Funds flow drives gold price to 25-year highs

Gold for immediate delivery reached as high as $575.35/oz last week. Higher inflation expectations, geo-political uncertainty, concerns of future dollar weakness, along with the talk of Central Bank buying gold for reserves and the general investor interest in commodities have pushed gold prices to its highest level in 25 years.   

Hedge funds and commodity trading advisors (CTAs) have been aggressively purchasing gold as of late. We think that macro funds now view gold as an alternative "currency" and that the trade is to remain net long gold (and a basket of currencies) offset by a short position in the dollar. 

This explains the strong negative correlation between the trade-weighted dollar index and the US denominated gold price. Note that gold prices collapsed in 1996 just as the dollar index strengthened, reflecting capital flows into US-denominated assets. But since bottoming in 2001, the gold price began to move higher in response to aggressive Fed easing and dollar devaluation.

In addition, gold-backed exchange traded funds (ETFs), like those listed on NYSE (as GLD) or on Amex (as IAU), are gaining popularity. It is estimated that about nine million ounces of gold, having a market value of $ 5 billion (assuming average gold price of $550/oz), have been invested in these products. 

Furthermore, the hedge funds and CTAs continue to push gold higher with net long position on Comex futures contracts reaching a record of 17.7 million ounces in October 2005. All these, combined with petro-dollars being converted into gold in the Middle East, have helped propel gold prices into higher territory.

Global supply not keeping up with rising demand

The major industry consolidation currently happening among senior tier companies is a direct consequence of the lack of quality projects to spur growth. Barrick Gold’ recent purchase of Placer Dome to create a global gold giant is a testament to this. While exploration spending is rising, there are no material new gold discoveries. 

As you can see from the following table, mine production peaked in 2001. Production declined and is expected to continue to fall in the absence of new technology that will replace the heap leaching "revolution" which boosted gold production growth rate in the 1980s. 

The lack of significant new world-class discoveries in established mining districts highlights the consequences of gold reserve depletion. It is an open secret in the mining sector that high gold prices tend to depress mines’ grades and thus, production.

GFMS World Gold Supply and Demand Source: GFMS Gold Survey 2005 Update 2

Meanwhile, the continuation of strong fabrication demand in India and China has also supported gold prices. Both countries have rising income and urban wealth. On one hand, India has just liberalized its gold environment which was previously under heavy duties and taxes. China, on the other hand, is now deregulating its gold market where previously its 1.3 billion inhabitants were restricted for almost three decades from owning gold. 

Also interesting to note is that in spite of official sector sales (from central banks) rising to a record 660 tons, gold prices continued to go higher – a clear testament that global supply is not keeping up with rising demand from jewelry demand and investor interest.

The current state of Philippine mining

For a country known to have the 5th largest gold and copper reserves in the world, the Philippines has not yet taken advantage of the secular bull-run in the commodities market that started as early as 2001. The last time such a run-up happened (1976-1980), mining accounted for over 20 percent of the country’ exports. During the last five years, it accounted for less than two percent of exports.

In December 2004, however, the Philippine mining industry caught a breath of fresh air when the Supreme Court upheld the Mining Act of 1995. This effectively allowed foreign mining firms to obtain exploration and mineral processing permits through Financial and Technical Assistance Agreements (FTAAs) where they can now own 100 percent of a mining project. 

As a result, investments quickly poured in and are projected to reach as much as $6.5 billion over the next five years. The Philippines is strategically located in the so-called Pacific ‘ring of fire’ which is known to be mineral-rich. The National Economic and Development Authority (NEDA) estimates that the current value of identified mineral deposits in the Philippines is around $90 billion, with a potential to reach $ 840 billion if exploration activities are undertaken.

But just as the momentum is picking up with about $1.5 billion lined up for this year, it recently hit a snag following a mishap in Rapu-rapu mine in Albay. Some sectors of the church and special interest groups have become vocal against mining in general, in reaction to the problems in Rapu-rapu. 

The government responded by issuing a moratorium on mining permits in Albay province but reassured investors in a statement over the weekend that it is in "full support for responsible mining which is both pro-environment and pro-growth."

Revitalizing Philippine mining = enforcing standards + information campaign

We concur with the government’ response and view the mishap in Albay as an isolated case which should not be generalized. However, we also recognize the valid and continuing concerns regarding the environment, livelihood, health and general social welfare of the communities surrounding the projects. 

We are also conscious that the growing NGO opposition to mining is not only present here in the Philippines but also everywhere in the world. We therefore encourage mining companies to do a better job of articulating the benefits – both economic and social – that new mining projects bring to local communities.

Lastly, we urge the government to continue having a proactive approach on mining. This includes not only monitoring and enforcing strict compliance to environmental and social impact standards but also promoting dialogue and information exchange within civil society, private sector and government partnerships. The government, for example, may undertake regional and national forums to discuss responsible mining with stakeholders. They could also form a high-level commission to address mining issues at a national level where participants include the government, the Catholic Church, local universities and NGOs. 

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