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1 Commodity Fundamentals Report No. 92, 27 th Mar 2019 Written by: Harry Colvin, CFA, Director & Senior Market Strategist: dl+44 (0) Brad Waddington, Economics and Markets Analyst: dl+44 (0) GOLD: Geopolitics doesn t matter much (if at all) Summary & Conclusion When analysed in detail, though, it becomes clear that central bank buying is not a key driver of prices. Indeed, it s an insignificant component of the supply-demand balance (see point i). Over and above that, several of the other major components of the supply-demand balance do not drive gold price direction but, conversely, are driven by the price (e.g. gold jewellery demand, see fig 2). In fact, and most importantly, the supply-demand balance (as a whole) is ineffective at determining gold price direction (point ii) Table of Contents 1. Summary & Overview p Section 1: Supply, Demand & the Gold Price p Appendix A: Supply Demand Balance p Appendix B: Key charts p. 8 This publication is for the use of named recipients only and is protected by U.K. and International Copyright laws. If you are not the intended recipient, please notify us immediately. It is an offence to copy or distribute this publication, in any form or by any means, without the prior written consent of Ltd. All rights are reserved. No license is granted to the user except for the user's personal use. No part of this publication or its contents may be copied, downloaded, stored in a retrieval system, further transmitted, or otherwise reproduced, stored, disseminated, transferred, or used, in any form or by any means, except with prior written permission from Ltd. Important disclosures are included at the end of this report Copyright All Rights Reserved 1

2 GOLD: Geopolitics doesn t matter much (if at all) 27 th Mar 2019 Harry Colvin, CFA, Director & Senior Market Strategist, Brad Waddington, Economics and Markets Analyst: d +44 (0) Direct Line: +44 (0) , harry@longvieweconomics.com; Summary & Overview Global geopolitical tensions have escalated in recent years: the US China relationship has become increasingly fraught as China has sought to grow its global political influence* and the US, under Trump, has pushed back. Elsewhere, populism remains on the rise in Europe with extreme parties on both the left and right side of the political spectrum increasing their share of the votes. As an expression of that, the UK & EU continue to struggle to conclude a Brexit deal. Russia, meanwhile, continues to meddle in Western affairs (whether elections or assassinations on British soil) while seeking to absorb small territories on its border with Eastern Europe. Possibly reflecting that rise in global tensions, central banks have markedly increased gold buying. Russian holdings, for example, have been increasing since 2006, with that rate of growth having increased sharply since Likewise, Chinese stockpiles have been growing since the early-2000s (see fig 1). Fig 1: Russian & Chinese gold holdings (tonnes) vs. gold price (USD/oz) Despite significant growth in central bank gold holdings over the past several years, gold prices have remained largely rangebound. * (Italy, for example, recently became the first G7 member to join China s Belt & Road initiative) Unsurprisingly, gold bugs use that narrative (i.e. of renewed central bank buying) as another reason to be bullish on gold (e.g. see the LBMA Precious Metals Forecast Survey 2019**). The key question, then, is whether they are right, i.e. will increased Copyright All Rights Reserved 2

3 geopolitical tension and concomitant central bank buying of gold significantly change the supply & demand balance and drive the gold price higher? Or, put another way, what is the price outlook and what s likely to drive it? When analysed in detail, though, it becomes clear that central bank buying is not a key driver of prices. Indeed, it s an insignificant component of the supply-demand balance (see point i). Over and above that, several of the other major components of the supply-demand balance also don t drive the gold price direction but, conversely, are driven by it (e.g. gold jewellery demand, see fig 2). In fact, and most importantly, the supply-demand balance (as a whole) is ineffective at determining gold price direction (point ii). Fig 2: Global jewellery demand (tonnes, INVERTED, 1 & 4 qtrs smoothed) vs. gold price (USD/oz) ** Instead, three key factors determine gold price direction: real US yields, Fed rate expectations, and the US dollar. Those factors are consolidated in our Longview multi-factor gold model (fig 7, see Commodity Fundamentals Report, 16 th Nov 2017: Gold Disaggregating the Drivers for detail on the model). Forecasting the direction of those three factors is therefore key for judging movements in the gold price. The analysis of those drivers suggests that gold prices will continue their current uptrend over coming weeks. Reflecting that, we continue to hold LONG gold positions for now (for original recommendation see Macro Trade Recommendation, 4 th Dec 2018: GOLD Start BUILDing LONG Exposure ). Key risks to this trade include: (i) our gold market timing model which has recently signalled SELL (fig 8); and (ii) the fact that both TIPS yields and Fed funds rate expectations have moved sharply in recent weeks. Copyright All Rights Reserved 3

4 Fig 3: Global gold mine supply (kg) vs. gold price (USD/oz) Fig 4: Central bank net gold purchases (tonnes) vs. gold price (USD/oz) Copyright All Rights Reserved 4

5 Section 1: Supply, Demand & the Gold Price (i) Central bank buying of gold is a relatively minor component of the supply-demand balance. In absolute terms, central bank demand typically averages 10 20% of global gold demand. Indeed, last year, demand from central banks contributed just 15% to global gold demand (despite reaching a new all-time high in terms of tonnage, see Appendix B for more detail on the supply-demand balance). Furthermore, central bank buying rarely correlates with the gold price. Up until 2009, for example, net central bank gold purchases were negative, yet gold was in its earlier years of a 15 year bull market (with prices rising over 300% between 2000 & 2009 fig 4). Likewise, and despite a doubling of demand growth from central banks over 2018, gold prices remained rangebound. Total gold holdings among global central banks also show little correlation with gold (fig 5). Fig 5: Global central bank gold holdings (tonnes) vs. gold price (USD/oz) (ii) Most other components of the supply-demand balance are driven by the gold price (and are therefore not useful for forecasting future gold prices). Uptrends in jewellery consumption, for example (i.e. approx. half of global demand), respond to a falling gold price (and vice versa, see fig 2). Similarly, since 1970, uptrends in global mined gold supply have tended to lag uptrends in the gold price by 5 10 years (see fig 3). Recycled gold supply also follows the gold price (although on a shorter timescale). In total, therefore, the entirety of global gold supply is determined by historical changes in the gold price (with varying time lags). Copyright All Rights Reserved 5

6 Most components of the supply-demand balance are, therefore, not useful for working out the future direction of gold prices. Reflecting that, the balance, as a whole, has limited, or indeed no use, for forecasting gold price direction (see fig 6). From , for example, the market was largely oversupplied yet gold prices remained in a bull market. Similarly, since 2013, gold prices have been trending largely sideways despite most years being in a surplus. Fig 6: Global gold supply-demand balance (tonnes, INVERTED) vs. gold price (USD/oz) Copyright All Rights Reserved 6

7 Appendix A: Supply & demand tables Table 1: QUARTERLY global gold supply & demand balance (2017 & 2018, tonnes) DEMAND Jewellery fabrication Technological fabrication Industrial Dental T otal fabrication ETFs & investment products Bar & Coin fabrication T otal retail investm ent Central Bank net purchases TOTAL DEMAND SUPPLY Mine production Net producer hedging T otal mine supply Recycled gold supply TOTAL SUPPLY SUPPLY & DEMAND BALANCE Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Source:, World Gold Council Table 1a: ANNUAL global gold supply & demand balance (tonnes) DEMAND Jewellery fabrication Technological fabrication Industrial Dental T otal fabrication ETFs & investment products Bar & Coin fabrication T otal retail investm ent Central Bank net purchases TOTAL DEMAND SUPPLY Mine production Net producer hedging T otal m ine supply Recycled gold supply TOTAL SUPPLY SUPPLY BALANCE Source:, World Gold Council Copyright All Rights Reserved 7

8 Appendix B: Key charts Fig 7: Longview multi-factor gold model*** vs. gold price (USD/oz) Most of the gold price movement can be explained by changes in real yields, the USD, and Fed rate expectations. *** For detail on the multi-factor gold model, see Commodity Fundamentals Report, 16th Nov 2017: Gold Disaggregating the Drivers Fig 8: Gold market timing model vs. gold price (USD/oz) Copyright All Rights Reserved 8

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