Precious Metals Report: Supply and Demand Analysis on Gold and Silver

This article was written as of August 5, 2018.

This article examines the long-term demand and supply, and their future outlook of gold and silver. It also recaps the markets for these two precious metals in July and gives a forecast of August.

I. Industry Overview and the Demand and the Supply of Precious Metals

1.1 Gold

The scarcity characteristic of the gold makes it inflation-proof and value-preserving. It’s not like paper money where the United States can print as much as they want. In the past 20 years, from the beginning of 1998 to the beginning of 2018, the price of gold rose 360%.

Supply of Gold

With its limited supply, gold has a constant attraction in terms of value-preservation and growth potential, as the demand of investors increases and there are more diversified investment channels (the rise of the ETFs). According to the report from Metals Focus, the global production of gold kept reaching a record high in the past eight years (Figure 1). China becomes the biggest gold miner. In the next several years, it is expected that the quantity of gold production can maintain its current high. However, due to the following reasons, the supply of gold tends to decrease in the following ten to twenty years:

  • Over the decade, there is a decline in new gold discoveries (Figure 2).
  • There are fewer major new discoveries founded.
  • The cost of mining increases.
  • A sharp decrease in capital expenditure
  • Stricter environmental, social, and governance requirements (ESG): Many local communities and central governments cannot tolerate surface mining.
  • A long process of getting a mining permit
  • Increased political risks in some potential areas

Attention is given to whether the price of gold can reach US$1500 or higher in order to inject enough incentive for gold miners to spend more capital discovering new gold.

Figure 1. The historical production of the gold in million ounces. The colors of the bar from down to top: Others, South Africa, America, Australia, Canada, and China.

Figure 2. The new gold discoveries versus mining cost. The red bars represent the new gold discoveries in million ounces for the left axis whereas the line represents mining budget in million US$ for the right axis. The source is from S&P Global Market Intelligence.

Demand for Gold

From the demand side, the demand for gold decreases (Figure 3) since the end of the financial crisis in 2012 until the first rate hike of the Fed at the end of 2015, reflecting the fact that the rate hike cycle and global economic recovery led by the U.S. generally suppress the hedging demand for gold. Money goes to more attractive assets like stocks. However, for the upcoming 5 to 10 years, the rising inflation caused by economic growth and under the expectation that the fast-growing economies of China, India, and south-eastern Asia lead to an increase in income per capita will lead to an increase in the demand for gold.

Figure 3. The demand for gold in metric tons. Source: Metals Focus; GFMS; Thomson Reuters; Intercontinental Exchange; World Gold Council

In general, due to the following two reasons, the price of gold is expected to break through the historical high of US$1900 driven by fundamental factors:

  • The supply of gold may encounter a bottleneck, even a decline in the following ten years.
  • Steady growth in the demand for gold

1.2 Silver

In precious metals, compared to gold, silver does not have the property of reserve assets. Therefore, there is less financial value in silver, and less sensitive to changes in political and economic conditions. However, the hedging demand for silver will surge if there is a big political or economic risks. For instance, at the beginning of the 1980s, the inflation rate of the U.S. was as high as 14%, and the price of the silver reached an all-time high of US$50. Another example is that the 2011 European debt crisis caused the silver to reach 48 dollars as well.

According to the historical supply and demand statistics from the Silver Institute, it is found that the physical demand for silver is generally greater than its supplies, but this phenomenon doesn’t cause the silver price to increase gradually, indicating that hedging demand is the deterministic factor in affecting the price of silver.

Looking back at 2017, from the supply side, silver production drops for a consecutive two years due to years of cuts in capital expenditures and supply disruptions from mainly the Americas.

From the demand side, the decline in 2017 was due to the decline in demand for silver coins and bars, because investors turned to the stock market which performed better. On the other hand, the silver demand for making jewelry increased 2%, which was mainly driven by India, North America, Mexico, Vietnam, and Indonesia. With respect to the industrial demand for silver, the industrial demand related to photography keeps dropping since 1990, where there was a 3% drop in 2017.

The silver demand for the photovoltaic industry is strong: There is a 19% increase in 2017, a consecutive two years’ increase in demand. The main contribution is from the photovoltaic industry in China, Europe, and India.

Looking forward to the next five to ten years, it is expected that the supply of silver will continue to remain the same or even decline, and demand for silver will grow slightly, with factors including:

  • The growing demand for industrial production, especially the photovoltaic industry and the electric car industry
  • An increase in demand for jewelry driven by the growing number of the middle class from emerging countries.
  • Hedging demand as a result of rising inflation

It is expected for the silver price to fall within the range of 20~30 in the following decade.

Figure 4. The world supply and demand for silver in million ounces. Source: WORLD SILVER SURVEY 2018, The Silver Institute

II. Recap of the Precious Metals Market and the Future Outlook

2.1 Gold

Figure 5. Recap of gold in July. 

Figure 6. Gold compared with other assets (100 as of the beginning of July).

To recap on July, at the beginning of this month, the pullback of dollars drove the gold price up. Afterward, the gold basically performed in a bearish way with the following negative factors:

(1) Strong Economic Data

Strong economic data in the U.S. reinforced the rate hike expectation:

  • On July 12, it was announced that the CPI increased by 2.9% annually, an increase of 0.1% from the previous month.
  • On July 27, it was announced that the GDP growth rate of the second quarter in the U.S. reached 4.1%, the highest growth rate in the past four years.
  • The consumer expenditure was strong as well with an annual increase of 4%.
  • Fed chairman Powell also stated that the Federal Reserve was planning a rate hike for every quarter. For this year, it would happen again in September and December.
  • And the interest rate futures forecast showed that the probability of a rate hike in September this year jumped from 73% to 90% (Figure 7).

(2) Strong Dollars

From April this year, the US Dollar Index kept rising from 89 to 95, benefited from the rate hike expectations.

(3) CFTC Gold speculative net positions

The CFTC Gold speculative net positions decreased from 81 thousand to 48 thousand.

(4) Surging Stock Markets

As a result of strong financial statements, three major stock indexes of the U.S. continued to hit record highs, suppressing the hedging demand for gold. Though there was a bit of support for the price of gold in the second half of July due to the political and economic tensions caused by Trump:

  • After the American government opted out of the Iran nuclear deal, Trump prepared to implement a more severe sanction towards Iran, threatening their exports of crude oil.
  • The president Trump enhanced the threats of increasing tariffs on products of China.
  • The interest rate hike had been slammed by Trump, saying that the credit shouldn’t be tightened.

Figure 7. Forecast of the probability of a rate hike by interest rate futures.

On the outlook of August, the gold is expected to remain weak due to the continuing strong fundamentals of the American economy. It is believed that the rate hike of September supported by strong economic data hasn’t fully reflected on the price of gold. It is expected that the price of gold will drop in the range of 1100 to 1200, and constant attention should be given to the trade war between China and the U.S. and the political tension between Iran and the U.S. which are positive to the gold price.

2.2 Silver

Figure 8. Recap of silver in July. 

To recap on July, the price of silver moved more or less the same as gold. However, the price of silver dropped more than gold (-2.2% vs -1.4%), indicating that the volatility of silver is bigger than the gold. At the beginning of the month, the rising dollars pushed the price of silver down. Afterward, due to the fact that the strong economic data of the U.S. reinforced the rate hike expectation, the bullish stock market, and the US Dollar Index continued to stay at a high level, the demand for silver was suppressed, pushing the price down to $15. The CFTC Silver speculative net positions dropped from 24 thousand to 3 thousand as well (Figure 9).

Then the silver was in a mean-reversion state at a low level due to the tensions between the U.S. and Iran.

On the outlook of August, under the expectation of the strong economies of the U.S. and a rate hike, the price of silver may still be under pressure. Also, major silver-related stocks like Pan American Silver and Hecla Mining were bearish in the near month. It is expected that the price of silver will drop down to a range of 14 to 15 in August.

Figure 9. CFTC Silver speculative net positions. 

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