By Ken Gassman
It would be easy to say that the price of precious metals is simply a function of supply and demand. But the factors affecting precious metal prices are much more complex and include, but are not limited to:
Fundamental supply and demand – This basic economic tenet defines capitalism: when demand increases, prices rise. As the world’s economy grows, there is more demand for precious metals for manufacturing needs, financial purposes and medical uses – as well as consumer needs for jewelry.
Tangible store of value – Gold has always been a store of value. Rarer precious metals tend to hold their value better than other readily-available commodity metals.
Safe haven for wealth – When the global economy shows signs of weakening, investors often seek a safe haven for their money. Gold has historically been the primary safe haven for worried investors and bankers.
Commodities trading – Investors who trade commodities can have a dramatic impact on the price of precious metals. In short, trading exaggerates demand-and-supply driven price swings of gold, silver, and platinum. For example, when traders detect that the price of gold is rising due to rising demand, they also buy gold and gold financial derivatives, which push the price up further, and vice versa when demand weakens.
Currency swings – Many of the world’s currencies are tied to a hard currency such as the U.S. dollar or the euro; they are “hard currencies” because they are perceived to have intrinsic value. While no major government offers to convert its currency into gold anymore, gold reserves are one component behind currency valuations. As long as these hard currencies move together, national banks don’t typically engage in significant buying and selling of currencies. But if one currency starts slipping – such as the U.S. dollar has recently – governments may sell dollars and invest in gold (or another hard currency) as a way to preserve the value of the reserves backing that country’s currency value.
Emerging economies – The economies of both China and India, as well as some other Asian countries, are growing rapidly – near 9-10 percent annually, or triple the growth rate of the global economy. Fast growing economies need precious metals for several reasons including manufacturing, banking and jewelry.
Supply sources – It is not enough to understand precious metals mining production to forecast the supply of metals. Governments that hold precious metals can sell their stash. Hoarders of precious metals often sell when the market appears to be over-priced. Speculators may sell long or short. Although it is relatively easy to determine mine production, it is near impossible to determine the amount of above-ground availability of precious metals, nor is it possible to determine the logic of decisions related to buying and selling above-ground reserves of precious metals.
Demand components – Demand for precious metals comes from disparate industries: jewelers, auto makers, electronics producers, the medical profession, dentistry, and mints for coins and medals.
Short-term factors – Short-term factors can cause precious metal prices to spike. For example, when geopolitical tensions rise, investors and bankers usually scurry to gold for safety. Even weather can have an impact: if all crops failed in India, farmers would not have money to buy gold jewelry, and prices would fall. There could also be a flight to gold as those farmers sought to assure that their remaining assets are converted into a safe haven of value such as gold. The big unknown, of course, is the impact of financial speculators. Many buy and sell commodities with little regard to logic and underlying fundamentals. If they all try to sell at once, precious metals commodities prices will fall, even if underlying fundamental demand remains robust.
Jewelry Prices: Higher in 2008
Although forecasting precious metals prices requires a mix of science and intuition, it is relatively easy to predict the price of precious metal jewelry in 2008 and beyond: up, higher, rising, elevated, escalating, expanding and swelling.
Why are we so confident that jewelry prices will rise in the near term? Three factors are driving our forecast, of which the first is by far the most important:
Jewelry producer prices and jewelry consumer prices have not kept pace with sharply higher precious metals commodities prices – In the U.S. , which consumes roughly half of all jewelry purchased in the world (by value), the increase in jewelry prices – either at the producer or the consumer level – has not kept pace with the sharp rise in precious metal prices. While there have been some offsets to rising commodity prices – such as moving jewelry production to countries with low labor costs – both producer and retailer margins are shrinking as they have absorbed some of the spike in commodities prices over the past three years.
While precious metal prices have risen as much as 115 percent over the past three years (see table), the price of jewelry has risen much more modestly. The U.S. jewelry consumer price index (CPI) rose 9 percent, while the U.S. jewelry producer price index (PPI) rose 15 percent.
The table below summarizes average prices and price inflation of precious metals from January 2005 to December 2007.
Source: Market Data |
The factors that have pushed precious metals commodities prices higher for the past three years are still in place – While there is some evidence that pricing pressure will moderate in 2008, the fundamental factors that have pushed prices higher– demand, financial, economic – are expected to remain in place for the foreseeable future.
The global economy is expected to continue to grow at a solid pace for the next two to three years – Not only are emerging economies expected to post continuous growth, though perhaps at a less blistering pace, but the U.S. economy is expected to emerge from its slowdown by late 2008 or the first half of 2009.
Precious Metals Prices: Likely to Rise, But At A More Moderate Rate
There are four key precious metals used in the production of jewelry: gold, silver, platinum and palladium. There are no reliable figures regarding the “market share” of each of these precious metals in the global jewelry market, though there are some guesstimates. The graph below represents a guesstimate of the market share of key jewelry components including gemstones and precious metals. Our sense is that the market share of gold may be overstated and “other” may be understated (colored gemstones, pearls, and other merchandise is included in “other”). Thus, this graph should be viewed more as a representation of “order of magnitude” than as accurate percentages of market share.
Source: IDEX Online Estimates |
In a recent report, KPMG, the global consulting firm, made a forecast for the year 2015 of the various components of precious metals and gemstones that would be important in the global market. They included silver in “other” and predicted that palladium would become a very important metal for jewelry fabrication, as the graph below illustrates.
Source: IDEX Online Estimates |
Current Price Trends Help Set the Tone for 2008
Commodity price increases for precious metals have been moderated in recent months, though some reaccelerated in the fourth quarter of 2007, as the graph below illustrates.
Source: Kitco |
While past history does not provide a forecast for the future – in other words, forecasters can’t “straight-line” past price action – it does provide some indication of market energy surrounding prices on a near term basis. Short of some cataclysmic event, there is no reason to believe precious metals prices will spike in early 2008.
However, if there is a shock to the “system,” market reaction would negate these forecasts. We believe there is an 80 percent chance that our forecasts will be accurate within a reasonable range.
Gold – Likely To Rise, But At A Moderate Rate Gold is the second most important commodity used in jewelry fabrication, after diamonds. Gold has a long history as jewelers’ favorite metal, due both to its natural luster and ease of fabrication. Arguably, it is the backbone of the fine jewelry industry worldwide, since there is a component of gold in the majority of jewelry pieces. Further, gold is the leading jewelry category in many markets, especially in Asia where it is viewed as a sign of the wearer’s wealth.
The graph below illustrates the average monthly price of gold over the past three years.
Source: Market Data |
The outlook for gold prices reflects a balance between supply and demand as well as a host of other external environmental factors. Those other factors are aligned to push the price of gold higher in 2008.
Demand: During 2007, gold demand for jewelry fabrication rose in both tons and value; this contrasts with 2006 when gold consumption for jewelry, as measured in tons, fell. Through the third quarter of 2007, gold tonnage for jewelry was up about 15 percent for the nine-month period versus the same period in 2006, and the value of gold used in jewelry was up 27 percent, year-over-year. Roughly two-thirds of all gold demand comes from jewelry fabricators. Despite a shrinking market for jewelry fabrication due to higher prices, the jewelry industry remains the largest user of gold globally.
The graph below illustrates the tonnage and value of gold used in jewelry, at the consumer level. The economies of a number of gold’s key markets – especially India, China, and the Middle East – have all been very strong. Further, reduced price volatility has helped boost demand, since volatility tends to dampen demand. In many Asian countries, gold is sold by weight, prices vary daily and the mark-up is very modest. When prices swing widely and wildly, consumers in those countries tend to wait to buy gold jewelry, fearing that their “investment” will prove inauspicious.
| 
Source: VGC & GFMS
|
Unfortunately for the Italian gold industry, business continues to decline. While quality and workmanship remain very high, the retail price of Italian gold jewelry puts much of it beyond the mass market’s ability to make impulse purchases.
The World Gold Council (WGC) points out that gold demand for jewelry is influenced largely by seasonal factors, with the most important season being late in the calendar year. In the U.S., shoppers buying gold jewelry for Christmas represent a very important market. India sees two key gold-buying events: Diwali and the main wedding season, and is the world’s largest market for gold jewelry by weight (the high mark-up on gold jewelry makes the U.S. the largest market by value).
Demand for gold used in electronics and coins, which represent about 17 percent of all gold consumption, rose in 2007. Finally, gold for investment purposes, which accounts for about 16 percent of all gold consumption, also rose solidly.
Supply: Mining production was forecasted to be up about 2 percent in 2007, but official government sales were down, and the amount of gold reclaimed from scrap also shrank. As a result, the total supply of gold available globally is estimated to have declined by about 2 percent last year.
The most interesting thing about gold is that it is practically indestructible, meaning that virtually all of the gold ever mined is still around. Through the ages, about half (52 percent) of this gold has been used in jewelry fabrication.
Outlook: Most consensus forecasts cal l for higher gold prices in 2008, though the rate of increase should moderate from the past two years’ levels. However, there are “gold bulls” who suggest the real inflation-adjusted price of gold should be $2,200 to $2,500 per ounce, assuming that gold prices nearly 30 years ago ($850 per ounce in 1980) are an accurate indicator of the intrinsic value of gold. Gold is a currency. It is liquid and freely traded. The “gold standard” no longer exists. Thus, the market will price gold based on a complex set of factors.
The consultancy firm GFMS says gold prices will eventually decline towards the metal’s marginal cost of production, but not in the near or medium term.
Silver – Headed Higher, But Who Cares?
Silver has a long history as a precious metal used in jewelry. Its use can be traced back nearly 6,000 years to Anatolia, the modern-day country of Turkey. Silver has greater reflectivity than gold, and can be polished to a higher brilliance.
Compared to gold, silver prices are “pocket change.” In most consuming markets, the sharp rise in the price of silver has had no notable impact on silver jewelry demand. However, higher prices in 2006 hurt consumption in some low-income regions such as India, where up to 80 percent of the population lives on $2 per day or less. The graph below illustrates the average monthly price of silver over the past three years.
Source: Market Data |
Demand: Overall, the rising price of silver has had little impact on global demand from any of the five major categories of users: industrial, investment, coins, photo, and jewelry/silverware. Industrial fabrication, which consumes just over 50 percent of all silver, has risen steadily, a trend expected to continue. Photo use of silver (15 percent) continues to decline as digital cameras replace photographic film and paper. Coin usage (4 percent) is a fairly steady and consistent market. The investment market for silver (15 percent) has risen at mid-to-high teen percentage levels and is largely responsible for pushing up prices.
Consumption of silver for jewelry is expected to be up by more than 25 percent (by value) in 2007 versus the prior year. Demand in most countries has been little affected by rising silver prices, except in India where there has been a shift by consumers from buying high carat silver jewelry to purchasing silver bullion.
Supply: Output from mining, which supplies roughly 74 percent of all silver consumed, rose in 2007, another trend likely to continue. The supply of silver scrap, about 20 percent of the global supply, has been declining, despite higher prices. Government sales have been soft, and supply only about 4 percent of the world’s silver needs. Finally, “other” sources supply about 2 percent of all silver consumed globally.
Outlook: Most forecasters are calling for silver to trade in the $13-$17 price range in 2008. This reflects a market where fundamental supply and demand are roughly in balance. In addition, it assumes investors will not create any significant price volatility or try to “corner the market.”
Platinum – Up, Up and Away
Platinum is referred to as the “new metal,” though it is anything but. In roughly 100 BC, pre-Incan South American civilizations used platinum to make nose rings. However, there is no reliable record of platinum use until about 1500 when, because there was only a very modest supply, it was used solely by royalty. In 1924, a major platinum deposit was discovered in South Africa, and the market for platinum expanded exponentially.
Platinum belongs to the Platinum Group of Metals (PGM), which consists of six types of extremely rare metals, each one of them possessing unique qualities and characteristics making them appropriate for a variety of applications in the automotive, medical, and jewelry industries.
Platinum, the most commonly used PGM, is 30-35 times more rare than gold. Initially, it was used exclusively for jewelry fabrication; however, it has become almost indispensable in the industrial sector – specifically in auto catalysts – and is a valuable raw material for the medical sector, especially in the development of cancer drugs. The graph below summarizes the price of platinum by month for the past three years.
Source: Market Data |
Demand: Total platinum usage has risen consistently, year after year. For the first half of the current decade, platinum demand grew at a compounded annual growth rate of over 12 percent.
The graph below illustrates the end uses for platinum.
Source: Johnson Matthey |
Conversely, platinum’s use in the jewelry industry continues to decline. In the U.S., it is 2 percent or less of total retail sales of jewelry (by value). Worldwide, platinum for jewelry continues to decline, primarily due to its higher cost. Consumers can get nearly the same “look” with white gold, silver or palladium.
The graph below illustrates the aggregate decline in the use of platinum for jewelry fabrication by region of the world during the current decade.
Source: GFMS |
While the market for platinum appears to have fallen in China, it may be ready for a resurgence. Three factors are aligned to fuel demand for platinum there: the strength of the Yuan, rapid growth of urban incomes in China’s major cities and substantial gains in equities in the stock market. Offsetting these factors is one key element: the sharply rising price of platinum is hurting demand, both in China and other major global markets.
Supply: Platinum supply is estimated to have grown approximately 3 percent in 2007. Mine operations, which supply about 89 percent of the world’s platinum needs, are forecasted to have increased supply by about 4-6 percent in 2007. The balance comes from recycling automobile catalytic converters.
Outlook: As long as the automobile and medical industries’ platinum usage continues to grow, prices will rise. Indeed, in the waning months of 2007, when prices of other precious metals appeared to be stabilizing, platinum prices resumed their relentless climb.
Palladium – Up in Sympathy With Other Precious Metals
Palladium, which was isolated in 1803, also belongs to the PGM and was a relatively anonymous member of the gems and jewelry industry until about 1940. It has been used as a filler in the fabrication of gold and platinum jewelry to help avoid allergic skin reactions that may result from wearing white gold jewelry made with nickel.
The global industry has mixed reviews about the future of palladium to fill consumers’ needs for jewelry that is “something different.” Some producers and merchants posit that palladium is a viable alternative to platinum, since it is similar to platinum, but much less expensive; it currently sells for about one-quarter the price of platinum. Others call it a threat to rhodium-plated white gold saying that there is no need for another new precious metal for jewelry.
Palladium, however, possesses qualities making it particularly appropriate for jewelry fabrication. Its natural white color reduces the need for additional polishing. It is about half the density of platinum, meaning that more jewelry can be made from palladium per dollar invested. Its light weight makes palladium jewelry comfortable to wear on a daily basis. Finally, it does not oxidize at room temperature and does not require frequent polishing.
While the jewelry industry acknowledges that palladium is a viable precious metal, there is the worry that it will cannibalize market share from platinum. According to KPMG, most industry experts believe palladium cannot replace the essential value proposition of platinum: it is highly coveted, rare, and expensive. The chances of palladium emerging as a credible substitute for white gold are relatively higher, especially in light of its reasonable price.
The graph below summarizes monthly prices for palladium for the past three years.
Source: Market Data |
Demand: Demand for palladium jewelry has increased recently, primarily in emerging markets such as China, where consumer incomes are still relatively low. Demand from Chinese consumers began to pick up in 2000, when Chinese jewelry producers sought alternatives for the high-priced platinum. In 2005, demand for palladium for jewelry fabrication exceeded one million ounces for the first time due primarily to robust demand from China. Outside China, palladium jewelry has had mixed responses. North American consumers seeking a “different look” have shown reasonable acceptance. In Europe, demand has been very modest, with no growth. In Japan, demand for palladium for jewelry has declined modestly, despite its price advantage.
In addition to jewelry demand, palladium is used in several industries: electronics, dentistry, medical, and technology.
Supply: Palladium supply has been relatively steady at about seven million ounces a year, though it appears to be growing moderately, at a rate of perhaps 6 percent annually. Estimates suggest that nearly 60 percent of all palladium comes from Russia, followed by perhaps 30 percent from South Africa, and the balance from North America (7 percent) and other locales (3 percent).
Outlook: Supply is erratic, primarily because Russia does not produce and sell palladium in a consistent, predictable manner. As a result, there can be significant price volatility in the spot market. In addition, its price seems to move in sympathy with other precious metals, especially platinum.
Precious Metals Price Pain Not Felt Equally
While the price of gold and other precious metals has soared, not everyone is feeling the pain equally. It all depends on the currency you are using.
Let’s take gold as an example. Since gold is denominated in U.S. Dollars, the value of the U.S. dollar versus other global currencies has an impact on the “real” price of gold to global jewelry fabricators and retailers.
The price of gold in U.S. dollars, the official currency used to denominate gold globally, has risen by 89 percent over the past three years. But, because the dollar has recently depreciated significantly against many of the world’s major currencies, the “local” impact of the sharp rise in gold prices has not been as great for most gold jewelry fabricators and merchants outside of the U.S. as it has been for fabricators and merchants located in the U.S. For example, a European gold jewelry fabricator who buys dollar-denominated gold using Euros has seen the price of gold rise by only 76 percent over the past three years, rather than 89 percent in U.S. dollar terms. Thai merchants are among the luckiest: the Thai Baht has appreciated by nearly 25 percent against the U.S. dollar over the past three years. Thus, the price of gold purchased with Thai Baht has risen by only about 51 percent, far less than the “official” price increase of gold denominated in U.S. dollars.
The graph below illustrates the increase in the price of gold, denominated in local currencies, for the three years between January 2005 and December 2007.
Source: Market Data |
The only major currency that has lost value against the U.S. dollar is the yen, making the rising price of gold particularly painful for gold suppliers and retail jewelers in Japan.
Graph 12 illustrates the price of gold near the end of 2007, based on various currencies, after adjusting for currency swings over the past three years from January 2005 through December 2007.
Source: Idex Online Research |
The price of each of the other precious metals used in jewelry has also been affected by approximately the same factor as gold. Thus, despite the sharp rise in the prices of all of these precious metals, many markets around the world are not feeling as much pain as the U.S. and Japan due to favorable currency swings.
RSS Feeds
