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September 6, 2010Global Economics & FI/FX Research
Commodity Outlook
UniCredit Research
page 1
See last pages for disclaimer.
Goldheading towards USD1,600
The Fed's decision to reinvest the proceeds from maturing and prepaidagency debt and MBS in longer-term Treasuries and to continue rollingover its holdings of Treasury securities as they mature has eliminated theslight tightening bias of US monetary policy.
Thus far, it is not yet clear whether this will now also result in alengthening of the Fed balance sheet. In the past, however, the goldmarketreacted extremely positively to a monetization of governmentdebt.
In the second quarter of 2010, demand for gold measured in tonsincreased by 34% yoy. On a USD basis, a new record was even postedfor the quarter. The reason for this is the surge in investor demandtriggered by the Fed decision and the renewed widening of CDS spreadsin Europe.
In the interim, a growing number of Chinese investors is also discoveringthe gold market. Although China has advanced in recent years tobecome the world’s largest gold producer, its annual production of mostrecently 330 tonsis by no means sufficient to satisfy this demand.
Hence, China announced key gold market reforms at the beginning of August. Foreign companies are now permitted to offer their gold coins atthe Shanghai Exchange, and more banksare permitted to import goldfrom abroad. The Chinese demand will now increasingly be felt on theglobal markets.
We are, therefore, raising our target price for 2011 from USD 1,250 toUSD1,400 per troy ounce. For 2012,we now expect USD 1,600 per troyounce (in each case calendar year averages).
PERSISTENTLY HIGH FED BALANCE SHEET TOTAL GIVES GOLD PRICE ANEW BOOST
700900110013001500170019002100230025002007200820092010
U S D b n
6007008009001000110012001300
U S D p e r t r o y o u n c e
Total factors supplying reserve fundsGold price (RS)
Source: Bloomberg, UniCredit Research
Energy
WTIBrentNatural gasUnit$/Barrel$/Barrel$/MMBTUcurrent
74.475.73.7
% 1M
-9.81-8.36-22.14
in 3 M
82.081.04.6
in 6 M
82.081.04.4
Ø Q2/10
78.080.54.3
Ø Q3/10e
78.079.04.6
Ø 2009
61.763.54.0
Ø 2010
80.080.04.5
Ø 2011
80.080.04.8
Industrial metals
CopperAluminumUnitUS$/MTUS$/MTcurrent
76462121
% 1M
2.98-3.32
in 3 M
70002150
in 6 M
73002100
Ø Q2/10
70722100
Ø Q3/10e
70002000
Ø 2009
51861670
Ø 2010
71002100
Ø 2011
74002100
Precious metals
GoldSilverPlatinumUnit$/Ouncects/Ounce$/Ouncecurrent
1247.01966.01553.0
% 1M
4.986.73-2.33
in 3 M
1250.02000.01550.0
in 6 M
1350.01875.01600.0
Ø Q2/10
1195.01831.51629.6
Ø Q3/10e
1200.01800.01500.0
Ø 2009
972.61463.21203.3
Ø 2010
1200.01800.01600.0
Ø 2011
1400.01900.01800.0Source: Thomson Financial Datastream,UniCredit Research
Author
Bloomberg
UCGR
Internet
September 6, 2010Global Economics & FI/FX Research
UniCredit Research
page 2
See last pages for disclaimer.
KEY EVENTS
US Department of Energy09/08/2010
16:30US crude oil, gasoline and distillates inventories
International Energy Agency09/10/2010
Monthly oil market reportSource:UniCreditResearch
Further monetization= new boost for the gold price
The Fed's decision to reinvest the proceeds from maturingand prepaid agency debt and MBS in longer-term Treasuriesand to continue rolling over its holdings of Treasurysecurities as they mature has eliminated the slight tighteningbias of US monetary policy. It therefore represents the exitfrom the exit from the ultra-expansive monetary policy.Apparently, the latest economic data releases have raisedsignificant concerns about the strength of the recovery withinthe Federal Open Market Committee (FOMC). We assumethat in the coming twelve months the Fed will this wayreinvest around USD 200bn–that is 7¾% of the current Fedbalance sheet total. This decision has halted the gradualshortening of the Fed balance sheet and eliminated the slighttightening bias of US monetary policy. Moreover, it opens thedoor to the further purchase of Treasury securities on a largescale (“Quantitative Easing 2“).The Fed's decision harbors two potential risks. First,concerns about inflation remain high. Second, the decisionhas encouraged the markets to consider the impact of further monetary policy measures. While investors have so far always consoled themselves with the notion that the UScentral bank would “help in some way“ in the event of aneconomic slowdown, after the most recent FOMC meetingthey were compelled to give somewhat deeper thought to theremaining possibilities of monetary policy.Thus far, it is not yet clear whether this will also result in alengthening of the Fed balance sheet. The monetization of government debt is, however, undoubtedly of specialsignificance for the gold market. In the last two years, thechanges in the Fed holdings of Treasuries were in each casethe catalyst for stronger price movements on the goldmarket. In 2008, the Fed swapped Treasury securities it heldwith the commercial banks for securities with a lower creditrating. The qualitative improvement of the deposit side of thecommercial banks was designed to restore confidencebetweenthe banks and thereby restore the ability of theinterbank market to function. In the process, the total of Treasury securities held by the Fed fell from close to USD800bn to less than USD 500bn. This triggered profit-takingon the gold market, with the result that the gold pricefell fromUSD1,000 per troy ounceto USD716. However,when theFed again purchased Treasury securities and this alsolengthened the Fed balance sheet,the gold pricesurged75% (see also chart on page 1).
MONETIZATION OF GOVERNMENT DEBT PROVIDES GOLDPRICE WITH A NEW BOOST
4004505005506006507007508008502007200820092010
U S D b n
6007008009001000110012001300
U S D p e r t r o y o u n c e
US Treasury securities on the Fed balance sheetGold price (RS)
Source: Bloomberg, UniCredit Research
Goldheading towards USD1,600 per troy ounce
The World Gold Council (WGC) reported extremely positivenumbers for the gold market for the second quarter. Demandmeasured in tonswas up by 34% yoy.
EXTREMELY STRONG RISE IN THE DEMAND FOR GOLD
6007008009001000110012001300
I / 0 7 I I / 0 7 I I I / 0 7 I V / 0 7 I / 0 8 I I / 0 8 I I I / 0 8 I V / 0 8 I / 0 9 I I / 0 9 I I I / 0 9 I V / 0 9 I / 1 0 I I / 1 0
T o n s
-40-30-20-10010203040
%
Gold demand% yoy (RS)
Source: World Gold Council, UniCredit Research
If the high gold price is also factored into the equation,demandeven surged 77% to a new historical record for the
September 6, 2010Global Economics & FI/FX Research
UniCredit Research
page 3
See last pages for disclaimer.
quarter. The reason for this is the strongly rising investor demand triggered by the Fed's decision and the renewedwidening ofCDS spreads inthe European periphery states.PIMCO, the world’s largest bond fund manager, is nowconvinced that Greece will not be able to avoid a default. Inthe second quarter of 2010, investor demand for gold surgedby 117% yoy to 534 tons. In the process, 243 tonswerepurchased in the form of coins and ingots, and 291 tonsviaETFs. For ETFs, 2010 is shaping up to match the recordyear thus far (2009), when for the full year 617 tonswerepurchased via ETFs. As a consequence, demand was higher than jewelry demandfor the second time.
EXTREMELY HIGH DEMANDFOR GOLD ETFS
Gold supply in tons
3613980734149954655741544291
133208260253321617
0100200300400500600
I / 0 7 I I I / 0 7 I / 0 8 I I I / 0 8 I / 0 9 I I I / 0 9 I / 1 0 2 0 0 5 2 0 0 7 2 0 0 9
0100200300400500600700ETFs & Similar ProductsAnnual (RS)
Source: World Gold Council, UniCredit Research
INVESTOR DEMAND OUTSTRIPS JEWELRY DEMAND
01002003004005006007008009001000
I / 0 7 I I / 0 7 I I I / 0 7 I V / 0 7 I / 0 8 I I / 0 8 I I I / 0 8 I V / 0 8 I / 0 9 I I / 0 9 I I I / 0 9 I V / 0 9 I / 1 0 I I / 1 0
t o n s
Jewelry & Industrial & Dental demandIdentifiable investment demand
Source: World Gold Council, UniCredit Research
These numbers are exactly in line with our centralassumption for the gold market: that gold supplywillincreasingly be determined by investors. Twenty years fromnow, investors will probably find it hardto imagine that therewas once a time when jewelry demand determined one of the world’s most important asset classes. If investors were toswitch only 1% of the global market capitalization of equitiesand bonds into gold, at the current gold price of around USD1,250 per troy ounce,this would translate into demand of 36,000 tons. According to the US Geological Survey, this isroughly equivalent to the known goldreserves. In reality,however, there will be a mix of gold purchases and increasesin gold prices. At a gold priceof USD2,500, only 18,000 tonsof goldwould be required to reach a share of 1%.
China’s goldinvestments are booming
The Chinese government has encouraged consumers toinvest in gold, and with great success. In the last 12 months,demand for gold totaled 532 tons. While jewelry demand ismerelystagnating, investors are increasingly discovering thegold market. While as recently as 2008 only 17 tonsof goldwere purchased, in 2009 the figure was already 73 tons. Inthe last 12 months, demand was even 143 tons! AlthoughChina has evolved into the world’s largest gold producer inrecent years, the annual production of most recently 330tonsis by no means sufficient to satisfy this demand.Hence, China announced important gold market reforms atthe beginning of August. Foreign companies are nowpermitted to offer their gold coins at the Shanghai Exchange,more banks are permitted to import gold from abroad, andmore domestic, gold-based investment products are to bedeveloped. As a result, demand of Chinese investors willincreasingly be felt on the global market. But the Chinesegovernment also has an ever greater interest in gold imports.In April 2009, China had reported an increase in its goldreserves from 19.29mn to 33.89mn troy ounces.Nevertheless,they arestill atavery low 1.7% of the entireforeign exchange reserves. If China is targeting a goldreserve of, for example,10%, it would have to purchase6,130 tonsof goldor 2.4 times global annual production. If China were to meet the demand only from domesticproducers, it would take 19 years to achieve this objective.Since the gold marketis per se only a very small market,further increases in the price of gold are pre-programmed.
Jochen Hitzfeld
+49 89 378-18709 jochen.hitzfeld@unicreditgroup.de
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