ScotiaMocatta Precious Metals 2018 Forecast · ScotiaMocatta Precious Metals 2018 Forecast Gold December 2017 Executive Summary Gold prices have generally consolidated in 2017 …

ScotiaMocatta Precious Metals 2018 Forecast Gold December 2017

Executive Summary Gold prices have generally consolidated in 2017 after their initial rebound in 2016, which

followed a four-year bear market. Gold prices are 21 percent above the 2015 low and 33

percent below the 2011 high.

Global economic growth has become more concerted in 2017 and that bodes well for

fabrication demand for Gold - greater prosperity is also expected to breathe some life

back into the depressed jewellery market, and that alone could have a significant impact

on demand.

We expect prices to work higher through the headwind of firmer US monetary policy and

expect there will be further bouts of safe-haven buying on the back of the North Korea

situation. We expect spot Gold prices to trade in a $1,190 to $1,390/oz range in 2018.

Introduction The Gold market seems fairly well-balanced

with prices trading either side of $1,290/oz. A

weaker dollar this year has helped underpin

the firmer tone, with higher Gold prices seen

when either geopolitical concerns have

become elevated, as they have at times over

North Korea, or when the Fed has shown a

more dovish hand. A look at the chart shows prices have made headway in an emerging

upward trend, following the downward trend that dominated between 2011 and December

2015. There have been three main up legs - the first ran from January to July 2016, the

second from mid-December 2016 to April 2017 and the third more recently between July

and September 2017. With equity markets booming, the opportunity cost of holding Gold

has been high, so in that sense Gold prices have done well to hold up - at some stage an

equity correction is likely and that may well result in a bullish time for Gold, but the

prospects of tighter US monetary policy will likely prove a headwind during much of 2018.

The one weak area with which the market has had to come to terms is the low level of

jewellery demand; this has suffered significantly since peaking in 2013, but demand has

stopped falling in 2017 and stronger global growth may well lead to a recovery in 2018

and beyond. While demand is expected to recover, mine supply is expected to fall due to

cutbacks in capital expenditure in recent years, which is likely to negatively impact supply

over the next two years. As such, we would say the underlying upward trend in Gold

prices should remain supported by improving demand and tighter supply, while there is

also the potential for safe-haven demand to pick up again, either on an escalation of the

North Korea situation, or should equity and bond markets start to correct. These two

markets are massive compared to the size of the Gold market, so it would not take much

rotation from other markets to Gold to have a significant impact on prices. Overall, we

remain mildly bullish for Gold prices in 2018, and a steady sideways-to-higher bull market

may well turn out to be quite sustainable.

Precious Metals Forecast - Gold December 2017

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The Big Picture Gold is at an interesting juncture at present. The opportunity cost of holding Gold is high as equities

continue to reach fresh records, the global economy is recovering and there are few threats to the

financial system other than the large amount of debt that has built up since the financial crisis. But,

with global growth recovering, debt may be something that can be lived with, although it will no doubt

come back to haunt the market at some stage. As such, there do not seem to be many pressing

financial security needs for investors to be seeking safe-havens – at least not yet.

On the geopolitical front there is cause for alarm as there is tension in the Middle East, especially

between Iran and Saudi Arabia, but this is not yet front-page news, while the more worrying nuclear

and missile ambitions of North Korea have fallen off the front page, even though they have yet to be

resolved. We still see North Korea as the most likely bullish driver for Gold prices in the months

ahead. In 2018, the Italian elections are likely to be watched closely, but for the most part concerns

about the European Union breaking up have subsided, so we do not expect European politics to

provide much support for Gold. In the US, economic recovery and prospects for tax reform should

help boost growth and provide a stable financial backdrop for investors and for the Fed to gradually

tighten monetary policy – both of these, combined with a probable firmer dollar, are likely to be

headwinds for Gold prices. That said, should an equity correction get underway then Gold could

benefit as investors look for safe-havens.

The US dollar, as shown by the chart of the dollar

index opposite, has been trending lower in 2017.

We think this is a result of the buying that has

been seen in recent years, when there was much

discussion about the ending of quantitative easing

(QE) and plans to reduce the Fed’s balance sheet.

We think the dollar ran ahead of itself and is now

consolidating, but with the Fed looking to tighten

monetary policy, while the ECB and Bank of

Japan remain dovish, we would expect the dollar to remain buoyant.

Stronger US monetary policy may start to worry emerging market economies that have high levels of

US denominated debt and this is one area to watch closely next year. More difficult borrowing

conditions could lead to emerging equity market corrections that could cause contagion which in turn

could boost demand for safe-havens. As such, for now the background is not very supportive for

Gold, but there are numerous potential developments that could trigger buying of Gold down the road.

However, the more overbought other markets become, the more likely it is that astute investors may

start to take out insurance against a market correction and that could benefit Gold.

FACTORS DRIVING GOLD

PRICES

The dollar The market generally expects an inverse

correlation between the dollar and Gold prices

but there are a few instances where Gold

prices have been rising at the same time as


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the dollar has been rising, as seen in the red boxes on the chart. These have tended to happen when

safe-haven demand has been high, causing flight into Gold and the dollar. In 2017, the more usual

inverse relationship has existed, which is surprising on two fronts. Firstly, safe-haven demand has

been high over North Korea, so we are not surprised Gold prices have been strong; perhaps the

dollar should have been strong on this too, but it has not been. The dollar has generally been weak,

we think because it has been so strong since 2012. In 2016, Gold prices climbed along with the dollar,

with the dollar’s rise driven by expectations that the US would be raising interest rates. Although this

would normally be a bearish environment for Gold, the stronger dollar did not deter investors due to

the fact that other economies had zero, or negative, interest rates and there were concerns about the

legacy of negative interest rate policies, combined with what had become an oversold market in 2015.

With the dollar generally climbing since 2011, when the dollar index was around 76, and reaching 103

in late 2016, the market had already discounted the ending of QE and a few interest rate rises. As

such, the slow pace of interest rate rises, that have often fallen behind market expectations, has led to

a dollar correction. So far in this tightening cycle rates have been raised 25 basis points four times, in

December 2015, December 2016, March and June 2017.With the Fed growing more confident over

the summer and with it announcing it will start to shrink its balance sheet, the dollar has halted its

slide and gold prices are suffering again. The stalemate in the North Korean saga has also removed

one of the supporting factors.

For 2018, we expect quantitative tightening (QT), combined with interest rate rises, to underpin a

stronger dollar. There is a possibility that President Donald Trump’s tax reform plans make headway

through Congress and lead to a deterioration in the country’s fiscal balance that could weaken the

dollar again, but it may be that the markets see the tax reforms as being good for the US and

therefore good for the dollar too. Another possible headwind would arise if the ECB and Bank of

Japan started to tighten monetary policy which could narrow the interest rate differentials at present

favouring the dollar.

Opportunity cost Record setting and multi-year high equity markets in many regions have increased the opportunity

cost of holding Gold, as have rising US interest rates. Most US equities have set record highs, as

have the German Dax and UK FTSE, while the Hang Seng set a post financial crisis high and the

Nikkei has been its highest since 1992.

Despite this, Gold prices have been oscillating higher and as of late November were up 14 percent

compared with the December 2016 low. Gold prices have managed to rise, despite the higher

opportunity cost, mainly due to the increase in demand for safe-havens that the unstable North

Korean situation has created. However, while tensions have often run high, equity markets have not

shown much concern about the developing geopolitical crisis and it appears the complacency shown

by equity investors has eventually spread to those that had bought Gold as a haven. While funds

trading Futures increased exposure earlier in the year, the more investment-minded ETF investors

only started to buy more Gold in July and they have not yet been spooked out of the market.

While rising equity prices have no doubt deterred some investors from buying Gold, it may mean they

start to rotate into Gold once equity prices start to get dizzy. If there is an equity or bond market

correction, then the money coming out of equities will need to go somewhere and as Gold prices have

already corrected heavily between 2011 and 2015, and are still relatively low, investors may well

consider Gold as a relatively cheap store of wealth. Gold prices fell $875/oz from the 2011 high to the

2015 low and at $1,280/oz have only recouped $234/oz. Prices are still 33% below the 2011 peak.


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Inflation below par, but fear of deflation passes Despite all the QE and ultra-low and even negative interest rate policies that leading economies have

undertaken at times over the past decade since the financial crisis, inflation has remained stubbornly

subdued. What is more, it has done so despite near full employment in many mature economies.

Given this, monetary policy is unlikely to tighten too much anytime soon, indeed stronger growth is

generally required to help countries pay down their debt. What is interesting is that, even with higher

oil and commodity prices, inflation has remained below optimum. Since the low in 2016, the London

Metal Exchange Index (LMEX) of base metals prices has climbed 56 percent and oil prices at

$63/barrel are up 14 percent since the start of the year. Whether there is a delayed reaction to this

remains to be seen. Judging by the University of Michigan inflation expectations data, inflation is

expected to be 2.7 percent in a year’s time – expectations have come up from a low of 2.3% at the

end of 2016.

While the various monetary policies have not been particularly successful in reaching target inflation

levels, they do at least seem to have prevented a deflationary spiral from getting underway. The fact

that central banks are now talking more about QT than QE also suggests they are more confident that

their economies are returning to normal. The Organisation for Economic Co-operation and

Development (OECD) expects all the 45 countries it tracks to grow this year – this concerted growth

suggests a more stable global economy and one would assume this is likely to underpin firmer

inflation. That said, it may be that inflation is being kept at bay by structural changes such as online

shopping and easier price comparisons which are increasing competition and keeping price rises to a

minimum. Average inflation across the G20 is 2 percent, but in the US inflation is running at around

1.4 percent and in Japan it is 0.7 percent, when both these economies have an inflation target of 2

percent. There is a danger that if the US and other leading economies do tighten monetary policy in

the absence of rising inflation, then ceteris paribus it could be a significant headwind for Gold prices.

There again, the unwinding of such large central banks’ portfolios is unprecedented so there is

potential for market concern that may keep investors’ interest in Gold, as a safe-haven, alive for

longer even if inflation remains subdued.

De-hedging once again over takes hedging At the end of September 2017, the global hedge book stood at 218 tonnes (7Moz) on a delta-adjusted

basis, according to the GFMS team at Thomson Reuters. This was down 23.5 percent from the 285

tonnes at the end of Q3 2016. At the start of the bull market for Gold in late 2001, which roughly

coincided with the start of de-hedging, the total hedge book stood at 3,107 tonnes (99.9Moz). The

hedge book fell to a low of around 77 tonnes in the Q4’13, before low prices in 2014 and 2015 saw

marginal producers step up hedging to safeguard their operations. It now appears the hedge book

more recently peaked at 285 tonnes at the end of Q3’16. After a long period when producer hedging

was unpopular with shareholders, it does now look as though the 2011 to 2015 sell-off changed

attitudes towards hedging somewhat, as the hedge book climbed, but with Gold prices now on the

rise again, so the hedge book is shrinking. Generally,

producer hedging does seem to remain unpopular

with shareholders and it tends to be used by new

mines to protect cash flow and by some to provide a

stable balance sheet to facilitate investment in new

mines. Generally, we expect a rising price to lead to

more de-hedging as producers may feel they have

enough cushion between market prices and their

cost of production.


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Central Bank activity Sales under the Central Bank Gold Agreement

(CBGA) have all but dried up with 4.2 tonnes sold in

the 2016-2017 period, which followed the 3.07

tonnes sold in the 2015-2016 period, the bulk being

sales made by the Bundesbank to provide Gold for

its coin programme. As the chart shows, since 2007

sales under the CBGA have declined rapidly, with

Germany’s three tonnes of sales per annum now

featuring as the bulk of sales.

Central banks, mainly in emerging markets, have continued to buy Gold, albeit at a slightly reduced

pace. In the first half of 2017, central banks have bought 176.70 tonnes of Gold, which is down 3.2

percent compared with the same period in 2016. In 2016, they collectively bought 390 tonnes. In the

first eight months of the year, the following countries have increased their Gold reserves the most:

Russia (129.1 tonnes), Turkey (111.9 tonnes), Kazakhstan (27.6 tonnes) and Indonesia (2.5 tonnes).

China has not reported any increases, while Belarus, which has been a regular buyer in recent years,

has sold three tonnes so far this year. For Turkey, the increase seems unusually large, but their

reserves can swell when commercial banks deposit Gold with the central bank as part of the

commercial bank’s reserve requirement; in 2016, Turkey’s holding fell 138.50 tonnes, so it is difficult

to read too much into the swings in Turkey’s Gold reserves.

Changes in official Gold holdings Russia’s central bank bought the most Gold in the period

November 2016 to October 2017 – it bought 201.6 tonnes,

which was up from the 190 tonnes bought in the same

period the year before. Whereas in 2015/16, China bought

130 tonnes, it has not reported any additional purchases in

the 2016/17 period. Now that the Renminbi is part of the

IMF’s Special Drawing Rights currency basket, has China

decided it no longer needs to build up its Gold reserves?

We would be surprised if it had stopped buying, as the

country’s holdings are still low at 2.4 percent when

compared with the US, Germany, Italy, France and the

Netherlands, although they are in line with Japan’s holdings (see table on right). Russia’s Gold

holdings have climbed to 17.3 percent of its reserves; in 2008 its holding equated to just 2.5 percent.

With China’s central bank governor, Zhou Xiaochuan, calling for a more market-derived yuan price, it

seems likely that the country would want to have larger Gold reserves to underpin its currency. If

China were to hold 10 percent of its reserves in

Gold, it would mean holding around 7,680

tonnes of Gold, which would put it just below the

US in terms of Gold held.

Oil and Gold Oil and Gold prices have tended to be positively

correlated, although oil prices fell more severely

in the financial crisis, while Gold initially sold off


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but then benefited from safe-haven buying. Both

commodities have generally been rallying since

the start of 2016, although both have had

setbacks along the way. Since the lows in

2015/2016, to the peaks, Gold prices have

climbed 30 percent and oil prices have climbed

129 percent. From the lows to the price levels in

late November 2017, Gold prices are up 23

percent and oil prices are up 118 percent. As

such, the Gold/oil ratio has been falling, meaning

it takes fewer barrels of oil to buy an ounce of Gold. Given Gold and oil prices are positively

correlated, the stronger oil price performance is a bullish factor for Gold prices. That said, oil prices

have bettered Gold’s price performance as oil prices fell more steeply in 2014 than Gold prices and

therefore the rebound in oil prices has been off a low base. The ratio, although well down from the

highs, is still relatively high compared with where it was between 2010 and 2014. With global growth

now more concerted and with OPEC working towards keeping output cuts in place, oil prices may well

have further to rise. The main swing factors are the shale producers and the fact that the current

production cap agreement expires in March, but assuming the agreement is renewed, the focus will

turn to shale producers. OPEC is, however, asking shale producers to take shared responsibility in

helping to cut the global supply glut. What is interesting is that the parties involved in the 2014 oil

price war appear to have realised the folly of their ways and are now looking for a more united front in

controlling supply. If successful, then a lower Gold/oil ratio will look likely. As this would mean higher

oil prices, it could quickly pass through to inflation, especially given all the other priming that has been

happening via QE. Higher inflation would likely be bullish for Gold prices and if higher energy prices

hit corporate profitability, it could lead to stock market corrections, which could help boost demand for

Gold as a safe-haven.

Demand Gold demand amounted to 4,481.40 tonnes in 2016, according to our interpretation of World Gold

Council (WGC) data, which was 3.2 percent lower than in 2015. In the first three quarters of 2017,

demand was off 9.8 percent at 3,018 tonnes, which annualised (basis the percentage drop) would be

4,063 tonnes. Based on the first three quarters of 2017 data (figures in brackets are for 2016),

jewellery absorbed 50 percent (46%), coin and bar investment 25 percent (24%), industry 8 percent

(8%), ETF investment 6 percent (13%), central banks bought 10 percent (9%) and producer

dehedging accounted for 1 percent (0%). As the data reveals, the main swing factor in demand in

recent years has been whether the ETFs have been net buyers or not. Between 2004 and 2012, ETF

buying was a major contributor to demand, then from 2013 to 2015 ETFs were net sellers, so they

were a factor of supply, but they returned as a strong factor of demand in 2016 (534 tonnes) and in

the first nine months of 2017 have bought 180 tonnes. Excluding investment demand for Gold,

fabrication demand in the first three quarters of

2017 has climbed 5.5 percent, which compares

with a 17 percent decline in the whole of 2016

over 2015.

Jewellery demand Historically, jewellery accounted for around 80

percent of Gold demand, but as the chart

opposite shows, this has slipped in recent


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years. The bull market in Gold prices between

2005 and 2011 negatively affected demand,

with jewellery demand as a percentage of total

demand falling to 43 percent in 2011. The drop

coincided with the pick-up in demand from

ETFs, but even on a tonnage basis less metal

was being consumed, with demand dropping to

1,817 tonnes in 2009 from an average of 2,636

tonnes in the period 2000 to 2008. Demand

recovered sharply in 2013 as there was a surge

in demand from China, but then fell between

2014 and 2016 as China destocked. The fall in

Gold prices tarnished Gold’s image as a store of

value, while at the same time slower economic

growth and an anticorruption drive in China led

to weaker demand for jewellery. In addition, the

Indian government’s intervention to try to

reduce the trade deficit led to various import

taxes being introduced and then last year’s

demonetising of the Rs500 and Rs1,000 bank

notes in early November also unsettled the domestic market. Another factor in recent years was that

the Middle East wealth effect was hit by lower oil revenues. These have all been external reasons for

the fall in demand and that is why jewellery demand has, for a change, not been particularly price

elastic. During 2014 to 2016, Gold demand from the jewellery industry fell even though Gold prices

were also falling – see chart.

In 2016, global demand for jewellery fell 18.7 percent, to 1,987.70 tonnes; this followed a 2.8 percent

fall in 2015 and an 18.8 percent drop in 2014, according to WGC data. Demand from the jewellery

industry has, however, started to recover – in the first three quarters of 2017, it has climbed 5.9

percent. It would appear that more concerted global economic growth combined with low but rising

prices have seen confidence slowly return. In addition, country-specific issues in India have helped

demand in the first half – there was a rush of restocking ahead of the introduction of the Goods and

Service Tax (GST) in early July.

India’s jewellery demand has been through a

challenging time in recent years, with import

taxes, a drawn-out retailer strike, the cash

crunch caused by the removal of Rs500 and

Rs1,000 bank notes, and more recently the

introduction of the GST. After peaking at 661.7

tonnes in 2010, jewellery demand fell to 595.2

tonnes in 2012, before recovering to 662.3

tonnes in 2015, only to then plunge to 504.5

tonnes in 2016. Demand has rebounded in the

first three quarters of 2017, to 349.9 tonnes, up

8.6 percent from the 322.3 tonnes in the same

period in 2016, according to WGC data. One bullish development is that whereas the Indian

government had recently placed the sales of gems, jewellery and gold bars/coins under the

Prevention of Money Laundering Act (PMLA), which meant sales valued at INR 50,000 ($765) and

over needed to be recorded along with the buyer’s Permanent Account Number, the government has

now retracted this, at least for the present. This means the INR 50,000 reporting limit will be returned


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to the previous INR 200,000 level. The legislation had reduced large ticket sales, but its repeal should

give India’s bullion market a much-needed boost.

Looking forward to the rest of 2017 and into 2018, we expect demand for Gold jewellery in India to

recover as the economy grows at a faster pace and as the market becomes more accustomed to the

government intervention of recent years. The three percent GST on Gold was lower than the market

feared and that should be positive for demand. Given the dip in demand in recent years, there may

well be considerable pent-up demand as well as stronger fresh demand, as India’s economy is one of

the fastest growing economies with GDP forecast to grow around 7 percent in 2017 and 2018.

India’s imports of Gold bullion were estimated at around 558 tonnes in 2016, according to WGC data,

which was down a hefty 39 percent from 2015 and the lowest for many years. One of the main

changes in the composition of imports in 2015 was the increased popularity of doré, as there were tax

savings to be made by importing doré and turning it into refined Gold domestically. But doré imports

dropped to 142 tonnes in 2016, from 229 tonnes in 2015 - they were still above the average of 48.1

tonnes imported between 2012 and 2014. They have recovered in 2017, with imports up 82 percent in

the first half compared with the same period in 2016, suggesting more refineries are receiving the

required Bureau of Indian Standards certification.

The government launched various Indian Gold schemes in 2015, such as the Gold Monetisation

Scheme (GMS), with the intention of mobilising domestic hoards so it could reduce the country’s

reliance on imports. The scheme has so far not been a success, having only attracted 10 tonnes

since November 2015, however efforts are still being made to get the scheme more operational.

The government also launched the Sovereign Gold Bonds (SGB) Scheme in 2015, whereby investors

can buy a bond and the return will be linked to the price of Gold. By offering SGBs the government

was hoping to reduce demand for physical Gold, and more importantly imported physical Gold, but so

far the Scheme has also not been adopted on a large scale and one reason for that is that the bonds’

prices in the secondary market are trading at a discount to Gold prices. This means if you need to sell

the bond before it becomes redeemable (after five years) you could make a loss. Changes have been

made to the SGB so individuals can now by up to 4kg of Gold annually, compared with the initial 500g

limit. With the SGBs paying 2.5 percent interest and being free of capital gains tax on redemption and

without the premium attached to buying Gold bars and coins, there are some incentives. If the

scheme takes off, then it could have an impact on the country’s Gold imports. Nine tranches have so

far been floated since the start, with a total of INR 6,030 crore raises, which averages 670 crore per

tranche, with the latest one raising INR 630 crore. Basis an average Gold price of $1,228 per oz

between November 2015 and July 2017 (when the SGB tranches have been available) suggests the

scheme holds some 23 tonnes of Gold; at the time of last year’s Forecast Report, some 10.22 tonnes

of Gold were held in the scheme.

China’s demand for Gold jewellery dropped to 630 tonnes in 2016, a fall of 16.3 percent compared

with 2015, but it was down 32.8 percent compared with 2013, when Chinese demand peaked at 939

tonnes. After the surge in jewellery demand in 2013, China’s appetite for Gold seems to have waned

for a variety of reasons - slower economic growth and the government anti-corruption drive have hit

demand for luxury items and falling prices have eroded confidence in Gold jewellery’s ability to hold its

value. In addition, the more upwardly mobile workforce has a much larger array of consumer and

luxury items on which to spend their money, including household appliances, retail brands and

holidays. But, given runaway property prices, the focus of many young middle-class Chinese is to get

on the property ladder, so they probably do not have too much to spend on other more traditional

luxury items such as expensive jewellery. This structural change is unlikely to go away, although older

generations benefitting from having properties will be in a better position to spend on luxury items and


9

there could be a pick-up in interest in Gold should property prices start to correct, as investment

money may then stay clear of property for a while.

In the first three quarters of 2017, Chinese jewellery demand climbed 1.5 percent to 472.4 tonnes

according to WGC data, compared with a 17.7 percent drop between the first three quarters of 2016

and the same period in 2015, so at least the decline appears to be over. As demand has slowed,

jewellery retailers have changed tack and they are now trying different types of jewellery to win back

consumers’ interest. Some are pushing harder 22-carat or 18-carat jewellery which can support more

complicated designs, with many of the jewellery pieces being hollow and priced more on their design

than Gold content. This has helped increase the range of designs, while at the same time increasing

jewellers’ margins, but it can mean the Gold content in each piece is considerably less than had it

been made out of solid 24-carat Gold. As such, it may take some time before the jewellery industry

reaches former peaks in terms of tonnage.

With China and India accounting for 61 percent of global jewellery consumption (China 34%, India

27%), what happens in these countries is all-important. The third largest consumer of Gold in

jewellery is the Middle East, where consumption equates to 10 percent of global demand, followed by

the US with 6 percent. Our forecast for jewellery demand in 2017 is for it to grow around six percent,

in line with the increase seen in the first three quarters of the year, and we expect the rebound to

gather momentum in 2018, with growth around eight percent. We expect Chinese demand to continue

to recover slowly after four years of declines, the Indian market to benefit from a more stable

regulatory environment and our expectations are for a higher oil price that should lift Middle East

demand. Better economic growth in the US and Europe and generally more concerted global growth

should also support stronger demand for jewellery in all areas.

Investment demand Investment demand was the area of strength for

Gold demand in 2016, with ETF, coin and bar

purchases totalling 1,587.40 tonnes in 2016, up

48.8 percent compared with 1,066.7 tonnes in

2015, according to WGC data. In the first three

quarters of 2017, investment demand has

slumped 32.5 percent to 935 tonnes, compared

with 1,386 tonnes in the same period in 2016.

Breaking down the data shows demand for

ETFs was down 75 percent, while demand for

bars and coins climbed 13 percent. That said,

during the fourth quarter these trends have

changed as bar and coin sales have slumped,

while holdings in ETFs been fairly flat.

Investors buying Gold ETFs returned in force in

2016, reversing the flow of redemptions seen

between 2013 and 2015. Holdings peaked on

1st January 2013 at 2,647 tonnes; they fell to a

low of 1,474 tonnes in December 2015.


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Holdings rebounded to 2,176 tonnes by early November 2016, before dropping to 1,950 tonnes by

year end. Up to late November 2017, they have climbed to 2,128 tonnes (up 177 tonnes) but have

turned flat in recent weeks.

While demand for bars and coins climbed in the

first half of 2017, it has since fallen rapidly.

Sales of American Eagle Gold coins averaged

32,250 oz per month in the first half of the year;

in the third quarter they averaged 9,333 oz per

month. During the same periods in 2016, the

split was 83,500 oz and 63,833 oz, so in terms

of both overall volume and the drop in monthly

average in the third quarter, demand seems to

be considerably lower. The fact US equity

markets have repeatedly been setting record

highs suggests the opportunity cost of holding

Gold has become too high in the recent climate.

In other uses of Gold, including technology, dentistry and other industrial applications, demand fell 2.6

percent to 323.5 tonnes in 2016 compared with 2015, according to WGC data. Year-on-year,

quarterly data did pick up in Q4’16, i.e. in Q4’16 Gold demand in these sectors climbed 1.5% to 84.5

tonnes, compared with a year earlier (Q4’15) and each quarter since has seen an improvement

compared with the same period a year earlier. Over the 23 quarters before Q4’16, only two had

shown an increase in demand. This highlights the structural downward trend affecting these areas as

substitution and miniaturisation reduced demand per item, while other materials are being used in

dentistry. With a series of four quarterly, year-on-year increases now seen, perhaps this sector has

turned a corner. That said, the increases have been seen in electronics and other industrial

applications, but not in dentistry. In last year’s forecast we mentioned the discovery of a new super-

hard metal alloy, Ti3Au, that contains three parts titanium, one part Gold and is four times tougher

than pure titanium and more biocompatible, so it could find use in the medical industry for dental

implants and joint replacements. With a typical titanium hip replacement weighing between one and

two pounds (450-900 grams) this could be an exciting new use for Gold. It is estimated that in 2011

there were three million joint replacements made worldwide. Although it is unlikely solid Ti3Au would

be used due to the expense, even if the alloy was used to coat ceramic joints, it could still consume a

meaningful amount of Gold.

The Futures market

The net long fund position (NLFP) has been

quite volatile in 2017; from around the 100,000

contract level at the start of the year it climbed

to 204,465 contracts in early June, bolstered by

the pick-up in geopolitical tensions over North

Korea. Short selling and long liquidation then

led to the NLFP dropping to 60,138 contracts in

mid-July, after which time short-covering and

fresh buying, seemingly on the back of a more

dovish Fed, led to the NLFP climbing to 254,760

contracts by mid-September, which coincided

with prices peaking at $1,357.55/oz. Profit-taking by longs has since seen the NLFP drift lower, but

the interesting take-away is that shorts have continued to reduce exposure into the weaker price


11

environment, which suggests fund sentiment is not that bearish. We see the pull back in the gross

long position since September being a result of a calming of geopolitical tension over North Korea

(although this has since picked up again) and a high opportunity cost of holding Gold when equity

markets continue to set record highs. As of late November, the NLFP stood at 224,417 contracts,

having ranged so far this year between 60,138 and 254,760 contracts. This year’s peak has been well

below the 2016 peak of 315,963 contracts. The gross short position at 62,967 contracts is the lowest

it has been all year.

SUPPLY Gold supply to the market can come from six sources: mined output, scrap sales, official government

sales, producer hedging, redemptions from ETFs and private stocks. In 2016, supply climbed 6.2% to

4,807.9 tonnes, from 4,525.7 tonnes in 2015, according to our interpretation of WGC data. In the first

three quarters of 2017, total supply is down 6.4 percent at 3,300 tonnes, a drop of 228 tonnes. This

has come about by some shifts in the factors of supply with 2017 seeing no supply from ETF

redemptions (on a net basis), no net supply from producer hedging and less recycling, while mine

supply edged lower. Official Gold sales all but

dried up in 2010.

Mine supply increased 1.3 percent to 3,264

tonnes in 2016, according to WGC, thereby

continuing the upward trend in mine production

that has been present since 2009. The rate of

growth, however, has been slowing in recent

years with increases of 2.2% seen in 2015,

2.5% in 2014 and 5.5% in 2013.

Reduced capital expenditure since 2013 is

leading to less new capacity in the years ahead, although the ramp-up of mines that was initiated

towards the end of the previous bull market has been adding to supply in recent years, but the impact

of reduced capital expenditure over the past four years is now likely to start being felt. Indeed, 2017

may turn out to be a tipping point, as in the first half of 2017 mine output is down 0.3% and reports

suggest that Chinese production is starting to suffer from lower ore grades and the impact of

environmental inspections as producers must adhere to tighter environmental standards, as has been

seen across the metals industry in China. With prices only picking up at the end of 2015, there is now

likely to be a time delay before a pick-up in capital investment starts to bear fruit – as such, we expect

mine output to fall for a few years. We forecast a three percent drop in mine supply in 2018.

Scrap The recovery in Gold prices in 2016 led to a

pick-up in scrap supply. In 2016, Gold supply

from scrap climbed 15.8 percent to 1,295

tonnes, this after a 6.2 percent fall in 2015. But,

supply in the first three quarters of 2017 has

fallen 15.2 percent to 880 tonnes, from 1,038

tonnes in the same period in 2016. As such, it

does look as though the run up in prices in the

first half of 2016, after four years of falling


12

prices, may well have meant that a lot of hoarded scrap was quickly released into the market.

Whether all the hoarded scrap entered the supply chain in the first half of 2016, or whether the

pullback in price in the second half of the year turned the taps off, remains to be seen. This year’s run

up in prices above $1,350/oz was short-lived, so it may be there is more scrap supply availability

above the market. For 2017, with prices still below the highs seen in 2016, we would expect scrap

supply to level out at around 280 tonnes per quarter, which would mean a 13.4 percent drop in 2017

compared with 2016. For 2018, we would expect scrap to pick up again as a recovery in jewellery

demand is expected to lead to a pick-up in scrap flow. That said, a tightening in China’s recycling

laws, in that it will announce a list of recyclables that will no longer be able to be imported, could

disrupt scrap supply and the amount of metal recycled.

No supply from ETFs Whereas in 2013 to 2015 there was supply from investors selling their ETF holdings, which saw 884

tonnes returned to the market in 2013, 158 tonnes in 2014 and 122 tonnes in 2015, in 2016 this dried

up, when investors bought a net 472 tonnes of Gold via ETFs. In the first three quarters of 2017, they

have added 180 tonnes, so for the second year running, ETF flows have once again become a factor

of demand, not supply.

Forward curve offers some incentive The forward price curve for Gold on Comex

shows a contango with a $26.5/oz difference

between December 2017 and December 2018,

widening out to a $30.7/oz difference between

December 2021 and December 2022 – so not a

lot of contango to take advantage of for nearby

hedging unless prices start to trade sideways

more. However, five-year forward Gold prices

are $145/oz higher than current prices, which

may be more tempting.

2017 looks set to be a year of considerably less supply as mine output growth halts and scrap supply

shrinks, while there is no net supply from ETFs, hedging and government sales. Looking forward, we

expect more of the same in 2018, although it may be more pronounced as mine supply starts to fall at

a faster pace given recent years’ reduced capital expenditure and the environmental inspections in

China, but a fall in mine supply may be somewhat countered by a pick-up in scrap supply.

Technical Outlook Gold prices have turned the corner from being in a downward trend from the 2011 peak to the

December 2015 low at $1,046.40/oz, to being in an upward trend. The first up leg took prices to a

high of $1,375.25 in July 2016; prices then corrected to $1,122.90/oz in December 2016, before

rallying to $1,357.55/oz in September 2017. They have more recently been consolidating above

$1,260/oz. As the chart shows, there is a clear resistance line capping the upside – in November

2017 this line was at $1,348/oz. The underlying up trend line is at $1,193/oz. Prices are for now

oscillating sideways between the resistance and up trend lines - the trend is sideways-to-higher, but

the stochastic indicators are crossed lower, so for now we expect more sideways trading. The main

resistance points are $1,300/oz, followed by the resistance line at $1,348/oz, the 2017 high at


13

$1,357.55/oz, the 2016 high at $1,375.25/oz and then the August 2013 resistance point at

$1,433.95/oz. On the downside the main support levels are the uptrend line at $1,193/oz, the 2016

low at $1,122/oz and the 2015 low at $1,046/oz. Overall, a rounded bottom seems to have developed

over the past five years, which could underpin an up trend going forward.

Forecast & Conclusion With the 2011-2015 downward trend over and with prices trading sideways-to-higher, but capped by

supply above $1,350/oz, it does look as though the Gold market is quite well-balanced. With monetary

policy in the US likely to tighten and likely to be followed by tightening in Europe at some stage in

2018, the opportunity cost of holding Gold, from a yield perspective, is likely to rise. The opportunity

cost of holding Gold is already high when viewed against the performance of equities - indeed Gold

has done well to hold up as much as it has considering this. Gold also benefitted from the pick-up in

geopolitical concerns over North Korea in the April-to-September period and that was fed by all the

rhetoric between the US and North Korea, but lack of escalation, or aggressive action, did mean

markets started to grow complacent from September onwards. With another even further-ranged

missile fired in late November, one that experts say could reach anywhere in the world, it does look as

though geopolitical tensions are likely to rise again before a solution is found. As such, we do think

the North Korean situation is likely to return as a bullish driver for Gold prices sometime in the months

ahead. The other potential development that may see safe-haven demand for Gold pick up is if there

is a significant correction in equity markets. US markets could undergo a correction at any time, while

emerging market equities may face headwinds if US monetary policy were to become more hawkish.

We do not see this happening at present, but stronger concerted global growth and rising oil and

commodity prices could bring about a pick-up in inflation and that may then make the Fed more

hawkish.

Outside safe-haven demand for Gold, we expect stronger economic growth to support fabrication

demand for Gold; there are signs that industrial demand is recovering, and we think there is potential

for jewellery demand to recover strongly after three years of significant declines, with jewellery

demand in 2016 being 27 percent lower than it was in 2013. Consumer habit changes in China may

have reduced the amount of Gold bought by individuals, but we think the upwardly mobile workforce


14

will create a bigger pool of potential buyers. While in recent years the Indian market has been

disrupted by government policies, which have created uncertainty, we think going forward that

consumers will get used to the new ways of doing things and that is likely to see stronger demand

return.

As the long-term chart for Gold shows, prices are off the lows and seem content to trade in the

$1,200-1,350/oz range. We expect supply to tighten in 2018 and 2019, as a result of lower capex in

recent years, and we are bullish on the prospects for demand to improve, so from a fundamental

viewpoint we would not be surprised to see prices work higher.

Our forecast for 2018 is for prices to trade in a $1,190 to $1,390 range.


15

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