The Gold Report: Rohit, in a recent interview you said gold is "not a guaranteed safe haven." In your view, what are effective ways to preserve capital?
Rohit Savant: If you're talking about preserving capital, it depends a great extent on your timeframe and your risk appetite.
"When the fiscal cliff debate intensifies as we get closer to the deadline, we may see the gold price rise in response."
If you're looking at the short term and want no fluctuations in your principal, the best way to preserve it would be either certificates of deposit or T-bills and hope that inflation doesn't rise significantly.
But if you are looking at the longer term and are willing to take some ups and downs in your capital, a better way of preserving or increasing your capital would be investments in equities, real estate and gold. You could reduce the risk a bit by purchasing dividend-paying equities.
TGR: Do you believe gold is an effective way to preserve capital?
RS: Over the long term, it is. In the short term, you are going to see fluctuations in prices.
TGR: What range do you expect gold to trade in through the first half of 2013?
RS: We expect it to stay more or less in the same range that it did this year, probably between $1,550-1,800/ounce (oz) for the first half of 2013.
TGR: Are you seeing a similar path for silver?
RS: In the case of silver, we have a more bearish view. One reason is that silver prices are going to be negatively affected by increases in supply. Today silver prices are significantly higher than the average cash cost for producing silver. So we expect that a lot of fresh supply will come onstream.
Another reason is expected lower investor interest. Silver tends to be more volatile than gold, so you might see sharper declines in prices with lower investment demand.
TGR: Does that mean you prefer gold to silver right now?
RS: At this point, we definitely see gold as a better investment than silver. We don't expect any significant increases in gold prices, but we don't think that gold prices will decline substantially from where they've been this year.
TGR: Is there a possibility that 2013 will be the first year in the last 12 when the gold price finishes the year lower than when it started?
RS: Yes, it will likely be the first year to end in a lower price in over a decade.
TGR: If you met a goldbug who is unabashedly bullish on the gold price and he challenged your price position on gold, how would you respond to that person?
RS: We face this situation quite often because our view on gold has not been as bullish as a lot of other market participants. Our response to them is that we think a lot of the factors that are being cited as reasons for gold prices going up are already factored into the price of gold.
"Central banks have been doing pretty much what we expect private investors to do, which is wait for gold prices to soften before they step in as buyers."
For instance, there are a lot of problems with the global economy. We're not denying that. We are just saying that these are problems that have been known now for several years and have already been factored into the price of gold. So gold prices won't skyrocket. But on the other hand, the global problems are a reason we think that gold prices will not decline sharply either.
TGR: In early December, we saw commodities including gold and silver sold off in response to concerns regarding America's "fiscal cliff." In your view, what are the three biggest downside risks to gold right now?
RS: The biggest risk to gold would be that investors lose interest. But we don't think that investors will lose interest, central banks will stop buying gold, or there will be a sudden increase in the supply of gold. These could all be potential downside risks. That said, we do not expect that any of these risks will materialize in 2013 or the near future.
The biggest risk for us is not so much that prices would go down, but that they won't rise substantially. We don't see a sharp decline in gold prices going forward. We don't see gold going up much. We see a sideways to potentially slightly lower range, but nothing significant.
TGR: What about the fiscal cliff itself? Is that a concern for the gold price?
RS: When the fiscal cliff debate intensifies as we get closer to the deadline, we may see the gold price rise in response. So the fiscal cliff could be positive for gold prices during December. I think the slight softness that we're seeing in gold prices recently is really the market—investors holding off to see if prices could decline further. Gold could potentially go down to around $1,680/oz and get some support at that level. Then you might see some investors coming back, buying gold in response to the fiscal cliff issue. Once in 2013, whatever the outcome of the fiscal cliff, it would result in softening of economic growth, which would weigh on gold prices during the first half of next year.
TGR: The World Gold Council (WGC) reports that the Indian market is showing signs of recovery in gold demand, up 9% to 223.1 tons from 204.8 tons in the third quarter of 2011. The WGC press release reads, "Indians appear to have acclimatized to recent price trends and have been buying into a rising market." What's behind that change in sentiment and do you believe it's likely to continue in 2013?
RS: The buying of gold for Indians is very deeply engrained in the culture. When a festival is coming up, or if it is marriage season, Indians are going to buy gold. It's highly unlikely that they would refrain from buying gold because of higher gold prices.
TGR: But they have cut back purchases in the past.
RS: The increase in demand in the third quarter, in a rising price environment, may have occurred because of pent-up demand. Demand from the first half of the year had been cut back by various factors.
Indians may buy a smaller amount of gold per person if the price goes up. But they're not likely to stop buying gold just because the price has increased. The demand is going to be there.
TGR: China is another culture where gold is much more prevalent in the lives of people than it is in the West. The Wall Street Journal reported this week that China, for the first time ever, will allow interbank gold trading with Shanghai as a major gold trading center. Do you expect that to have any impact on investment demand?
RS: That is something that would increase investment demand, in that China is trying to open up its markets. It's all part of China liberalizing its financial markets.
TGR: Another report says Deutsche Bank is predicting gold will rise above $2,200/oz in 2013. Part of the reason is that it believes China eventually wants the yuan to challenge the U.S. dollar as the world's reserve currency.
To do that the Chinese Central Bank is going to need to buy more gold in a big way. Right now it's currently ranked sixth in total gold reserves, at least the reported gold reserves. Does that strike you as a credible thesis or is that something that you believe is still a long way off?
RS: I'm not sure that China would want its currency to be used as a reserve currency because that would inherently push up the value, which would in turn hurt the country's exports. I don't believe it's going to happen over the next several years. It will take a number of years for any currency to challenge the U.S. dollar.
"The PGMs definitely have some promising fundamentals."
I believe the gold that China holds right now is about 1.8% or 2% of the total reserves. As for buying gold, the Chinese Central Bank does not release that information quickly. The last time it bought gold, nothing was said about it until a few years later. It could be buying gold right now and we won't know about it until China discloses that information.
I think that central bank buying is price supportive, but I don't believe that it's something that would push gold prices sharply higher. Central banks have been doing pretty much what we expect private investors to do, which is wait for gold prices to soften before they step in as buyers.
We saw that this year in March when gold prices came down. Central banks added on a net basis 2.3 million ounces (Moz) of gold to their holdings. Central banks followed the same logic again in July, when gold prices were moving sideways at the lower end of the range for 2012, adding 2.95 Moz of gold to their holdings on a net basis. This was the largest net purchase of gold by central banks for 2012.
Bottom line, central banks are not buying gold when prices are going up. Therefore, the impact of central bank gold buying is more likely to be price supportive than price positive.
TGR: At investment conferences across North America, senior gold producers are routinely making presentations about why their companies are better investments than gold exchange-traded funds (ETFs). Much of their arguments are based on the idea that gold ETFs own far less gold than they claim. What's your view?
RS: The gold that ETFs own is publicly disclosed and transparent, so I'm not sure how companies can make that claim. As far as talking up investing in their companies, that's their job—they're supposed to get investors interested in owning their stocks.
TGR: Does CPM have any analysis on ETFs versus senior gold producers? Performance-related data comparing those two?
RS: We haven't done any specific analysis. But gold ETFs basically track the gold price, so it's really a question of whether you are invested in physical gold or whether you want to invest in equities.
Equities do have the advantage of performing better for the most part over the long term. But in recent months, we've actually seen gold equities get slammed for various reasons. One of the biggest reasons is that their costs are getting out of hand.
TGR: If the gold price remains range bound near current levels, does that make gold producers more appealing?
RS: Only if gold producers are able to control their costs. If producers can prove to the markets that they can control costs, then equities would be a good investment compared to gold. Also, if gold prices remain range bound, and that prompts miners to shift their focus to higher-grade gold, that could potentially reduce costs and again make them more attractive as an investment. So it depends on how the mining companies deal with it. If they let their costs escalate and the price of gold stays sideways, their margins will get squeezed, so that will make them a bad investment.
TGR: Is there is a particular jurisdiction or jurisdictions that CPM Group sees as being more appealing for gold production?
RS: For gold production, there is a jurisdiction that is not appealing. South Africa is not very appealing at this point. The atmosphere surrounding the mining industry in South Africa at the moment is pretty complicated.
A lot of factors are at play. The country has deep-level mining, which makes it difficult for miners to control costs. You also have additional problems related to labor and infrastructure and government policies. All of those things collectively make South Africa a fairly difficult environment to mine in.
TGR: Is your near-term forecast for other precious metals like platinum, palladium and rhodium more encouraging than it is for gold and certainly for silver?
RS: The PGMs definitely have some promising fundamentals. The supply side is constrained because a lot of supply comes from South Africa. Those mines are facing the same problems as the gold mining industry in that country. So the potential is there for supply to possibly decline.
Then you have the fabrication demand side where there is little substitution for PGMs. For example, in the case of auto catalysts, any other combination of metals used would not reduce emissions at the same level of efficiency as the PGMs do. So you have expectations of heavy fabrication demand and the potential for constraint supplies that are both supportive and positive for the PGMs.
TGR: What advice can you give to precious metals investors in general that they can put to good use in 2013?
RS: It's about doing your homework. When you're looking at equities, you need to look at a number of factors besides metal prices. For example, investors need to look at the management, specific country risk, and within country risk you have government policies, infrastructure. There's also the mining grades of the deposits and the costs to get the metal out of the ground. Costs are especially important to pay attention to in the current environment where mining cash costs almost across the board are rising pretty substantially.
TGR: Are you predicting cash costs among gold miners are going to rise in 2013?
RS: We do think gold mining cash costs will continue to rise. One of the problems is the rising gold price itself. That has been encouraging miners to mine lower-grade ore, which in turn pushes cash costs up. Another problem is mining regions, such as South Africa, where all these other additional factors are pushing cash costs up. So, yes, we do think the costs for gold mining will continue to rise in 2013.
We have data going through the second quarter of this year. What we saw is a peak in the profit margins in mid-2011 when gold prices were high. What we saw in the second half of 2011 and the first half of 2012 is the slight decline in gold prices and a continued increase in the costs. So companies' profit margins got squeezed. We think this will continue if mining companies don't curb their cost increases. This is the biggest problem or threat to the gold mining industry.
TGR: What are the biggest inputs into those rising costs for miners?
RS: The biggest input cost is labor, which represents about 50% of total cash costs for gold mining. We keep hearing of strikes and shut downs and those kind of problems. That is not good for the largest component of costs, labor. Fuel, for instance, only accounts for about 8% to 9% of costs. And about the same amount for utility costs, such as electricity and water.
TGR: Were fuel costs 8% or 9% five years ago or were they a smaller percentage? It's a number in a vacuum otherwise.
RS: Fuel costs were a little bit less than 8% or 9% five years ago. Fuel costs haven't been the biggest issue for cash costs. It's labor costs. The inflation in labor costs is what's pushing up the whole cash cost curve.
TGR: Are there any parting thoughts you have for our readers?
RS: A lot of times our gold outlook comes out sounding bearish when it's not. I just want to say that we do think gold prices will stay high. We just don't think that they're going to skyrocket.
TGR: Where was CPM Group in its forecast for 2012?
RS: We had an annual average of $1,620/oz at the beginning of the year. The average price for gold so far in 2012 is about $1,670/oz. So we were lower than the average. We did do well compared to 85–90% of the other analysts whose price forecasts are way, way higher.
TGR: Thanks for your insights.
Rohit Savant is a senior commodity analyst at CPM Group and joined CPM Group in 2005. Savant is the lead analyst for CPM Group's Precious Metals Long-Term Market Outlooks, Precious Metals Yearbooks and Precious Metals Advisory. These publications include in-depth analysis on gold, silver, platinum, palladium and rhodium markets. Savant provides consulting services for all of the precious metals on an ongoing basis to various hedge funds, individual traders, producers and end users.
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