Commodities | Jul 21 2020
A look at the relationship between the price and supply of gold; resurging covid-19 cases pose a risk to global mining; post-lockdown recovery leading to rising freight rates
-Is the gold price driven by supply?
-Mining disruptions continue in Latin America
-Rising shipping rates for bulk commodities
By Angelique Thakur
Establishing causality between the gold price and gold flows
Longview Economics highlights how rising uncertainty across the world, led by rising geopolitical tensions and the pandemic, along with gold prices reaching all-time highs has given birth to many conspiracy theories suggesting the upside to gold prices remains significant.
While the theories are abundant, ranging from the collapse of the US dollar to a spending spree by China for gold mines, a common thread linking all these theories is they assume the flow (or the demand-supply dynamics) of gold affects the price of the yellow metal.
Longview Economics believes it is actually the other way round: the price of gold determines demand-supply dynamics. The analysts substantiate their claims by highlighting that three out of the four key factors impacting global gold supply are driven by the gold price.
Out of the four factors – demand by central banks around the world, real US treasury bond yields, Fed rate expectations and the US dollar – Longview Economics notes the last three are driven by the gold price itself while the first, though independent of the price, forms just a small component of the total flows.
The conclusion is most of the major gold flows are ineffective in determining gold price trends.
As an example, Longview Economics cites global gold supply over the past decade has shown a strong correlation to the gold price, with higher prices leading to a corresponding growth in supply.
Another example is the way higher gold prices typically lead to a reduction in jewellery purchase volumes on the one hand, while an increase in investment demand (demand for gold ETFs, investments products, coins and bars) on the other.
Longview Economics cites that in the last five years, investment demand for gold has increased by 370t per quarter while jewellery demand has fallen by -240t per quarter (due to rising gold prices).
Coming back to the first factor, central bank demand is the only component of the supply and demand balance that does not correspond to the gold price since it is mostly a political/economic decision, suggests Longview.
One of the conspiracy theories arguing an upside to the gold prices talks about the hoarding of gold by central banks across the world. However, Longview Economics reveals central bank purchases form only 10-15% of the total global demand for gold. Also, and most importantly, central bank purchases have actually slowed down this year with four of the largest buyers over the last ten years deciding to halt purchases over the past 12 months.
Other theories like central banks hoarding gold to prepare for de-dollarisation and a new international monetary system have similarly been debunked as central banks have made it clear these reasons figure at the bottom of their list of reasons to purchase gold.
Second wave and demand-supply dynamics
Resurging covid-19 cases in many parts of the world including the Latin American region has JP Morgan worried about the supply-side risks for iron ore and copper, with prices for iron ore already trading 60% above its long term price forecast.
For steel, JP Morgan believes April was the trough month with May showing strong Chinese demand and a recovery in rest of world steel output. On the supply side, JP Morgan notes supply in Brazil is recovering although productivity is still low. The broker thinks Vale needs to increase export rates to meet guidance.
Even with less than expected supply disruptions to copper, the current price of the bellwether of the global economy is nearing JP Morgan’s long-term price forecast of US$3/lb and is already above pre-covid-19 levels. The broker attributes this to the market already pricing in future supply disruptions.
The broker expects more interruptions at Chilean copper mines but is also worried about the impact to demand. In the medium term, JP Morgan expects delays in greenfield projects as well as in the expansion of brownfield projects.
There have been minimal supply disruptions to aluminium from the pandemic but research firm Wood Mackenzie expects global demand to fall -6% with production increasing 1%, causing stocks to build up to 6mt by 2022.
JP Morgan notes while prices for alumina and aluminium have bounced since May, supply-demand dynamics remain weak.
Nickel, up about 20% since April 1, remains a story of potential oversupply, with JP Morgan forecasting 700ktpa of nickel pig iron to come from Indonesia by 2022 from 400kt last year.
With the exception of iron ore and copper, most other commodities remain oversupplied because of a simultaneous loss in demand, notes JP Morgan.
Rising freight rates
Macquarie reports shipping bulk commodities like iron ore and coal has become more expensive. The Bulk Dry Index which covers about 20 major shipping routes has seen a spectacular recovery in the last 8 weeks, rising by 400% to almost 2,000 on July 6th.
These spikes are driven by a post-lockdown recovery and rising demand from China for imported iron ore. Some other factors responsible are restricted vessel throughput with Australia insisting on incoming vessels quarantining for 14-days, and poor weather in China.
The broker notes factors supporting dry bulk shipping rates include the weather (summer) in Asia, stimulus measures by major economies leading to stabilising economic activity and crude oil prices actively managed by OPEC/Russia.
The bearish risks involve a second wave across many parts of the world and trade conflicts erupting between China and countries like the US and Australia.
Macquarie is of the view that the rally is yet another China-led story but thinks with the lockdowns in Asia easing and freight activity also expected to become subdued during the northern summer, rates will stabilise soon.
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