rise. For example, some mining companies in South Africa must dig as much as 4,000 meters in order to reach the yellow metal. The associated effort is a tremendous technological feat, but it simultaneously drives already rising production costs even higher. Thus in recent years expenditures—for example, for energy, fuel and steel—have risen substantially for all mines. Labor costs have also risen sharply, reflecting salary increases in recent years in this very labor-intensive industry.

For the reasons cited, production should climb in the next several years only in Russia and China. In the other significant production countries, the trend is expected to be downward.

Purchasing by central banks has passed its peak as well and should move much lower in the future. The agreement among the European central banks, which expires in 2009, is expected to be extended again. However, it would be surprising if the central banks were to approve another annual purchase quota of 500 tons after this target was already been missed in 2007 und 2008.

It is difficult to estimate the future supply of scrap gold because it is exclusively a function of the price of gold. Should prices again rise significantly above $1,000 per troy ounce, an increased influx of scrap metal into the market would be expected. This would have a dampening effect on further price increases. However, if the price remains stuck in the $750-to-$1,000 range, the amount of scrap gold entering the market should be closer to 900 tons than over 1,000 tons.

Not only does the influx of scrap metal on the supply side depend on the price of gold, but so do various application areas on the demand side. Foremost among these is the jewelry industry, whose customers are extremely price sensitive in certain parts of the world. In 2007, the jewelry industry’s share of global gold sales was still greater than 60%. At the beginning of the decade, the demand for gold jewelry still amounted to more than 3,200 tons. In 2007, despite a still very high share of the total, demand accounted for only 2,400 tons.

Last year, industrial applications comprised a record sum of almost 460 tons. This primarily reflected the impact of the global economic boom, which stimulated the electronics industry (sales: approximately 300 tons). However, demand from the dental industry declined recently to 60 tons, corresponding to just 1.5% of global demand. A series of other industrial applications contribute almost 100 tons in sales.

Compared to other precious metals, a special feature of gold is that mines can be found on the demand side as well with purchases up to 500 tons. The reason for this is that they have been steadily closing out many of their forward transactions—entered into during the last decade—prematurely every year since 2000 (often at a loss). However, an end is in sight. After approximately 500 tons anticipated for the current year, this amount should plummet in 2009 and no longer serve as support for the price of gold.

In view of the rather mixed news regarding industrial sales, it was mostly investors who, with their newly discovered love of gold, drove the price so high in recent years. An important reason for the popularity of gold was the development of new financial products, which enabled institutional investors to invest directly in gold for the first time, thus no longer needing to invest in mining stocks as a proxy.

During 2005–2008, investors purchased as much as 1,000 tons of gold in form of exchange traded funds (ETFs). In addition, there were possibly record-breaking sales of bars and coins as well as an increase in long positions on futures exchanges.

The financial crisis that has been spreading since the third quarter led to a flight of investors from presumably speculative investments. Surprisingly, the “crisis metal” gold was also affected. Most of all, the above-mentioned positions on the futures exchanges were substantially reduced. Related sales contributed just as signifcantly to the price decline.