Gold Demand Trends Q3 2016

Mine production

The outlook for mine production is rock steady. Mine production in the third quarter was virtually unchanged (-0.5%) year-on-year, as miners brought 846.8t onto the market. Year-to-date, gold production totalled 2,393.1t, versus 2,373.3t for the same period in 2015 (+1%). Despite an expectation that 2016 will see a marginal increase in production, the overall trend of plateauing output remains in place. The operational changes - cost reduction and focus on core assets - enacted by gold producers over the last few years will define the industry for years to come.

While the production figures are still provisional - owing to the varied timings that producers release their quarterly results - Q3 appears to be a mirror image of Q2: both increases and declines were seen across projects globally. Higher production at established projects helped lift year-on-year output from Canada (+1t) and Indonesia (+6t), with the latter likely to see a significant pick-up in production in Q4 owing to higher output at Grasberg. The ramping up of projects in Guyana, as well as commercial production being reached at the Merian project in Suriname (one of only a few new mines being brought onstream by major producers), also helped the industry maintain a steady supply of gold. Offsetting these gains were lower output at some larger projects: Q3 production in the United States likely fell around 6t year-on-year, while lower-grade mining at Oyu Tolgoi dented Mongolian production (-3t).

Cost management continues to significantly influence the industry. Although all-in sustaining costs (AISC) crept up in Q2 due to currency movements, costs are still significantly lower than they were in 2013. One example of this frugality is project expenditure – which captures the cost of developing projects – which peaked in 2012, and currently remains at multi-year lows as producers remain hesitant to loosen the purse strings (chart x). Not only are existing mines impacted by this parsimony, but the project pipeline is too, as new projects are contributing less to the amount of gold that is being mined annually.

Producer hedging

Producers’ third quarter hedging hiatus. Net hedging has been a feature of the gold market since the second half of 2015. Gold producers have eyed the dramatic price increase in 2016 as a further – more favourable – opportunity to lock-in higher, in some cases record, gold prices. This led some to question whether this heralded a return to heightened levels of hedging.

Yet, in a break from the last four consecutive quarters, Q3 2016 brought with it a more muted tone from producers. Net hedging of 79.8t in H1 has been followed by a return to net de-hedging of 15t in Q3, lowering the global hedgebook to 282t. This shift away from fresh hedging positions (on a net basis) was partially driven by the behaviour of the gold price. Compared to the first six months, the gold price was confined in the US$1,300– 1,350/oz range, and volatility fell. Combined with fewer new projects coming on stream – which often require hedging to secure financing – this reduced the appetite for hedging.

The most notable fresh hedge position occurred at the start of the quarter, with Harmony Gold hedging 20% (432,000oz) of its production over the next two years. The company made clear that: “The limited size and duration of the hedge means shareholders retain full upside exposure on 80% of Harmony’s future gold production for the next two years, after which shareholders will have 100% exposure to the gold price.” ¹

Further upward momentum in the price may elicit additional small-scale hedging – on a sporadic basis – as producers continue to secure cash-flow, but it is unlikely that the industry will return to large scale hedging.

Recycling

Elevated gold price has boosted recycling. Some gold consumers aren’t shy in selling a portion of their gold holdings when advantageous to do so, often responding to near-term price movements. And the dramatic increase in price witnessed so far in 2016 has proved too enticing for some. The third quarter saw a continuation of the elevated levels of gold recycling - the exchanging of gold for cash - seen in the first half of the year. Recycled gold amounted to
340.9t in Q3, surging 30% higher than the same period last year (261.6t). Year-to-date, recycling has added 1,042.3t to annual supply, compared to 882.7t between Q1-Q3 2015 (+18%).

As discussed in Gold Demand Trends Q2 2016, this is a somewhat predictable pattern. Empirical evidence - both through regression analysis and direct consumer research - has shown that price is a primary driver of recycling amongst consumers. With the local gold price hitting new highs in some currencies, it would be unusual not to see this type of response from consumers, who - as we have stated previously - are often keenly aware of the gold price in markets where recycling is most prevalent.

India was a prime example of the elevated recycling seen across several price-sensitive markets. With local gold prices in vicinity of Rs.31,000/10g during the first half of the quarter, Indian consumers opted to cash in, swelling the supply of recycled gold to 65t, its highest level since Q4 2013. This boost to local supply enabled some jewellers to reduce their reliance on fresh imports to satisfy demand. One such example of this is Muthoot Pappachan Group's
Swarnavarsham Scheme. Muthoot has collected about 200kg of gold through its nine recycling centres so far, which has been used to meet gold demand from consumers with lower incomes.

As the price started to soften by third week of August, recycled gold levels tapered as Indian consumers anticipated higher prices ahead of the festival and wedding season. With the onset of Raksha Bandhan and Janmashtami, both auspicious festivals, towards the end of the third quarter, consumers opted to postpone further recycling of gold.