Is Gold losing its shine?

Alexander Le Grys

The price of gold rose 0.2% to settle at $1,280.25 per troy ounce (oz t)  this week in New York, and with little fluctuation occurring in 2017, some suggest this precious metal has stagnated. The price has remained within the $1250-1350 range since April 2016, except in December 2016 following a surge in the dollar in response to Trump’s shock presidential election.  The consistency of value has created a divide over gold between those who are bearish and those who are bullish.

Firstly, bearish proponents in the gold market believe fundamental changes in the foreseeable macroeconomics of the global economy may put the precious metal on a perilous path. As a world recovery gathers pace, the Federal Reserve is shrinking its balance sheet and raising interest rates. The Fed started its latest tightening cycle in December 2015, with four rate hikes so far and another expected next month. Other Central Banks are moving the same way. The European Central Bank (ECB) is about to begin receding bond purchases to €30 billion euros, half the current pace, while the Bank of England raised interest rates for the first time in more than a decade earlier this month, and the People’s Bank of China will probably intensify efforts to  reduce the build-up of debt. This scenario makes it very hard for a non-interest bearing asset like gold to do well.

Linked to the reasons above, the demand for gold has slumped to an eight-year low, resulting in reduced buying by institutional investors. Data released by the World Gold Council on Thursday 9th November showed demand for bullion fell to 915 tonnes in the third quarter, down 9% year-on-year. The latest figures were hit by “significantly” lower inflows into gold exchange traded funds (due to a stronger US dollar), which fell to 19 tonnes from 144.3 tonnes, and a softer jewellery market in India. After three consecutive quarters of growth, demand in India following a new tax regime (the world’s biggest consumer of gold after China) dropped 25% year-on-year in the quarter to 114.9 tonnes.

The bulls in the gold market, albeit in a minority, have also turned heads. Firstly, investors in gold believe that in addition to interest rate hikes, nominal inflation will pick up, putting faith in a rising oil price due to OPEC’s expected supply cuts. Historically, the price of gold has risen during times of inflation as investors look for an inflation hedge to provide protection against the decreased value of their respective currencies.

Furthermore, the bulls in gold have strongly argued that it is fallacious to think that cryptocurrencies could replace gold as a financial hedge. They argue hype and speculation are the drivers to cryptocurrencies’ value. Since the beginning of the year, the value of Bitcoin has more than quadrupled. Among others, Ray Dalio founder of Bridgewater Associates, one of the world’s largest hedge funds, and Jamie Dimon CEO of JP Morgan, have called Bitcoin and its counterparts a ‘bubble’. At the end of September this year, Dalio’s Bridgewater Associates boosted its holdings in SPDR Gold Shares almost seven-fold believing the value of the metal will soar once the cryptocurrency bubble crashes.

Whilst cryptocurrencies are unlikely to replace gold as a financial hedge, caution is advisable. Many are comparing the current state of blockchain cryptocurrencies to the early days of the internet – a digital wild west teeming with opportunity. On balance it seems likely that the price of gold will remain flat over the coming months.  Minor movements around the £1300  t oz. seem most likely, with any bullish movements by investors expected to be more painful than rewarding.

Won’t stop surging: Would I Li to you?

Nicholas Ogilvie

In a recent report, Citi bank stated that it expected to see 1.04 million electric cars in production by 2020, a sevenfold increase on current production rates. The golden commodity required for electric vehicles and, more importantly, the batteries running these vehicles is lithium. Although diverse, the dominating market for lithium is batteries, at 35%. With the future looking very much focused on a transition towards electric vehicles and all things battery-powered, it is no surprise that surge in the price of lithium has occurred. 99%-pure lithium carbonate, having been fluctuating around $6000 per tonne for the past seven years, is now trading at over $13,000 per tonne. Most shockingly, this price surge occurred in just two months, September to December 2015, whilst the rest of the commodities market was tanking.

nic week 4

Lithium products, including lithium hydroxide, lithium carbonate and pure lithium metal, are derived from two main sources: hard rock mines and continental brines. The big players in the lithium market are Talison and SQM who produce 51% of all lithium traded on the market. Talison’s operations are predominately in Australia where lithium ore, or spodumene, is mined out of the copious amounts of hard rock. SQM takes the alternative approach in extracting lithium due to its operations being located in Chile. As Chile’s largest lithium producer its operations hold 26% of the global market. Lithium is produced in the form of lithium chloride, derived from brine that is pumped into small reservoirs and allowed to evaporate, leaving the precious metal behind. The lithium chloride is processed and turned into tradable commodities such as lithium carbonate and hydroxide.

The world has seen a boom in power utilities and large scale battery projects. The goal of conquering the intermittency of wind and solar power may have found a solution through effective storage of power produced during the day to allow the lights to be kept on at night. Many researchers say that this demand cannot be met by the technologies of lithium-ion batteries, but some companies take a different view. Most notably, Tesla.

Tesla states that its goal is simply, “to accelerate the advent of sustainable transport by bringing compelling mass market electric cars to market as soon as possible.” The US Geological Survey, in a recent report, announced that there is approximately 40 million tons of lithium resource remaining. If you’ve ever read into Tesla’s vehicles, one thing that always astounds readers is the weight of the battery pack. The Tesla Model-S, 85KWh version, has a battery pack with a weight of 544kg. Now, using some basic mathematics [i] and knowing the number of cells in each vehicle [ii], it can be estimated that each battery pack contains around 8.5kg of lithium. There are currently an estimated 1.2 billion cars on the road globally. Swap these out for electric cars and one quarter of the world’s lithium resource is exhausted. This is also assuming that all grades of lithium can be used in electric cars, which is a bad assumption as only 10% of lithium sold at market is EV Plus grade, required for highest efficiency electric vehicles.

The future may look bright for lithium producers as demand soars, but in order for the lights to stay bright at night, we may have to look elsewhere.

[i] http://images.fedex.com/us/services/pdf/LithiumBattery_JobAid.pdf
[ii] http://www.roperld.com/science/TeslaModelS.htm

Zinc- Time to buy? Have a think

Aiden Jackson

It certainly appears that zinc is the only bull in the commodities sector as prices surged to a 3 month high of $1715 per metric tonne as markets closed on Friday. The metal, commonly used for galvanizing of iron or to form brass, is showing some signs of a comeback after heavy falls in the previous nine months.

In a contrast to most other areas of the natural resources sector where supply continues to massively exceed demand, a significant production fall in the extraction of zinc is responsible for the recent price increases. Recent closures of major mines in both Ireland and Australia have helped significantly in the supply adjustment which is needed by so many other commodities. Lisheen mine in Ireland as well as Century mine in Australia have both reached the end of their utility. Lisheen, as the second largest European zinc mine will no longer extract 165,000 tonnes per year.

Meanwhile Glencore, the world’s largest trader and miner of zinc, announced in October that it would slash production by a third, accounting to around 500,000 tonnes. It was this news that sent concerns along the supply chain with China’s smelters cutting output in addition to increasing imports prior to further price surges.

Prices were even enhanced by the unexpected closure of Horsehead Holding’s zinc plant in North Carolina, US. As a secondary producer of zinc, the plant processed recycled material rather than extracted concentrates and so was seen as an unlikely victim.

But despite Goldman Sachs’ analysis that Zinc has ‘the strongest bulls case’ of all the metals market, many analysts still have their doubts that this isn’t just a short term recovery which follows many long-term falls.

It is not only decreases in production that will lead to supply adjustment and recovery in price. With large stockpiles continuing to flood the market, significant price rises will only be seen as the large stock overhang is cleared.

The problem is mainly seen in New Orleans where over 80% of the current global stockpile is held, an ideal location to offload metal due to its isolation from the main global trading hubs. The risk for traders here is that a large majority of the zinc stored here is unlisted on the London Metal Exchange (LME). When it seems that the stockpile is falling and a price increase will follow, companies can quickly reshuffle metal stored in off-shore exchanges into LME sheds. Suddenly there is a lot more metal in the market than was previously thought and all predictions of a price increase are incorrect.

And so it is impossible to estimate the true extent of the stockpile. Until zinc stops magically appearing in New Orleans, any price adjustments to a decrease in supply will be cautious and minimal.

One commodity to rule them all and why does gold go up in times of peril?

Erdenebilguun Gan-Och

There is a good number of finance literature attempting to explain the correlation between stock prices and gold prices but mostly with mixed results. But there exists a logical explanation as to why gold prices increase when stocks go down, because on many occasions gold is considered to be a safe investment.

First a little bit of history. During the dominance of mercantilism or bullionism in Europe during 16th – 18th century, an accumulation of precious metals was considered the measurement of a nation’s wealth. Even after mercantilism, gold was officially considered as a valuation measure for US Dollars – hence the gold standard. It was valid until 1971 when Richard Nixon abolished the standard that was holding on since 1792. Since then it became an independent but important investment asset. Currently gold price is considered as a barometer for the financial industry as an actively traded but universally accepted currency. In terms of gold price and US dollars, there is definitely a negative correlation between two. This negative correlation applies to almost any major currencies around the world.

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Source: World Gold Council

US employment data released few days ago sent mixed messages among investors on their confidence in the green as the reducing of the country’s unemployment rate slowed in January. At the same time gold price reached its 3 month high at US$1,165 per ounce. It is the one currency that investors run back for safety in uncertainty. Although disputed for its true validity for risk diversifying asset, gold is currently the most sought after precious metal in the world. Nations maintain gold reserves to back their currencies and curb inflations. Gold reserve is also an important indicator for national security. In terms gold possession US holds the largest gold reserves at 8,133.5 tons followed by Germany at 3,381.0 tons, while China and Russia has 1,722.5 tons and 1,370.6 tons respectively according Word Gold Council’s December 2015 rankings. According to United States Geological Survey the total world holdings in gold is divided by 49.2% in jewelry, 19.26% in investment, 17.2% in central banks, 12.14% in industrial usage and the remaining 2.2% unaccounted. However, it is also noted that the true measure of gold mined is impossible to estimate as many countries do not report their gold reserves for security reasons plus the metal has been mined for thousands of years. There are mixed views on whether the gold price will go up in the long term. Given volatility in the current financial markets many believe gold prices will go up.

Despite speculations and observations, gold remains the one commodity that supersedes all other assets, one that rules them all.

Will the Oyu Tolgoi underground development save Mongolia’s economy?

Erdenebilguun Gan-Och

The 17th largest country by territory in the world with a mere 3 million in population was the hot topic in mining during its short lived “golden era” of early 2010s. Historically, the country largely relied on agriculture and light manufacturing; Mongolia became an international spotlight after the signing of the Investment Agreement between Rio Tinto and the Government of Mongolia for the development of Oyu Tolgoi copper gold deposit in 2007. Oyu Tolgo is considered one of the largest and highest quality copper-gold deposits in the world that is largely untapped. This led to large influx of foreign direct investment into the country’s tiny economy. Several Mongolia based mining companies managed to tap the international equity markets by listing on the major exchanges such as the Hong Kong Stock and London Stock Exchanges. In a relatively short time, a new social group of rich individuals emerged as direct result of the development in mining industry. The GDP rose by 17% in 2011 which was the highest in the world. Mongolia was considered as a true emerging economy with a bright future. The country’s elite swiftly dove into luxurious and lavish lifestyles as if there was no tomorrow.

However, starting from mid-2012, the mining industry showed its early signs of decline as Chinese economic development slowed down. Bulk commodities such as iron ore, coking coal were the first victims of the down trend. Trading at almost US$200 per ton at Tianjin port in late 2011, iron price has steadily declined to its decade low of US$50 per ton in just 2 years. Numerous other commodities followed suit including coking coal, Mongolia’s largest mineral exports product. Following the crisis mining companies around the world switched to a cost-effective stance by cutting capital expenditures and started laying off people, Mongolia was no exception. The difference was that mineral products comprise over 85% of Mongolia’s export income by 2011. Therefore, the monetary impact from the crisis was particularly hard for the country. Mongolian government raised billions in sovereign debt during its high times with the hopes that the mining industry will do well in the future. As of 2015, the short term outlook for the country looks bleak as payments of its sovereign debts come close.

Yet, a shining light during these harsh down times is the underground mine development of the Oyu Tolgoi project. The project already brought in over US$6.4 billion in investment to the country’s economy since the signing of the Investment Agreement as part of its Phase 1 development. However, the highest quality copper and gold ore of the deposit lies underground and this where the main operations will take place. The massive underground tunnels and related development will require at least US$7 billion in investment, and this could be a saving grace for Mongolia’s economy during the upcoming slowdowns. This is especially important given Mongolia’s current state of affairs, its sovereign debts, struggling local entities and its economy in general. It is now completely up to the country’s policymakers to properly handle the matter, as it has some notorious record populist agendas and unstable regulatory environments.

Six year low in copper prices – China responsible?

Aidan Jackson

Copper prices have continued to fall to $2.13/lb, a six and a half year low as the commodities slump shows no sign of ceasing.

The cost of the dollar traded asset is by no means helped through the growing strength of the American currency, as oil production begins to stabilise and hints that the Federal Reserve will raise interest rates emerge to boost the U.S. economy. An increase in dollar strength only worsens the situation for purchasing companies who have to compensate for the increased cost of purchases that comes with a dollar traded commodity, often by decreasing demand.

The cause of the commodities slump has been well documented with the links to the Chinese economy’s falling growth rates with China currently responsible for over half of global copper consumption. A decrease in acquisition from such a large buyer is only going to lead to a decrease in price to compensate for the surplus in production. A surplus predicted to be 78,000 tonnes in 2015, even with mining companies cutting output. The decrease in Chinese demand is a result of dwindling industrial and construction outputs, heavy users of copper, amid fears of the overall state of the economy.

These fears are perhaps not misplaced with Chinese GDP growth slowing to 6.9pc in the third quarter of 2015, the slowest rate in six years. Much of this growth is stimulated by the retail sector with the larger falls within manufacturing. China has however massively increased the strength of its own production of refined copper. Although the need for copper may be changing so is China’s method of obtaining it. And by no means is it a scarce commodity with stockpiles estimated to have increased to 430,000 tonnes in China at the end of September.

In an effort to stimulate Chinese demand, the world’s largest copper producer Codelco plans to cut the premium that purchasers who then sell to China must pay. The move only highlights the level of concern over Chinese consumption with the 2016 premium set at $98 a tonne down from $133 with other producers likely to follow suit. Such a fall was unexpected but was viewed as necessary to retain market share by Codelco, aware that Chinese consumers will not pay a higher premium.

The commodity dominated FTSE 100 has been particularly affected by the decreasing copper prices with companies such as Anglo American down 4.8pc and Glencore dropping 6.7pc. It is of no surprise that Glencore has been struggling of late with 33pc of the commodities giant’s income derived from copper. The extent of this relationship is demonstrated by the similarity between Glencore share price and copper price demonstrated below.

Ultimately though without an increase in confidence in the Chinese economy it is hard to see anything but further falls in both copper demand and price.

1st aiden jackson week one
Copper price January 2010 to October 2015.

2nd aiden jackson week 1
Glencore share prices May 2011 to September 2015.

BHP Demerger: plans to be put to shareholders

Chris Makowski

BHP Billiton – the largest mining firm in the world – has announced demerger plans, which the company states will “unlock shareholder value by significantly simplifying the BHP Billiton Group and creating two portfolios of complementary assets.” In reality the mining giant is separating itself from its underperforming assets, namely its aluminium, nickel and manganese businesses. This is an interesting move given that BHP had a full year profit of $US 13.8bn up 23% from 2013. It brings about the question of why it should choose to follow through with this radical move when profits stand strong.

It does seem that the innovatively titled New Company (NewCo) is a dumping ground for BHP’s less valuable assets, and this represents a change of character for the firm. When BHP and Billiton merged in 2001 the firm appeared to be trying to diversify its portfolio to an extreme degree, taking a “shotgun approach” to assets acquisition. The creation of NewCo means BHP will have shed nearly all the assets it acquired in 2001.

Chief Executive Andrew Mackenzie stated “Separating these businesses via a demerger has the potential to unlock shareholder value by allowing BHP Billiton to improve the productivity of its largest businesses more quickly.” Which again points to the idea that the focus is on specialisation at BHP, with NewCo representing more of a secondary-thought side venture.

Despite Mackenzie’s assurances of unlocking shareholder value, UK investors lashed back against the announcement, leading to share price falls of 5% despite an announcement of 4% annual dividend increases. The share price continued to drop throughout October, falling 22% from £2067 just prior to August, to £1610.50 at the beginning of November. NewCo still has not been listed, but it was originally only planned that it should be done so in South African (JSE) and Australian (ASX), before BHP broke under investor pressure and decided to list in London.

NewCo may not however be the slagheap that it first appears to be. Iron ore accounted for 46% of BHP’s profits last year and tumbling price (from $US92.63 per ton in August to $US82.27 in September) was likely the recent driver of recent stock performance. Furthermore, the Chinese growth slowdown has negatively affected the expectation of BHP’s future share price, as the demand for hard commodities falls.

NewCo may in fact see high profits over the next few years. The consultancy firm CRU Group estimates that the assets held by NewCo will increase 33% in price by 2018. In those business areas that BHP is holding onto – Iron, Potash and Copper –there is a general consensus of future price declines.

The demerger still has to go past shareholders, but it will mark an interesting time for the industry. Investors will have to weigh up whether they think there is significant potential growth in the assets that will be held by NewCowith BHP offering a more stable investment alternative.