March/April 1997
Though most precious metal markets had a disappointing 1996, world fundamentals and investment opportunities seem to point to better times ahead for gold, silver, and platinum-group metals this year and beyond.
By Kent Kiser
Kent Kiser is Editor of Scrap.
What a difference a year can make, especially when you’re talking about the precious metal markets in 1996.
Most precious metals began last year with bullish expectations, with gold trading above $415 per troy ounce (t.o.)—a 5 1/2-year high—on both the LME and Comex in early February. Silver and platinum, meanwhile, rose above $5.80 and $434 per t.o., respectively, on Comex that same month. Two factors were underpinning these price increases: investment and hedge fund buying and statistical evidence that reportedly indicated that new supplies of precious metal would fall well short of anticipated demand.
Since February 1996, however, the markets for most precious metals have headed south to the point where gold sunk to a 3 1/4-year low of $352.45 per t.o. in January 1997, while silver and platinum declined to around $4.70 and $362 per t.o., respectively. These decreases, which have occurred despite positive supply-demand fundamentals, have been attributed to gold sales by the central banks of the largest industrialized nations, as well as shifting investor interest from precious metals to other investment vehicles, especially the exceptionally strong U.S. stock market.
The bottom line was that precious metals lost their luster in 1996 and have entered 1997 on a bearish foot. The burning questions this year are whether precious metals are now undervalued and whether a fresh demand—and, hence, price—rally is in sight?
Five precious metal executives addressed those and other questions at ISRI’s precious metals roundtable, held in New York City in December. Here’s what they had to say.
Gold Waits for a Revival
When examining gold market fundamentals, analysts usually focus on mine production and other supplies, followed by fabrication demand and official, or central bank, transactions, noted Joseph Rosta, research director for CPM Group (New York City). In many cases, investment demand is treated as a footnote or dummy variable, the residual of total supply, less fabrication demand, and adjusted for changes in central bank inventories.
This is the wrong approach, Rosta said. The truth is that, even though investment demand represents only a small segment of the gold market in terms of ounces, it is “the single most important variable in gold’s supply and demand fundamentals.” The virtual absence of investor demand for physical gold, in fact, is what has kept gold drifting between $370 and $400 per t.o. for most of the past three years, continuing a contraction that traces back some seven years. “It will take a change in investor attitudes to move gold prices out of these latitudes in the future,” he said.
Even with a projected increase in investment demand from 2.2 million t.o. in 1996 to an estimated 3.9 million t.o. this year, overall investment demand is expected to remain “extremely low” compared with earlier years, Rosta said.
As for supply fundamentals, mine production, as the largest component of gold supply, was estimated to grow 1 percent in 1996 to 60.5 million t.o. and increase 2.4 percent to around 62 million t.o. this year, Rosta noted. Total gold supply—encompassing mine production, net exports from transitional economies, and scrap—was expected to rise 4.2 percent in 1996 to 89 million t.o. and a slower 2.2 percent in 1997 to 91 million t.o., with the largest supply increase coming from the recovery of gold from scrap, he said.
Turning to consumption, Rosta noted that physical demand for gold in bullion and coin form is at its lowest level since the early 1970s. Total fabrication demand was forecast to rise 5.3 percent to 96.8 million t.o. last year, yet exhibit a slower rate of growth of 0.3 percent in 1997, reaching an estimated 97.1 million t.o. While that demand will technically outstrip the projected total gold supplies of 91 million t.o., creating a statistical shortfall of more than 6 million t.o., this gap will be more than filled by central bank gold sales. According to Rosta, the “official sector” is projected to continue to be a net seller of around 10 million t.o. this year. In January, for instance, the Dutch Central Bank announced that it had sold 300 mt of gold, or about 20 percent of its reserves.
On gold price dynamics, Rosta noted that gold prices have moved in a tight range for the past three years, adding that this range has been contracting for most of the past seven years. In addition, the volatility of gold prices has fallen to the low levels seen in 1991 and 1992.
What could these dynamics mean for gold prices this year? Rosta was coy in his predictions, simply recalling that similar market dynamics in 1993 squeezed gold market liquidity to such low levels that prices shot up 11.4 percent to $392 per t.o. He also said that some investors are “watching the freight train that is the equities market with some trepidation,” suggesting that “the Dow Jones Industrial Average and other major indices seem long overdue for a major technical correction.”
A Silver Lining for Silver?
As with gold, silver saw its fortunes head steadily downward throughout last year, with much of its price decline being attributed to short selling, Rosta said. This period of lower prices, however, “cannot last for long,” he asserted, offering that silver prices could rise to much higher levels—at least up to $7 to $8 per t.o.—in the next 12 to 36 months. This revival could be driven by a number of factors, including a steep drop in stock market prices, a continued drawdown of silver inventories, and/or waves of heavy speculative buying.
In addition, the silver market continues to exhibit healthy fundamentals that suggest higher prices in the near term. According to Rosta, industrial demand for silver continues to outpace newly refined metal. With total 1997 silver supplies projected to reach 587.2 million t.o. and demand expected to total 727.6 million t.o., the market’s supply-demand gap could reach 140 million t.o. this year, he reported.
While admitting that large above-ground inventories exist—totaling 780 million to 920 million t.o., according to CPM Group estimates—Rosta asserted that the actual amount of what he termed “market-available” silver stocks may not be anywhere near what others have long assumed.
In summary, he said, “strong fundamentals underpin our projections for higher prices in the next few years.”
A New Wave of Mining Investment
In a review of the precious metal mining industry—and specifically the growing investment interest in the field—Victor Flores, executive vice president of U.S. Global Investors Inc. (San Antonio), asserted that the industry has “gone global in a big way in the past five years.” Whereas Canada, the United States, and South Africa were the focus of precious metal—particularly gold—mining before, now the business is much more international, with exploration turning to more varied and more specialized areas such as Ghana, Brazil, Peru, and other countries. What this means is that “gold will be coming from more and different places than in the past,” Flores said.
As an anecdote to illustrate the changes occurring in the industry, he told the story of Arequipa Resources Ltd., a little-known Peruvian gold deposit. Following financing and encouraging drilling results, the firm’s stock on the Toronto Stock Exchange rose from 25 cents to $6 a share, catching the attention of Barrick Gold Corp., a major Toronto-based producer. Barrick ultimately paid $30 a share—around $814 million—for Arequipa. The end result, Flores noted, was that the Arequipa venture “made a lot of money for its funds and shareholders.”
The Arequipa example shows how quickly and efficiently investment capital can move in the international market, and its success—along with other profitable mining startups—has made it easier for new companies to secure capital to pursue exploration and mining ventures, Flores explained.
While this wave of investment support is encouraging, it has also created “great pressure on mining companies to deliver dividend growth to their shareholders,” Flores contended. This pressure has prompted large producers such as Barrick Gold to aggressively pursue mergers and acquisitions of other mining concerns, causing a general trend of consolidation in the industry.
In the longer term, Flores concluded, the expanded investment interest in the mining industry will not only result in more gold being mined—“there will be no lack of gold, that’s for sure”—but will also encourage additional financing of mining properties despite today’s “languishing” gold prices.
Palladium’s Picture
Picking up the mining vein, J. Michael Sharratt, vice chairman of Stillwater Mining Co. (Denver), reviewed the operations of the Stillwater palladium, platinum, and rhodium mine, mill, smelter, and refinery complex near Billings, Mont., noting that it is the only U.S. palladium mine in operation today.
The underground mine sends 1,000 tons a day of ore to its mill, with the processed ore being smelted and refined at the firm’s operation in nearby Columbus, Mont., Sharratt explained.
Though primarily a mining operation, he noted, Stillwater also consumes about 3 tons a day of spent platinum-group metal-containing catalysts from automotive and petroleum reforming operations.
The complex is currently undergoing an expansion that, by early 1998, will double its capacity to 2,000 tons of ore a day and 5 tons a day of scrap, with the potential to handle 10 tons a day of scrap later, Sharratt reported.
Offering a quick look at the palladium market picture, Sharratt was optimistic about the longer-term demand prospects for the metal, based primarily on platinum-group metal-containing automotive catalysts for which, he said, “there is no real substitute.”
On the price issue, however, a “general industry slowdown,” especially in sales to the electronics industry, and the sale of 2 million t.o. of Russian stockpiled palladium to the West kept prices down in 1996, Sharratt said. The extent of market recovery in 1997 will depend largely on the level of existing Russian-origin material earmarked for export, he summed up.
What Does a Depository Do?
While precious metal depositories are certainly in the business of storing material for customers, they are “much more than a storage or vaulting service,” said Jonathan E. Potts, vice president of the precious metals services division of Wilmington Trust Co. (Wilmington, Del.), which operates a depository for more than 600 different product forms of silver, gold, and platinum-group metals, from 400- and 1,000-t.o. gold and silver bars to containers of rhodium sponge.
According to Potts, storage is “the least of what depositories do,” asserting that their main purpose is to serve as efficient trading and distribution centers. “We’re in the business of moving metal in and out.”
When a depository is used simply for safekeeping, that service represents a cost to the customer, Potts said, noting that depositories also provide other services that are moneymakers for customers. “We help them generate revenues, and that’s what we’re really all about,” he stated.
Among their non-storage services, depositories offer accounting, inventory control and deployment, delivery (including fulfilling just-in-time arrangements), customs clearing for international shipments, and more for a wide variety of customers, including producers, brokers/traders, investors, smelters, refiners, manufacturers, mints, banks, and exchanges. In short, Potts noted, depositories serve as facilitators, linking clients with their customers.
Depositories also offer their customers the benefits of confidentiality, potential tax advantages, and reduced credit exposure and security costs, Potts said.
Thinking Globally, Acting Locally
A comprehensive perspective on precious metal scrap marketing around the globe was provided by Robert Bullen-Smith, sales and marketing manager for the precious metals division of Johnson Matthey (West Deptford, N.J.).
In his view, Johnson Matthey’s “personal approach” to scrap recovery ultimately enhances its end-product business around the world. This approach, which jibes with the popular slogan to “think globally, act locally,” is based in large part on forging long-term relationships with its scrap suppliers.
Johnson Matthey is concentrating its scrap-securing efforts in North America, Western Europe, Latin America, and Asia, he said, noting that each region is distinctly different in its infrastructure and environmental considerations. Consequently, each region requires a different approach between what he termed “direct” services with scrap generators and a more “indirect” approach to potential scrap suppliers through non-Johnson Matthey “facilitators.”
In the United States, for example, with its well-established scrap recovery infrastructure, the company works closely and directly with scrap-related sectors such as collectors and refiners, while it works indirectly with the petroleum, petrochemical, electronics, and jewelry industries.
In Western Europe, Johnson Matthey takes a more direct route to all collection and consuming markets using local company personnel. This, Bullen-Smith pointed out, contrasts with Latin America, where the firm relies on agents for its scrap supplies. Government regulations and trade barriers are the main obstacles it faces in that part of the world, he noted.
As for Asia, there is “no real established infrastructure we’re comfortable with,” except in Japan, Bullen-Smith said. Among the remaining Asian nations, China possesses the largest market potential, but it currently has a developing infrastructure and requires companies that buy and/or sell precious metals to be licensed by the government. Johnson Matthey continues to develop a strategy for dealing with China and has thus far established offices in Shanghai and Guangdong. “Market research continues,” he concluded. •
Though most precious metal markets had a disappointing 1996, world fundamentals and investment opportunities seem to point to better times ahead for gold, silver, and platinum-group metals this year and beyond.