Morgan Stanley has released its comprehensive quarterly metals outlook update for Q3, which while traditionally furiously wrong in its price targets for the assorted metals under consideration, represents one of the best reference materials for the underlying fundamentals behind each hard asset including base and precious metals, steel and bulk commodities, mined energy, rare earths, even such arcania as zircon and titanium dioxide. We suggest readers avoid the conclusion by Morgan Stanley which ultimately will be based on the firm's prop trading bias, and instead focus on the key supply/demand mechanics in any given product. For the sake of reference, we break down MS' outlook on gold, silver due to the special place these hold in the modern geo-political and voodoo economic discussions.
Investment demand is strengthening again…
- Identified and implied investment has become the main driver of demand in the gold market over the past decade and has become essential to absorb the fundamental surplus resulting from mine production, secondary supply, any net sales from central banks and producer hedging, and the long-term decline in jewellery fabrication demand.
- As the transparency of reporting of bar hoarding demand has increased along with the growth in physically backed ETF demand, the depth and structure of the physical investment market has become more visible. In our view, assessing the sustainability of this investment flow has become critical to the gold price outlook.
- According to GFMS, total identifiable investment demand for gold reached a record 1,514t in 2011, or 1,675t if implied investment demand is included, for a new annual record of US$66bn.
- More dramatic growth in investment demand for gold can be pinpointed to 2008-09 and the global financial crisis, which raised serious concerns about a debt deflationary spiral and the long-term purchasing power of the world’s major fiat currencies, especially the US dollar and the Japanese yen.
…as sovereign debt concerns highlight fiat currency risks
- More recently, a sharp rise in inflationary pressures partially driven by a surge in oil prices since February 2011 and the growing risk of sovereign debt default in peripheral countries of the Eurozone have given added impetus to investment demand growth as the fear of sovereign debt contagion has also raised questions over the long-term future of the euro.
- Even more recently, the impending threat of technical default by the US government if the government debt ceiling is breached, and the associated risk of a sovereign debt rating downgrade if a satisfactory long-term debt reduction program is not established have added to investor concerns about the long-term outlook for US treasuries and “risk-free assets.”
- In these circumstances, we expect the long-running bull market in gold will receive further impetus, even if there is no return to QE in the US. However, QE3 is a potential further upside risk to prices in the current environment.
- A further illustration of the growing quasi-monetary role of gold in the current global financial environment has been the persistent trend in official sector sales from net selling to net buying, a trend that we expect to continue, especially now that the sale of the IMF gold tranche has been completed.
- We have increased our annual gold price forecasts by 8%, 22% and 24% for 2011, 2012 and 2013 respectively to US$1,511/oz, US$1,624/0z and US$1,550/oz.
Global supply / demand
May 2011 correction has reduced risks of demand destruction…
- As GFMS observed in the 2011 World Silver Survey published for the Silver Institute, silver’s “hybrid” precious and industrial nature leads to links with gold, copper, and the CRB index, which can vary greatly.
- In the course of 2011, silver’s precious metal status and therefore its links with gold have been strongly reinforced by investors’ preference to hedge systemic financial risk, rising inflationary pressures, and resurgent political risk in MENA through a cheaper vehicle with characteristics similar to gold as a store of value.
- Driven by a spectacular rally between late March and May led by retail investors, the gold:silver ratio narrowed sharply, reaching its lowest point since October 1980 in early May 2011 at 30:1.
- Closing prices for silver at the peak of the rally in late April 2011 at US$48.70/oz came within 1.5% of the all time high established in January 1980 during the Hunt brothers’ squeeze. Successive increases in the Comex margin requirements then saw prices trade between US$33 and US$36/oz and the gold:silver ratio stabilize around 40 to 44:1.
…helping sustain investment demand going into 2012
- In our view, the 2,000t outflow of silver from ETF funds that has followed this correction is likely to be temporary, as all of the drivers for the initial 3,500t surge in ETF inflows between September 2010 and late April 2011 are still in place.
- Furthermore, the lower trading range for prices since the crash in early May should be an incentive for investors to return to the physical investment market now that the impact of the violent correction has largely been discounted.
- Investor sentiment should also be encouraged by evidence of strongly rising fabrication demand, especially in the brazing alloy/solder and jewellery markets, which are forecast to grow by 8.2% and 3.7%, respectively, in 2011.
- As a result, we have made significant upgrades to prices throughout the forecast period. For 2011, we now expect an average price of US$36.21/oz, up 15% from our previous forecast, and in 2012 we see prices averaging US$36.90/oz, 30% higher than our previous estimate.
- For 2013, we have raised our forecast 32% to US$32.98/oz.
Global supply / demandMS Q3 Metals