The Lower Gold Price

What is going on?

On 20th July, US$1.7bn of gold was sold in just 3 – 4 minutes. While fairly dramatic, and somewhat suspicious (very large trades were put through during the quietest market period), this was just the latest in a series of downward price moves. The price of gold (around US$1,090 per troy ounce) is now near a five-year low and down by more than 40% since its highs in 2011. 

Graphic - from The Financial Times

Graphic - from The Financial Times

Why has the price fallen?

  1. A strong dollar and prospects of a US interest rate rise: Gold earns no interest, so when interest rates in safe havens like the US rise gold looks less attractive. Its also priced in dollars, so when the US$ is strong, gold looks more expensive to holders of other currencies.
  2. Global stability: China is still growing and there are no signs of a “hard landing”; Greece is in one piece; Iran just did a nuclear deal and the US Federal Reserve successfully prevented a global economic melt down. Gold looks less attractive when the world isn’t coming to an end.
  3. No signs of inflation: Gold is a hedge against inflation. However, despite central banks printing money on both sides of the Atlantic, inflation remains stubbornly low, driven by the fall in the price of oil.
  4. Weak physical demand: China has been buying far less physical gold than expected.
  5. Weak investor demand: US Exchange traded funds (ETFs – equivalent to low cost unit trusts) used to be large buyers of gold. However as the economy recovers, investors are switching their preference to stocks.

Why is this a problem?

According to Investec, higher cost global gold miners become unprofitable at a price below US$1,150 per troy ounce. Unfortunately, South Africa is the world’s highest ‘all-in’ cost major gold producer. This means that SA gold mines are amongst the first to suffer when the price falls – bad for the economy. The problem is worse for gold producers with high levels of debt (e.g. Gold Fields) that will need to funnel decreasing cash flows into making interest payments. The good news is that analysts at HSBC see a floor for gold prices around current levels. In the bigger picture though, the falling gold price is only one part of the end of the global commodity super cycle. Slowing growth in China and a shift from heavy infrastructure investment into services and a consumer driven economy means that commodity prices in general are likely to remain under pressure. This is bad news for the commodity economies of Africa (e.g. Zambia ). In order to thrive, African countries need to become more competitive, growth their industrial bases and become less reliant on mineral extraction – no small task.

(Sources: Minerals Council of Australia, Bloomberg, FT, The Economist) 

DR ANDREW LOUW CFA