Around this time of year The Perth Mint puts together its budget for the
June 2014 to July 2015 financial year. For normal companies the whole
budgeting process can be a cynical exercise but for a precious metals
business it is even more problematic – our sales volumes are driven by
the gold price, and if anyone knew how to forecast those,
well they’d be “see you later suckers, I’m off to trade gold in the
Bahamas based on my computer model.”
But they have to be done. Our approach is generally to use current
precious metal prices and FX rates without any real aggressive forecast one
way or the other. While we have no direct exposure to metal prices themselves
(our unallocated clients own the metal in our business) our
profit is impacted by price changes in that it affects the amount of, and mix
of, coins and bars we sell and our premium revenue (for coins priced as
a percentage of metal value). The result is we focus more on “what ifs” in
our budgeting – for example, if prices decline, then what is the impact to
our profit from volume and revenue changes.
Following on from that, the budget write up around the outlook for
precious metal prices also takes a classic economist approach: on one hand X,
on the other hand Y. For those who don’t want to read a whole lot of words,
I’ve summarised the current competing forces that will drive precious metal
prices during this year in the diagram below.
Foremost on the negative side for precious metals is the outlook for the
US economy, with the consensus being that an improving US economy (which is
debatable I think but that is the current consensus) will give the US Federal
Reserve scope to increase interest rates, although in a tentative manner due
to conflicting economic data about the strength of the recovery. With
continued low inflation any interest rate rise will increase real interest
rates, which have a long run negative correlation to gold prices. Increasing
rates will also support the already strong US dollar, putting further
pressure on gold.
Weak oil prices have impacted on gulf country gold demand with some
retailers in Dubai reporting drops in sales volume of up to 40%. Lower oil
prices have also lowered import costs for some emerging markets, particularly
India, where the resulting easing of pressure on their current account
balance has allowed the Government to tolerate higher gold imports, which is
a counterbalancing positive force.
Recent strong gains in the Chinese stock market in conjunction with a weak
to sideways trend in gold prices has resulted in Chinese investors favouring
stocks over gold recently. However, GFMS see a growing demand side response
from China and India as prices approach $1,100 that will help contain any
falls. Currently we are seeing Chinese demand weaken on prices above $1,200
but return once it gets below that.
Finally, there is some risk that mining companies may cap any strength in
gold prices with forward selling, which has doubled over the past year, as
exemplified by some Australian producers who took advantage of higher AUD
gold prices on the Aussie dollar’s weakness. GFMS do not however that the
hedging increases have been limited to a handful of miners.
On the positive side (for precious metals, that is) continued weakness in
the Europe and uncertainty around Greece has weakened the Euro which drives
up local gold prices and attracts investor interest. For those emerging
markets reliant on oil revenue or European consumer demand, the resulting
economic slowdown leads to a continuation or increasing of financial
repression policies, increasing demand for gold within the country as well as
capital flight (some of which is going into gold but from local media noise
it seems to all be going into Sydney real estate, but it seems that
Vancouver, New York and London property are also getting some money flow).
Continued low gold prices have put pressure on mining companies, with many
below all-in production cost or at very low margins. In this environment
analysts do not forecast any significant increase in gold production, which
some see as support for gold (at least those focusing on annual flows and not
stock, which many mainstream financial analysts do).
I think the market continues to be complacent about geopolitical risks in
Eastern Europe and the Middle East (lessened somewhat with recent US-Iran
negotiations), which provides the potential for surprises to the upside in
precious metal prices.
Right now prices are “stuck” as there is no compelling
narrative or story to get mainstream professional investors to buy
gold – the longer precious metals continue in this sideways range
the more traders sell the bottom of the range and buy the top of the range
and it becomes self fulfilling.
