The fundamentals underpinning the surging gold price 2011
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Peter Ker
April 30, 2011
For a man carrying the title of treasurer, Peter Costello sure seemed comfortable getting rid of the treasure.
It was the winter of 1997, and the Reserve Bank of Australia had decided that a gold price about $450 an ounce was the ideal time to part with two-thirds of its bullion.
Conducted in secret over several months, the move spectacularly punctured both the gold price and confidence in the local mining industry.
As the utterances of the US Federal Reserve chairman, Ben Bernanke, helped propel gold to new heights this week, the metal that seemed to have lost its lustre in 1997 is fast reclaiming its standing as the world's currency of choice.
Amid the sandalwood trees east of Kalgoorlie, Chris Cairns can hardly believe his luck.
In the six years since his company, Integra Mining, acquired the Randalls deposit, the international spot price for gold has risen by close to 350 per cent.
In the seven months since the first gold was poured at the site in September, the price has leapt 17 per cent.
By Thursday, the gold price had enjoyed eight record highs against the US dollar in the space of nine trading days, putting yet more cream on the cake for miners like Integra.''We like to take credit for a lot of things, but we can't take credit for the timing of the project … had we tried to plan it any better I don't think we could have,'' Cairns jokes.With the price pushing past the $US1500-an-ounce barrier shortly before Easter, Cairns can contemplate the sort of cash margins that were once unthinkable.''I've been in gold for about 20 years and in the old days if you had a $200 per ounce margin you were pretty pleased, so [close to] $1000 per ounce is just unprecedented,'' he says.
For a nation versed in the history of its gold rushes, the present boom has had a comparatively low profile beside the extraordinary export climate for coal, iron ore and liquefied natural gas.
But cast an eye over the statistics, and it is clear the modern boom - which some experts say stretches back to the 1980s - deserves its place alongside the legendary finds in Victoria and Western Australia during the 19th century.
Gold production in Australia grew faster than in any other nation in 2010, up 17 per cent on the year before. Australia is now the world's second-biggest producer behind China, with the 2010 haul of 266 tonnes lifting Australia above the third ranked nation, the US.
While the soaring Australian dollar has blunted some of the gains over the past six months, this week's $1400-an-ounce price in Australian dollar terms was still close enough to the record high - set in February 2009 at $1547 - to be lighting a fire under explorers and their corporate suitors.
A gold expert at Surbiton Associates, Sandra Close, says exploration in Australia has been more focused on reviving deposits that have been previously explored, rather than the pursuit of genuine greenfield discoveries.
The trend is playing out at the scene of Australia's first gold rush near Ballarat, where junior miner Castlemaine Goldfields hopes to be producing by September.
The company took over the field from Lihir Gold in a $4.5 million fire sale last year.
Castlemaine's managing director, Matthew Gill, says elevated prices are making projects like this more attractive, and his company could be turning margins of close to 100 per cent if gold retain its strength throughout 2011.
''It is certainly causing a review of old mining areas, and the economics of old mining regions are now quite different,'' he says.
Despite several years of consolidation in Australia's goldmining sector, Mathew Kaleel from H3 Global Advisors says mergers and acquisitions are likely to continue to be the flavour of the month.
''New discoveries in copper and gold, in terms of grade and quality, are becoming much harder to find - it's much easier to buy something which has already been discovered,'' Kaleel says.
''Any company that finds or has found a decent deposit, it becomes almost a no-brainer to buy them because their enterprise value per ounce is $100 to $200, and you can't discover gold for that.''
The hold that international companies have on Australian gold resources - estimated by Close at nearly 60 per cent - highlights the global nature of the gold boom.
Gold production from the world's mines hit a record last year, with 2689 tonnes taken out of the ground.
The tally eclipsed the previous record set in 2001, and a new record is likely again this year, with forecasts suggesting global production will grow by 4 per cent.
West African nations like Burkina Faso are fast joining the ranks of China, Australia, Argentina and the US, aggressively expanding their volumes of gold production in a bid to satisfy demand that is growing from a range of sources.
Part of the demand story is familiar: the growing middle classes in India and China have developed a taste for jewellery, and they seem to want it made from gold.
A report by London-based precious metals consultancy GFMS revealed that demand for gold jewellery rose by nearly 40 per cent in China between 2001 and 2010. In the same period demand for gold jewellery rose by more than 20 per cent in India.
But other factors driving demand are far less familiar: after spending the period between 1997 and 2009 as net sellers of gold, the central banks of the world have started buying again.
Russia, Kazakhstan, the Philippines, India and China have ranked among the biggest buyers over the past couple of years.
Hedge funds and pension funds appear to be following suit, as investors seek the security of gold amid a perfect storm of political unrest in the Middle East, sovereign debt problems in Europe and a plummeting US dollar.
This month the University of Texas's $US20 billion endowment fund revealed it had taken possession of 6643 bars of gold bullion. The purchase, kept in a vault below New York City, represents 5 per cent of the fund's value, and analysts say the implications could be huge if other pension funds follow suit.
''It is being treated as a currency again and it is significantly under-owned,'' Kaleel says.
''If gold is going to become a conventional portfolio holding for pension funds and central banks of 5 to 10 per cent, there is a lot of gold that needs to be bought.''
The latest noises from the US Fed suggest the drive towards gold is not misguided.
Speaking on Thursday morning Australian time, Bernanke indicated there was no end in sight to the enormous stimulus effort under way in the US.
That means interest rates will stay close to zero, and the volumes being spent - more than $US2 trillion - buying back Treasury securities will continue to be pumped into the US economy beyond the end of the current round of buybacks.
The policy is expected to further undermine the US dollar, which traditionally has an inverse relationship with gold.
Against that backdrop, it is hard to find anyone predicting the gold price will retreat any time soon.
Tony Parry from Resource Capital Research says conditions are a ''win-win'' for continuing strength in gold but it could be dragged lower next year if there is sustained recovery in major equity markets.
He points to recent selling out of gold-focused exchange traded funds (ETFs are securities that track the performance of the gold price) as evidence that some investors believe the metal has reached the top of its range.
ETFs have proved popular since they came into vogue about five years ago but flows out of the funds were noted late last year.
The best known gold ETF - New York's SPDR Gold Shares - was holding 1280 tonnes of bullion for its investors at the start of the year but is now holding 1230 tonnes.
''The investment flows [in ETFs] have switched from soaking gold up to releasing it on to the market, so we think that shows a bit of a shift in investor sentiment …'' Parry says. ''That's a significant factor to make us more cautious on the sustainability of the current investment demand for gold.''
But the Goldman Sachs analyst Ian Preston does not believe the flow out of ETFs is a portent of things to come. ''I don't think its a trend,'' he says. And he won't be surprised to see the price stay close to $US1500 for the next 15 months at least.
''We are not in the camp that calls a $US2000 gold price but, so long as people are trying to protect their wealth, you continue to have central banks buying and you have low real interest rates, those are all recipes for continued strength in the gold price.''
In New York the Euro Pacific Capital economist Michael Pento says a breach of $US1600 will be achieved this year. The GFMS experts in London predict a price as high as $US1620 this year.
''Market imbalances suggest that at some point the gold price will have to retreat. Nevertheless, this is most unlikely to occur on a secular basis in 2011 and potentially not until well into 2012,'' the GFMS report says.
Fourteen years after eulogising gold's place in the global economy, Peter Costello did not respond when invited to reminisce about the 1997 sale.
But in an attack on the Gillard government's handling of the mining boom - published in the Herald this week - he reveals the sharp rises in commodity prices have not escaped his attention.
''We are not in normal times. We are living through a period of unprecedented prosperity in Australia's terms of trade. This is bigger than the gold rush of the mid-19th century,'' he writes.
Those gold rushes occurred when currencies were tied to a formal gold standard and, after the recent credit crises, Kaleel reckons we can learn something from our past.
''It worked for 3000 years and the current system has not worked for 30 years,'' he says. ''If the only reason to reintroduce something, whether it's a gold or another type of standard, is to limit leverage, it would be a very good thing.''
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