IN the classic 1964 James Bond film Goldfinger, the villain hatches a dastardly plan to corner the world bullion market. If he were around today, he might well decide to drop the scheme and concentrate instead on counting his wealth — the price of gold has surged from $250 a troy ounce in 2001 to a peak of $574 this month.
And, anyway, what would be the point of cornering the market? The increasingly exuberant upswing in the price of gold — and other precious metals — in the past four years seems to have become a self-fulfilling prophecy.
Rhona O’Connell at GFMS Analytics, a gold-market research firm, said: “The higher precious-metals prices have risen, the more demand has been generated from investors and speculators. You might expect extra supply to appear to meet this demand, but the lack of spending on exploration in the late 1990s means it will be some time before substantial new mine supply comes on stream.”
No market moves in a straight line, and the gold price has fallen $35, or 7%, in the past fortnight — as slightly weaker jewellery sales coincided with speculative excess and the start of the traditional February-May lull in demand.
However, the underlying figures, according to GFMS, show production around the world has been about 2,500 tonnes in every year from 2002 to 2005, while demand has increased from 3,355 tonnes in 2002 to almost 4,000 tonnes last year.
Where is this extra demand coming from? Answer No1 takes us to an ultra-high-security cellar, belonging to the banking giant HSBC, at a secret location in London. In its vaults are piling up the gold bars purchased by Exchange Traded Gold, the world’s biggest exchange-traded fund (ETF) for the yellow metal, marketed to British investors under the name Lyxor Gold Bullion Securities.
This ETF is listed on the stock market, and allows institutional and private investors to get exposure to the gold price, without actually having to take delivery of any bullion. The gold is held by the fund, while investors get ETF shares.
Exchange Traded Gold held $7.6 billion (£4.4 billion) worth of gold by the middle of February — equivalent to 431 tonnes. This is more than the Bank of England’s reserves, which are now a shrunken 311 tonnes, after Gordon Brown’s controversial gold sales in 1999.
O’Connell reckons ETFs have been very influential in the gold price’s 23%, or $100, surge in the past six months.
“The underlying physical demand for gold from jewellers and others runs at about 3,500 tonnes a year. Investor demand for ETFs has led to those funds buying more than 200 tonnes in the past six months — equivalent to a 10%-15% increase in physical demand,” she said.
In Britain, roughly a quarter of the demand for the Lyxor ETF has come from institutional investors, another quarter from wealthy individual investors and 14% from market professionals and active traders.
Answer No 2 takes us to the noisy trading floor of the New York Mercantile Exchange’s Comex division, the world’s biggest exchange for gold, silver, platinum and palladium futures.
The number of gold futures contracts traded on Comex in 2005 was a record 15.9m — worth a theoretical $800 billion — up from 15m in 2004, 12.2m in 2003 and 6.6m in 2000.
Kevin Grady, a gold trader with Man Financial, has been working in the trading pit at Comex for 22 years.
Whenever gold breaks through a key level, such as $500 late last year, there is a loud cheer across the pit. “But the cheer tends to be short-lived, because a break like that tends to lead to chaos as everyone wants to trade,” said Grady.
The rise in trading volumes on Comex has been due partly to individual speculators, feeding off the volatility in precious metals. Grady said: “The dynamic has changed — it is no longer just hedge funds and commodity trading advisers on one side, and central banks and producers on the other.”
An echo of this in Britain is provided by spread betting, which many investors use to speculate on every financial market from the FTSE index to the price of gold, silver and oil.
Will Armitage, a dealer at IG Index, said the majority of his customers have been bullish on gold this winter: “Some people take very large positions, equivalent to an exposure of £500,000 to the gold price, but there are also a lot of very small bets.”
One of IG’s clients is “Adam”. A member of one of the professions, he bets on gold by mobile phone in his spare time. “The gold price seems to be on an upward trend, taking two steps forward then one back. I normally open a position when gold takes one of those steps back.” Adam said he had four large bets open, the largest a stake of £500 for every dollar move in the gold price.
Answer No 3 takes us to Dubai, and to ATS Bullion, a seller of gold coins and bars in Southampton Row, London.
Colin Griffith, chairman of the Dubai Gold and Commodities Exchange, said: “There are 300 gold stores in the souk. Jewellers make up the majority but there are places that sell coins and gold bars, mainly the one kilo bar or the 100 gram bar.”
At ATS in London, managing director Sandra Conway said: “Our turnover is up 100% in a couple of months. In 20 years in this business, I have never seen so many private individuals involved. The average purchase is $5,000 to $10,000, with the occasional one of $250,000 to $500,000,” she said.
Answer No 4 takes us to the jewellery shops of Shanghai and Mumbai. Jill Leyland, economic adviser for the World Gold Council, said: “In the fast-growing economies of Asia and the Middle East, there are sophisticated jewellery buyers, and until a couple of years ago they weren’t being offered quite the right product.
“In China, traditional gold is 24 carat, yellow gold with an ornate or fussy design. It was sold at a very small margin, so retailers were more interested in pushing diamond and platinum items. The solution was to use 18 carat gold, re-brand it as “K-gold” — in white or yellow — add Italian-inspired design, and sell it at a fixed price, leaving retailers happier. It has been a tremendous success.”
Figures from the World Gold Council show that gold jewellery sales to China were 231 tonnes in 2003 but were heading for a total of some 285 tonnes in 2005. Sales to India were heading for at least 650 tonnes in 2005, compared with 440 tonnes in 2003 — a rise equivalent to nearly 10% of annual world production.
Our final source of the extra demand for gold is to be found in the boardrooms of the big institutional investors in London, New York and Europe.
Graham Birch, manager for Merrill Lynch Gold & General and for his firm’s even larger Luxembourg-based fund, is arguably the world’s biggest and most influential investor.
Birch said: “Our regulators do not permit us to invest direct in gold, but we do have a little of the Lyxor exchange-traded fund. This makes up some 3% of the Gold & General fund, equivalent to us holding two tonnes of gold.”
The bulk of the £855m Gold & General fund is in gold-mining shares. Birch and his colleagues achieved their market pre-eminence by persevering with gold when precious metals were unloved in the late 1990s. “We stuck with it, a lot of our competitors did not,” he said.
“Institutions are looking at diversifying their portfolios: Hermes, for instance, recently put £1 billion into commodities on behalf of the BT pension fund. Where they tread, others will follow.”
And supply can prove sticky as projects take years to mature.
In the first three-quarters of 2005, the world’s gold-mining companies are estimated to have produced only 1% more than in the same period of 2004.
Leyland at the World Gold Council said: “Exploration for gold has picked up in the last couple of years, but there is a very long time lag. Feasibility studies, environmental-impact reports and the rest can mean it is 10 years before anything comes on stream.”
Ian Watson, chairman of Galahad Gold, a mining firm listed on London’s Alternative Investment Market and valued at £80m, said that the original exploration for his firm’s Pebble project in Alaska took place as far back as the late 1990s.
“We have been doing environmental-permit work for two years, at a cost of $40m and using 25 consultancy companies. We expect Pebble to be in production around 2010-11.”
There is no shortage of companies trying to mine precious metals — AIM is awash with nearly 30 would-be producers, from African Platinum to Patagonia Gold. The latest newcomer is likely to be Galantas Gold, hoping to extract gold from a prospect in Northern Ireland.
Meanwhile, the other traditional sellers of gold — the central banks of the West — are unlikely to have released in 2005 more than the 617 tonnes they sold in 2003.
Conspiracy theorists argue that, in fact, emerging-economy central banks are likely to be buying gold, not selling it. Argentina and Russia have hinted at this, and China, with a monstrous $819 billion in foreign-exchange reserves, would have to buy some 340 tonnes of gold to get the proportion of reserves held in bullion up to its traditional figure of 2%.
Then there is Iran, one of the few countries whose central bank does not submit regular figures on its reserves to the International Monetary Fund.
Birch at Merrill said: “The Iranians are a particularly good candidate to be buying gold — here we have a country that is involved in a political dispute with America over nuclear research, and the likelihood is that this will escalate, with sanctions coming in.”
So is there no chance of more gold coming onto the market and cooling the price? At the margins, unusual projects may come up with some gold: there is now interest in a number of shipwrecks around the world — notably in HMS Sussex, which sank in 1694 off the Spanish coast, with 10 tonnes of bullion on board (worth $174m at today’s prices).
The best candidate for boosting the supply of gold, however, is hedging. One gold industry insider said: “If producers decide to lock in current prices for their future output, it causes their counterparties to hedge themselves by borrowing extra gold and releasing it into the market.
“Recently, producers have been reducing their hedging activity as the gold price has risen, and this has added impetus to the price increase. However, this de-hedging process cannot go on forever and when it ceases one upward pressure will disappear.”
If so, it would be a blow to investor hopes that gold might return to, or surpass, its 1980 record of $860 a troy ounce.
