hsbc precious metals outlook

8/6/2019 HSBC Precious Metals Outlook

1/64

ab cGlobal Research

For gold, unease about monetary andfiscal policies should rekindle the rally;supply is likely to rise modestly

For silver, strong industrial demand anda recovery in investor appetite shouldoffset mine and scrap supply growth

Industrial demand is boosting PGM off-take; ETFs hold sizeable metal; erodingRussian stocks may buoy palladium

We are raising our average price forecasts for gold, silver,

and the platinum group metals and introducing forecasts

for 2013 (see the table below). The bull markets remain

essentially intact for gold and the PGMs, and although silver is

priced closer to its equilibrium value, its near-term bias is

upward, in our view.

Gold: Prices have retreated from record highs. But they should

remain buoyed by investor concerns about the global economy,

geopolitical risks, high commodity prices, easy monetary

policies, and fiscal profligacy. Increased mine output, amplescrap supplies, and moderate jewelry demand are freeing up

metal for the investment sector.

Silver: Prices have corrected sharply from 31-year highs near

USD50/oz. Higher mine and scrap supplies are being absorbed

by robust industrial off-take. Investors have favored silver and

coin sales, but prices appear high, especially relative to gold.

PGMs: Moderating growth in auto demand and robust

industrial off-take are offsetting slow growth in mine supply.

Platinum jewelry demand is moderating. PGM ETFs holdconsiderable amounts of metal. Widespread belief that Russian

stockpiles are near exhaustion supports palladium prices.

HSBC precious metals average price forecasts (USD/oz)

___2011 ____ ___ 2012____ ___2013 ___ _ Long term__Old New Old New Old New Old New

Gold 1,450 1,525 1,300 1,500 1,450 1,050 1,250Silver 26 34 20 29 24 15 20Platinum 1,750 1,850 1,650 1,750 1,650 1,600 1,625Palladium 750 825 650 750 725 600 700

Source: HSBC

CommoditiesGlobal

Precious MetalsOutlook Bound to rebound; raising our priceforecasts

10 May 2011James Steel AnalystHSBC Securities (USA) Inc.+1 212 525 6515 [email protected]

View HSBC Global Research at: http://www.research.hsbc.com

Issuer of report: HSBC Securities (USA) Inc.

Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it
http://www.research.hsbc.com/http://www.research.hsbc.com/http://www.research.hsbc.com/


2/64

2

CommoditiesGlobal10 May 2011

ab c

Bound to rebound 3

HSBC gold outlook 9 Boosting our gold forecasts 9

An ill wind blows good for gold 9

Gold should rebound 10

Geopolitics and gold 12

Macroeconomic influences 14

Trends in supply and demand 21

Silver 30 Lifting our silver price forecasts 30

Back to earth 30

Recovery phase 31

Supply trends 34

Demand trends 37

Platinum 40 Raising our platinum price forecasts 40

Heading moderately higher 40

Driving moderately higher 41

Supply trends: Looking flat 42

Demand trends 46

Palladium 52 Increasing our palladium price forecasts 52

Already high but may go higher 52

Start and stop 53

Supply trends 53

Demand trends: Shifting gears 57

Disclosure appendix 62

Disclaimer 63

Contents


3/64

3


ab c

GoldIncreasing our gold price forecastsGiven the prevailing macroeconomic conditions and

golds proven utility as an inflation hedge, a safe-

haven instrument, and a portfolio diversifier, we are

raising our forecasts of average gold prices for:

2011 to USD1,525/oz from USD1,450/oz.


The long term (five years) to USD1,250/ozfrom USD1,150/oz.

For 2013, we are introducing an average price

forecast of USD1,450/oz.

Cocktail of factors ushers gold to newhighsThe 10-year gold rally remains intact, despite the

recent steep pullback in prices. Prices had reached

a new high of USD1,575/oz as investors

continued to seek out bullion for its inflationhedge and safe-haven qualities. The most virulent

phase of the gold rally can be traced to the global

economic and financial crisis, which began in

mid-2007, and the subsequent unprecedentedmonetary and fiscal responses. Investors appetite

for gold was increased by inflationary concerns

that were prompted by highly accommodative

monetary policies, including quantitative easing

and huge fiscal spending increases throughout

member states of the Organization for Economic

Cooperation and Development (OECD), and a

flight to safe-haven investments.

Easy accommodative monetary policies by the USFederal Reserve stimulated already high demandfor commodities, notably but not exclusively

in the emerging world. In addition to higher oil

prices, agricultural prices surged, which prompted

the UNs Food and Agricultural Organization to

declare a global food crisis earlier this year.

Commodity price rises fanned inflation fears and

stimulated demand for hard assets, including gold.

The eruption of popular discontent in the Middle

East, in particular the civil war in Libya, withimplications for oil supply disruptions, raised theglobal geopolitical risk thermometer, which

Bound to rebound Despite the steep pullback in gold, concerns about the inflationaryimpact of highly accommodative monetary polices, deficitspending, and high commodity prices should rekindle the rally Silver has retreated; investor sentiment will be crucial to pricedirection; strong industrial demand is more than offsetting minesupply growth but greater scrap supply may help weigh on prices PGMs are benefiting from growth in global auto production androbust industrial demand; ETFs hold considerable metal


4/64


5/64

5


ab c

producers to increase output wherever possible.High prices may also curb jewelry demand, which

is still recovering from a near-collapse of demand

in 2009. Moderate jewelry demand and increases

in scrap and mine supplies will free up

considerable amounts of bullion for the

investment markets, we believe. This should also

eventually help cap any further rallies.

Silver

Increasing our silver price forecastsWe are raising our forecasts of average silver

prices for:

2011 to USD34/oz from USD26/oz.

2112 to USD29/oz from USD20/oz.

The long term (five years) to USD20/ozfrom USD15/oz.

For 2013, we are introducing an average price

forecast of 24/oz.

Silver roller coasterBefore retracing heavily at the beginning of May,

silver had rallied from USD18/oz in September

2010 to 31-year highs near USD50/oz by lateApril 2011. Just as the case for gold, silver prices

have benefited from demand for hard assets

stemming from the 2007-09 financial crises and

the monetary and fiscal responses. The most

recent phase of the silver rally coincided with theFeds signal in August 2010 that it would

reintroduce quantitative easing, in which lending

programs are financed by the Feds balance sheet,

essentially creating and using cash to finance

lending facilities.

For investors interested in hard assets, such as

gold, silver has a similar attraction based on

growing inflation concerns, higher commodity

prices, and elevated geopolitical and sovereignrisks have spurred demand.

Silver prices gained noticeably on gold for much of the past year. The silver/gold ratio moved from 68:1

at end-April 2010 to 30:1 one year later, marking the

lowest point since the early 1980s. The recent

correction in silver which drove prices back down to

USD34/oz, also buoyed the ratio back to 42:1.

Although this indicated a growing preference among

some investors for silver over gold, we believe that

the ratio is likely to increase as investors recognizethat silver has become too expensive relative to gold

and reverse their positions. Indeed, the silver/goldratio increased at the beginning of May to 42:1.

Meanwhile, in early May, silver prices pulled back

to USD34/oz in the days after the CME Group, the

Comex operation, announced margin increases,

which triggered heavy long liquidation, and a wider

retreat in commodity prices.

The earlier surge in silver prices came in tandem

with a modest increase in holdings by silver

exchange-traded funds (ETF). The combinedholdings of all three ETFs the Barclays iShares

and the smaller ETF Securities and the Zurich

Kantonalbank Bank (ZKB) increased by

c9.0moz to 467moz on 30 April 2011 from

457.9.6moz on 1 January 2011. Since then,

investors liquidated a substantial 16moz, taking

ETF holdings down to 451moz. Sales of coins andsmall bars remain vigorous, following on from

robust levels in 2010.

We forecast that the silver market will be in

surplus this year due in large part to increases in

scrap and mine supplies. Substantial investments

in silver mine projects earlier in the mining cycle

are bearing fruit. Also, a greater supply of base

metals will increase the silver byproduct supply,

we believe. In addition to growing mine output,

increased scrap recycling will contribute to silver

supply. As long as prices remain aboveUSD30/oz, we expect both individuals and

manufacturers to supply considerably more scrap

metal for recycling than in recent years.


6/64

6


ab c

Increases in mine and scrap supplies will be offsetby robust industrial demand, we believe. More

than half of the annual silver supply is regularly

consumed by industrial sectors. High prices have

not yet deterred industrial demand for silver.

Based on HSBCs macroeconomic forecasts for

global industrial production, we forecast

substantial increases in silver purchases by

industries this year.

Photographic demand for silver, meanwhile,appears likely to extend its decline, as traditional

photography continues lose market share to less

silver-intensive digital cameras. The decline in

silver for photography has led to a corresponding

decline in recycled silver nitrates.

The recent pullback by silver prices is a closer

reflection of the underlying fundamentals, in our

opinion. Conditions in the global economy may keepsilver prices elevated and well above historical

averages this year and next year, in our view.

PlatinumRaising our platinum price forecastsWe are increasing our forecasts of averageplatinum prices for:




For 2013, we are introducing an average forecast

of USD1,650/oz.

Driving higherPlatinum prices rallied from a year-to-date low of

USD1,654/oz on 17 March 2011 to a high of

USD1,884/oz on 2 May. The price decline earlier

in the year was prompted by the earthquake and

tsunami in Japan and anxiety that global auto

production would be significantly disrupted,

limiting the need for platinum. After recovering

from this decline, prices weakened again in earlyMay in tandem with a broad-based pullback by

commodities. We believe this latest platinum

price decline was triggered more by weakness in

other precious metals, notably gold and silver,

rather than a change in platinums underlying

fundamentals.

Based on our supply/demand model, we expect the

platinum market to remain in deficit this year. A

production/consumption deficit seems to be thenormal state of affairs for the platinum market.

According to our supply/demand model, the market

has been in deficit every year in this decade except

for 2006 and 2009, when auto and industrial

demand almost collapsed due to the global

economic crisis. As deficits continue, we expect the

platinum price to be increasingly well-bid.

The listing of a US platinum group metals (PGM)exchange-traded fund (ETF) has been a notable

success, absorbing a significant amount of

platinum since its launch at the beginning of the

2010. Last year, the combined holdings of the

four major platinum ETFs jumped by 555,000oz

to 1.126moz. This year so far, combined platinum

ETF demand is up by 145,000oz to 1.271moz.

The demand has been driven by the same factors

that propelled investor interest in hard assets in

general, namely, concerns about potentialinflation, the direction of the USD, heavy deficit

spending by governments, loose monetary

policies, and geopolitical tensions. Despite the

recent pullback in the platinum price, these factors

appear likely to support platinum ETF demand for

the rest of this year. If appetite for the ETFs

should dim and investors choose to liquidate even

a fraction of their holdings, the market could

move into surplus, according to our

supply/demand model, with a commensurateimpact on prices.


7/64


8/64

8


ab c

relatively better than in the primary diesel-fueled

markets of Europe. The US and Chinese auto

markets, together, account for the bulk of

palladium autocatalyst demand worldwide. Based

on HSBC research forecasts of auto production,

we expect that auto industry growth in palladium

consumption this year will moderate considerably

from 2010 but remain positive.

The overwhelming bulk of palladium mineproduction is derived as a byproduct of platinum

production in the case of South Africa and nickel

output in the case of Russia. Together, these

countries make up the vast bulk of global

palladium mine production. By our calculations

and based on producer comments, both regions

should increase palladium output this year. Such

increases appear likely to be modest, however, asproducers face a variety of challenges, including

falling ore grades, inadequate infrastructure, andconstraints on power and fresh water. Also,

concern about the level of Russian palladium

stockpiles, and therefore the potential for a large

decrease in Russian exports, remains a factor.

Prices are well in excess of marginal costs of

production, however, and producers are makingevery effort to increase output wherever possible.

The launch of a US-listed PGM exchange-traded

fund (ETF) by ETF Securities last year was highly

successful and is absorbing a significant amount

of available above-ground stock. Palladium ETF

demand has been static this year. Industrial

demand has been robust, in keeping with the

recovery in global industrial production. Based on

HSBC macroeconomic forecasts of continuedindustrial expansion this year, we believe that

industrial off-take for palladium will increase. The

combination of industrial demand and reduced

Russian stockpile sales has the potential to tighten

underlying supply/demand balances and maintain

high prices for the rest of the year, we believe.

HSBC economic and metals price forecasts

2003 2003 2004 2005 2006 2007 2008 2009 2010 2011f 2012f Long term

G-7 IP % pa 1.0 1.0 2.6 1.9 3.5 3.5 -2.2 -12.9 6.9 4.1 4.2Global IP % pa 4.6 4.6 6.3 5.3 6.3 6.3 1.5 -6.1 12.4 6.4 6.3Aluminum USD/t 1,433 1,433 1,270 1,886 2,557 2,557 2,571 1,587 2,160 2,534 2,600 2,204Copper USD/t 1,768 1,768 2,866 3,682 6,702 6,702 6,965 4,930 7,339 8,970 7,493 5.069Nickel USD/t 9,634 9,634 13,845 14,749 24,052 24,052 21,070 14,727 21,665 25,434 22,04 15,428Zinc USD/t 772 838 1,058 1,389 3,263 3,263 1,873 1,543 2,072 2,181 2,314 1,741Aluminum USc/lb 61 65 78 86 116 116 117 72 98 115 118 100Copper USc/lb 71 81 130 167 304 304 316 224 333 407 340 230Nickel USc/lb 307 437 628 669 1,091 1,091 956 668 983 1154 1000 700Zinc USc/lb 35 38 48 63 148 148 58 70 94 99 105 79Gold USD/oz 210 364 410 445 604 604 872 990 1,225 1,525 1,500 1,250Silver USD/oz 4.60 4.88 6.66 7.29 11.55 13.55 14.97 14.80 19.00 34.00 29.00 20.00Platinum USD/oz 539 692 846 897 1,139 1,106 1,574 1,210 1,725 1,850 1,750 1,625Palladium USD/oz 337 200 230 202 319 356 351 265 525 825 750 700

IP = Industrial productionSource: HSBC


9/64

9


ab c

Boosting our gold forecastsWe are raising our forecasts of average gold

prices for:

2011 to USD1,525/oz from USD1,450oz.



For 2013, we are introducing a forecast of

USD1,450/oz.

An ill wind blows good for goldDespite the recent pullback in gold prices, weremain positive on the metal going forward. Gold

prices will be determined largely by the interplay

between monetary policy, inflation expectations,

the direction of commodity prices, the evolving

sovereign debt crisis in the euro zone, similar

concerns regarding US debt levels and fiscal

policy, and geopolitical risks.

HSBC gold outlook Gold pulls back on commodity price correction after hitting recordhighs on concerns about highly accommodative monetarypolicies, deficit spending, USD weakness, and elevatedgeopolitical risks Prices should remain elevated as investor demand offsets impactof increased mine and scrap supplies and weak jewelry demand We are raising our average gold price forecasts and introducingan estimate for 2013

Gold prices, 1971-present (USD/oz) Gold prices, 2005-present (USD/oz)

0200400600800

10001200140016001800

A p r - 7 4

A p r - 8 0

A p r - 8 6

A p r - 9 2

A p r - 9 8

A p r - 0 4

A p r - 1 0

0200400600800

1,0001,2001,4001,6001,800

A p r - 0 5

A p r - 0 6

A p r - 0 7

A p r - 0 8

A p r - 0 9

A p r - 1 0

A p r - 1 1

Source: Reuters Source: Reuters


10/64

10


ab c

How confident investors will be in government toremedy global economic and geopolitical

challenges, and the direction of the foreign

exchange markets, also will be important factors

in determining gold prices. In this atmosphere,

traditional supply/demand factors including mine

supply, producer hedging policies, and jewelry

and industrial demand may take a second place to

macroeconomic and geopolitical influences andinvestment demand on gold. We believe that on

balance, these factors will keep demand for goldelevated for the rest of the year.

As outlined by the HSBC macroeconomics team,

US monetary policy is likely to remain

accommodative, even after the end of the Feds QE2

program, scheduled for June. Meanwhile, inflation

fears based on surging commodity prices and looseUS monetary policy are increasing inflationary

pressures in the emerging world. This is supportive

of gold. Although core inflation is not rising in theOECD nations, commodity inflation to which gold is

sensitive is increasing sharply. The food crisis

declared by the UN and popular uprisings in the

Middle East introduce a geopolitical dimension that

is further supportive of gold. Though the recent

pullback in commodity prices was steep, this does

not indicate a reversal in the long-runningcommodity bull market, we believe.

Investment demand was firm for gold until May.

We believe that high prices contributed to the

decline in ETF and physical bullion demand. At

lower gold prices, ETF demand should recover.

Also, demand for coins and small bars implies

that retail and institutional demand is still

underpinning the gold rally.

Jewelry demand has risen from multiyear lows.But the combination of high prices and economic

uncertainty will limit demand growth this year,

we expect. The continued recovery in golddemand in the emerging world may be tempered

by high prices.

The main source of physical supply, mine output,is set to increase this year and next year, as high

prices encourage greater output and producers

increase reserves. Dehedging, an important source

of demand for a decade, is all but disappearing.

The official sector turned into a net buyer of gold

in 2010 after two decades of heavy sales. Central

banks appear likely to increase net purchases this

year in an effort to diversify their foreignexchange holdings. This may be an important

bullish development for gold.

Golds status as a safe haven and portfolio

diversifier has been confirmed by the increase in

investor demand since the beginning of the

economic crisis. However, if US monetary policy

were to be tightened and commodity prices ease

and geopolitical tensions fall, the rationale forowning gold would fall with a commensurate

impact on prices. The balance of factors argues

for higher, rather than lower, prices over much of this year, in our view.

For gold, we anticipate a wide trading range this

year of USD1,300-1,650/oz , with a possible spike

to USD1,700/oz. At prices above USD1,500/oz,

we expect jewelry demand would weaken and

scrap supply increase. Conversely, we would

expect any price decline below USD1,300/oz to

encourage greater emerging-market demand forbullion. The new dynamics for investors have

renewed their demand for gold as both a safe

haven and a hedge against inflation. Eventual

normalization of the global economy and ultimate

tightening of monetary policies explain our view

on gradual price declines from 2012 onward.

Gold should reboundIn 2010, the gold price rose for a 10th consecutive

year. The rally was driven by a recovery in some

sectors of physical demand and continued global

economic uncertainty. The gold price rose 29%

y-o-y to USD1,405/oz after hitting what was then

an all-time high of USD1,430/oz on 7 December


11/64

11


ab c

2010. The average price for the year wasUSD1,225/oz, up from an average of USD973/oz

in 2009. Gold also outperformed all other major

asset classes and most other commodities. This

year, prices corrected to USD1,308/oz, a year-to-

date low, on 28 January. We attribute this sharp

but brief drop to a shift in investor sentiment.

Well-received Portuguese and Spanish bond

auctions and positive comments about the USeconomy by US Federal Reserve Chairman Ben

Bernanke increased investor appetite for riskierinvestments and triggered a flow out of gold.

Long liquidation on the Comex and a decline in

the holdings of the largest gold-backed exchange-

traded funds (ETFs) were visible signs of the

change in investor demand. Gold would have

penetrated USD1,300/oz, we believe, were it not

for robust physical demand in Asia. Heavy

exports globally of bullion to China, India, andother parts of Asia from December 2010 through

February this year not only sustained the gold

market when Western investor sentiment dimmed,

but helped push the metal price to new highs later

in the year.

Bullion prices recovered in February, spurred by

accelerating commodity prices, notably oil. Rising

petroleum prices were tied to unrest in NorthAfrica and the Middle East. Regime change in

Tunisia and Egypt, demonstrations throughout

that region, and civil war in Libya amplified safe-haven demand for bullion. Underpinning the rally

were concerns that popular discontent in the

Middle East would disrupt the smooth flow of oil

from the region. A move into gold by investors

also was triggered by the aftermath of the

earthquake and tsunami in Japan in March, which

caused widespread destruction and significantdamage to nuclear plants that leaked radiation.

Until the Mideast upheavals began, gold prices

reflected closely the course of the financial and

economic crisis. Prices have more than doubled

since the onset of the subprime mortgage crisis inmid-2007. Gold benefited from its stature as a

safe haven and its lack of counterparty and credit

risk as the initial subprime mortgage crisis

morphed in a full-blown credit and financial crisis

with the collapse of Lehman Brothers in 2008.

Gold benefited further as governments andmonetary authorities across the globe slashed

interest rates, boosted spending, and implemented

unprecedented measures such as quantitativeeasing. Investor concerns shifted from

counterparty and credit risk to anxiety that highly

accommodative monetary policies and rising

government debt levels would inevitably bring

back high inflation rates. Gold remained a popular

alternative to paper assets throughout 2009 as

investors sought out bullion for its inflation hedgeproperties. Gold investment remained robust as

the economic crisis developed into a sovereign

risk crisis in 2010. A second round of quantitativeeasing by the Federal Reserve gave gold a second

wind later in the year, helping to propel gold

prices to new highs.

More recently, fiscal concerns and events in the

Middle East have helped push commodity prices

up, buoyed further by rapacious demand for

commodities in much of the emerging world. This

momentum led the surge in gold prices to recordlevels above USD1,575/oz by early April. A price

correction took gold back to USD1,462/oz in

early May.

The price correction has blunted but not

reversed the gold rally, in our opinion. For the

rest of this year, we expect elevated geopolitical,

inflation, and sovereign risks to support bullion

prices. Longer-term, we anticipate an eventualend to the current highly accommodative

monetary policies. This could gradually undercut

the gold market as real interest rates rise and thesafe-haven bid for gold diminishes. Increased

fiscal restraint by the worlds major economies


12/64

12


ab c

also should eventually curb gold rallies, but webelieve that heightened sovereign risk worries will

buoy gold prices in the near term. A flattening of

the US yield curve may be the most visible

expression of a tightening of monetary policy and

an easing by gold prices.

The following chart shows how well goldperformed in relation to other asset classes during

the economic crisis.

Geopolitics and goldIn addition to reflecting the global economic and

financial climate, gold is a barometer of

geopolitical and even social risks. We believe thatthe severity of these risks is increasing and is

likely to have a commensurate effect on gold

prices for the rest of this year.

In our 14 January research note, Golden Risks:The World Economic Forum identifies major risks

to the world economy that may influence gold

prices, we discussed a WEF report, Global Risks

2011, which outlined economic and geopolitical

risks facing the global economy as assessed by

580 world leaders and decision makers. These

risks hold potential ramifications for gold. TheWEF found that the financial crisis had greatly

weakened economic positions of governments,

societies, and institutions, particularly in matureeconomies. This has reduced the capacity of the

world to absorb any major new shocks or meetglobal challenges.

In addition to reducing overall global economic

resilience, the financial crisis has led to a rise in

geopolitical tensions and raised global social

discontent, according to the WEF, increasing risks

across a range of economic, geopolitical, socialand even climate categories. This is likely to mean

that economic and geopolitical events, even

relatively low-level events, may have anexaggerated effect on gold prices, as governments

and institutions struggle to cope with fresh

challenges when they have depleted resources in

the wake of the financial crisis.

An additional factor addressed by WEF is the

interrelationship between risks, and its report

suggested that because of globalization, risks for

contagion have grown significantly. This mighthold important implications for gold prices.

Increased contagion is likely to boost golds

sensitivity to global economic and geopolitical

events and to make gold prices more volatile than

would otherwise be the case. This helps explain

our expectations of a relatively wide trading range

for gold prices this year of USD1,300-1,650/oz ,

with a possible spike to USD1,700/oz.

The WEF report identified economic disparity and

global governance failures as significant risks to the

world economy. The was confirmed by the WorldBank, which found that income inequality as

measured by the Gini Index, a traditional economic

measure of income inequality, over the past decade

increased most rapidly in emerging economies,

notably but not exclusively in India, China, and

Indonesia. Income inequality also increased across

the OECD world for the same period.

The growth in income inequality broadlycoincides with the long-run rally in gold prices.

During periods when income inequality is

relatively stable or narrowing, gold prices tend to

Gold: Safe haven among asset classes, 2008-end April 2011

Returns for Various Asset Classes 2008-Present

-60.00%-40.00%-20.00%

0.00%20.00%40.00%60.00%80.00%

100.00%

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11S&P 500 Gain (Loss) Gold Gain (Loss)T-Note Gain or Loss Lipper MuniIndex Gain (Loss)

Returns for Various Asset Classes 2008-Present

-60.00%-40.00%-20.00%

0.00%20.00%40.00%60.00%80.00%

100.00%

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11S&P 500 Gain (Loss) Gold Gain (Loss)T-Note Gain or Loss Lipper MuniIndex Gain (Loss)

Source: Reuters
http://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=DYaj4sJD2APIx6Dfrmtbe-3&key=5UfNuDXn7X&n=288506.PDF


13/64

13


ab c

weaken. This could be because growing inequalityis often associated with rapid economic growth,

rising commodity prices, and sometimes higher

inflation. Narrowing income inequality tends to

occur against a backdrop of more-stable and less

inflation-prone periods.

Typically, economic disparity also is highlyconnected to asset bubble collapses, fragile

governments, inefficient economies, corruption,

and general social immobility. Data collected bythe WEF suggest that economic disparity and

geopolitical conflict reinforce each other. Asset

bubble collapses, in particular, stimulate interest

in gold as a safe haven. According to the Council

on Foreign Relations, income disparity,

corruption, and social immobility are the principal

drivers of the wave of protests againstgovernments in the Middle East this year.

We found it interesting that gold prices dropped to

their low for this year of USD1,308/oz in mid-

January after well-received Spanish and Portuguese

bond auctions reduced euro sovereign risk. Gold

prices subsequently surged in response to the

popular discontent that began in Tunisia and quickly

spread to much of the rest of North Africa and the

Middle East. It is no coincidence that gold prices

have accompanied worries that the Libyan civil war

and popular discontent in the oil-producing Gulf states would disrupt global oil supplies. The surge in

oil prices was crucial in preventing gold from

breaking below USD1,300/oz earlier this year. Oil

prices have spurred higher gold prices before,

notably in the 1973-74 and 1979-80 energy crises.

We visit the impact of commodities on gold

throughout this report.

History has shown that gold prices are sensitive togeopolitical and social dynamics, as well as

economic and financial events. The WEF report

stated that the severity of these risks is increasing,and we believe this is likely to have a commensurate

effect on gold prices for at least the rest of this year.

The intensity of geopolitical challenges and howthey are faced will help dictate the direction of gold

prices. The US National Intelligence Council, a

center for strategic thinking, and the European

Unions Institute for Security Studies recently

concluded that current frameworks for international

cooperation leave the world ill-equipped to keep

pace with mounting geopolitical challenges without

extensive reform. This implies that geopolitical riskswill continue to bolster gold prices.

The golden ghost of MalthusThe Reverend Thomas Malthus, a British scholar,

is regarded as one of the founders of political

economy. In An Essay on the Principle of

Population (1812), he postulated that population

growth was exponential but that agriculturalgrowth was arithmetic. Thus, any sharp rise in

population would eventually lead to a food

shortage, which would ultimately be self-

correcting. To date, technological and scientificadvances and rising productivity have prevented

Malthuss prediction from coming true.

Malthuss theories have been amplified and

applied to natural resources, and they are

periodically revived, typically triggered by fears

of too-rapid depletion of world resources. These

periods usually coincide with prolonged bullmarkets for gold. The last such period was the

1970s, when the world was rocked by food and

energy crises. The Club of Rome, a global think

tank, produced in 1972 a now-famous report,

The Limits to Growth, which attempted to

model the consequences of a rapidly growing

world population and finite resource supplies. The

dominant thesis later in the 20th century was that

the market would always solve the problem high

prices would encourage technological advances,and producers would find new sources of supply.

This view generally coincides with low or stablegold prices.


14/64


15/64

15


ab c

One reason the commodity rally has had such a

bullish impact on gold is the timing of thecommodity upswing. Mr. King pointed out that

never before had there been such a large increase

in the cost of raw materials so soon after the end

of a deep and protracted recession impacting most

of the Western world. The suddenness of the

commodity rally changed inflationaryexpectations, according to Mr. King, thereby

contributing to demand for gold as an inflation

hedge. Such a large rise in commodity prices also

could puncture business and consumerconfidence, Mr. King said. If so, we would expect

gold to be a beneficiary. The recent pullback in

commodities, while steep, is not of sufficient

magnitude to allay inflation fears, especially if the

retreat proves to be short-lived in the near term.

Unorthodox policies help goldIn an effort to stave off a repeat of the GreatDepression and jump-start their economies,

Western central banks have pursued highly

accommodative monetary policies. These include

unconventional policies, including a huge increase

in bond purchases via an expansion of central

bank balance sheets. Fear of the inflationary

consequences of these policies has stimulated the

demand for gold.

According to the HSBC economics team, this

approach has been partly successful. Asset priceshave recovered, and consumer and business

confidence has risen. But while low interest rates

and easy credit have led to a rebound in activity in

the developed world, it has stimulated far greater

growth in the emerging world. Unlike the situation

in the developed world, emerging economies arenot shackled by debt. As a consequence, they have

responded vigorously to easy global monetary

conditions. The vitality of emerging nations,

combined with investor unease about the printingof money, has led to increased demand for

commodities and other non-paper stores of value,

such as gold. This helps explain the heavy demand

for gold in both the emerging and developed

worlds and the resulting price rally.

The rise in commodity-led inflation has led

financial markets to begin to price in an increase

in interest rates. Some OECD central banks,including the European Central Bank, have raised

rates, and prospects have diminished for an

extension of the second round of the Federal

Reserves quantitative easing program, scheduled

for 30 June, according to the HSBC economics

team. Despite this, monetary policy in Western

economies remains highly accommodative and is

still gold-supportive.

Metals prices have risen sharply Foodstuffs: Recent price increases eclipsed those in 2008

050

100150200250300350400450

00 02 04 06 08 10

050100150200250300350400450

Metals

Index , 2004=100 Index, 2004=100

6080

100120140160180200220

00 02 04 06 08 10

6080100120140160180200220

Foodstuffs

Index , 2004=100 Index , 2004=100

Source: Thomson Reuters Datastream Source: Thomson Reuters Datastream


16/64

16


ab c

The experience of emerging nations is different,according to Mr. King. The focus on inflation in

these countries is more pronounced, particularly

given the effects of inflation on the less well-off. The

rise in commodity prices has hastened a tightening

of monetary policies in the emerging world.

Emerging nations have favored unconventional

tightening policies, including quantitative

tightening and a clampdown on domestic credit, inaddition to conventional rate increases.

The Chinese authorities have employed a

combination of reserve requirement increases and

supply-side measures aimed at cooling food

prices, according to the HSBC economists. These

authorities have repeatedly raised reserve

requirement ratios in an effort to soak up excess

liquidity, and growth of the broad money supplyand new loans has eased since the Chinese central

bank began its tightening policy. Other emerging-

market central banks are monitoring Chinassuccess in managing inflation and may follow

suit, according to the HSBC economics team. If

the Chinese authorities fail to rein in inflation,

gold is likely to be a beneficiary.

The Middle East shock, oil, and goldUnrest in North Africa and the Middle East has

buoyed oil prices. As with other commodities, therapid rise in oil prices comes shortly after the end

of a stiff recession. Typically, oil prices do not

rise until years into an economic recovery. The

recent correction in oil prices of USD10 per barrel

to USD95, though steep, still leaves prices

historically high.

According to the HSBC macroeconomics team,

the impact on oil prices, caused in part by theuprisings in the Middle East and North Africa and

the risk of economic dislocation following the

earthquake and tsunami in Japan, threaten the

world economy with a near perfect storm.These upheavals have greatly benefited gold by

increasing inflation concerns and elevating

economic uncertainty. Oil prices are very

sensitive even to slight disruptions in supply. The

chart immediately above forecasts the effects of

tight supply on prices.

Between the rise in oil prices and the disaster in

Japan, the biggest threat to the world economy is

higher oil prices, according to the HSBC

economics team. This is also positive for gold.Higher oil prices lead to a redistribution of global

income away from oil-consuming but high-

spending economies such as the US and toward

oil-exporting and high-saving nations such as

Saudi Arabia. The propensity in oil-consumingcountries to purchase gold is high and increases

with higher oil prices. More important, perhaps,

the wealth transfer from higher oil prices leaves

oil producers with excess savings, which can be

invested elsewhere in the world. In a period of economic and political uncertainty, there is likely

to be a flight to hard assets, including gold.

Higher oil prices also lead to losses of business

and consumer confidence and changes in

inflation, which increase safe-haven demand for

gold. The rise in oil prices, which can act like atax in oil-consuming nations, may lower incomes

and curb discretionary spending on luxury items

such as gold jewelry. In this regard, higher oilprices may be negative for gold demand.

Oil prices are sensitive to small fluctuations in supply

0

20

40

60

80

100

120

140

2005 2007 2009 2011 2013 2015

0

20

40

60

80

100

120

140Lower Production

Feb base

USDUSD World oil price

Source: Oxford Economics, HSBC


17/64

17


ab c

A monetary conundrum is good forgoldAs discussed in previous editions of our Precious

Metals Outlook, inflation expectations and

monetary policy wield enormous influence on

gold prices. Although the European Central Bank recently raised rates and countries in the emerging

world are pursuing various forms of quantitative

tightening, the US Federal Reserve is unlikely totighten monetary policy, according to the HSBC

economics team, even if it does not extend its

second round of quantitative easing (QE2) and

chooses instead to maintain an accommodative

monetary policy for the foreseeable future for fear

of setting off a recession in light of substantially

higher oil and other commodity prices.

The chart at upper left shows that as the USTreasury yield curve steepened, gold prices had a

tendency to rally.

The conundrum facing US monetary policymakers is

that if they tighten policy, they may be criticized for

acting prematurely and possibly snuffing out

economic recovery. If they leave interest rates low,

they may be blamed for stirring up inflation and

boosting commodity prices. Given the history of oilprice-related recessions in the US, the Fed is more

likely to choose to keep rates low for the foreseeable

future, according to HSBC Economics. This wouldlikely extend further support to the gold rally.

Fiscal concerns are good for goldWe discussed the bullish impact of the eruption of

the euro sovereign-risk crisis on gold in our 14

May 2010 report, Precious Metals Outlook:

Golden sovereign (risk) . Gold is benefiting from

deepening government deficits and accommodative

monetary policies. If investors believe theauthorities are using fiscal policies excessively, this

poses a significant risk of rising uncertainty in theprivate sector. One channel for this uncertainty is

likely to be the gold market.

Concerns about mounting government debt levels

are not limited to the peripheral euro-zone

nations. Gold has attracted significant safe-haven

buying in the wake of action by Standard &

Poors; though S&P affirmed its AAA credit

rating on US sovereign debt, it revised its long-

term outlook to negative from stable. Sovereignrisk concerns are supportive of gold prices. At the

height of the Greek crisis in May 2010, German

banks sold a record number of gold coins, and

gold prices surged above USD1,200/oz. Even

small countries with sovereign debt problems can

have a positive effect on gold. With a GDP of

USD330.78bn, according to the latest national

figures, the Greek economy is roughly the size of

that of Washington state, which has a GDP of

USD338.33bn, according to the latest US data.

Gold and the US Treasury yield curve

0200400600800

1000120014001600

A p r - 0 1

A p r - 0 2

A p r - 0 3

A p r - 0 4

A p r - 0 5

A p r - 0 6

A p r - 0 7

A p r - 0 8

A p r - 0 9

A p r - 1 0

A p r - 1 1

-0.50.00.51.01.52.02.53.03.5

Gold (USD/oz) - LHS 10yr - 2yr (%) - RHS

Source: Reuters

Gold and the US debt-to-GDP ratio (USD/oz)

0200400600800

1,0001,2001,4001,6001,800

A p r - 7 1

A p r - 7 5

A p r - 7 9

A p r - 8 3

A p r - 8 7

A p r - 9 1

A p r - 9 5

A p r - 9 9

A p r - 0 3

A p r - 0 7

A p r - 1 1

30%

40%

50%

60%

70%

80%

90%

Gold (LHS) US Gross Federal Debt as a % of GDP

Source: Reuters, Congressional Budget Office
http://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=3ufbx4opgb&n=267580.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=3ufbx4opgb&n=267580.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=3ufbx4opgb&n=267580.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=3ufbx4opgb&n=267580.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=3ufbx4opgb&n=267580.PDF


18/64

18


ab c

The chart at the top right of the previous pageshows that as the US debt-to-GDP ratio moved

above 60%, the gold rally accelerated. The chart at

the bottom of this page shows the increase in US

government liabilities. A change in the credit

rating of the US, the worlds largest economy and

home of the worlds reserve currency, could be

risk-sapping event, according to HSBC chief

US economist Kevin Logan and G-10 currencyanalyst Robert Lynch. In a research note, Messrs.

Logan and Lynch outlined the long-term fiscalproblems faced by the US: The federal deficit is

likely to average about 7% of GDP for the next

three years. On current trends, the US debt-to-

GDP ratio will surpass 90% by the end of this

decade. In addition, interest payments on debt

outstanding are likely to rise to 20% of federal

revenues, making any long-term solution to the

deficit problem that much more difficult toachieve. It is the financial markets reduced

confidence that a long-term solution to the debt

problem will be found that has helped propel gold

to new highs.

The ugly sisters currencies andCinderellas golden slipperIn Currency Outlook: The ugly contest turns

uglier (7 April 2010), David Bloom and the

HSBC currency research team outlined the lack of a clear positive choice among the Big Four

currencies: the USD, EUR, GBP, and JPY.

Gold seems to be one of the Cinderellas in the

currency ugly sister contest. In a pre-crisis

world, the foreign exchange market would likely

be looking to sell the USD, Mr. Bloom said, basedon US economic fundamentals. However, the

situations in Portugal and Ireland, as well as

Greece, mean that it is difficult to turn naturally tobuy the EUR. Meanwhile, the UK has its own

fiscal problems. The JPY is not a good candidate

for purchase due to recent coordinated

intervention by the Group of 7 nations. The

unintended consequences, the HSBC currency

research team said, are that the market is bullish

on currencies of OECD and emerging-marketcommodity-producing nations and the CHF. Gold

and currencies of EM and OECD commodity-

producing countries have had a positivecorrelation going back well before the financial

crisis. In this climate, appreciation of these

currencies would benefit gold. Strength in these

currencies also helps explain some of golds rally.

The chart overleaf shows what the HSBC

currency research team describes as the smaller

OECD good currencies versus the four major

US government debt outstanding has doubled since 2004

US Gov ernment Debt Outstanding

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

2010200620021998199419901986198219781974197019661962195819541950

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000USD bn USD bn

Source: Bloomberg, HSBC
http://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=gWfqTEcpGF&n=295396.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=gWfqTEcpGF&n=295396.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=gWfqTEcpGF&n=295396.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=gWfqTEcpGF&n=295396.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&$sessionid$=hbyPBrQDud6IlNkPYv2eFBG&key=gWfqTEcpGF&n=295396.PDF


19/64

19


ab c

bad currencies. The team defines goodcurrencies as traditional safe havens and those of

commodity-exporting countries and bad

currencies as the four most heavily traded OECDcurrencies (see the chart immediately above).

Even if the US economy begins to recover and the

Fed starts to unwind some of its ultra-

accommodative policies, a sustained USD rally

should not be expected, Mr. Bloom said.

According to the currency teams analysis, if the

US economic recovery accelerates, then the US

current account deficit will start to start to widenagain. This implies that overseas investors will

acquire yet more US assets at an increasing rate,

and it may well be that this can be achieved only

if US assets are made less expensive through a

weaker dollar. Based on the historical dollar/gold

inverse relationship, a weaker USD is a long-term

recipe for strong gold prices.

Macroeconomic themesThe currency markets are supportive of gold.

Each of the major four freely traded currencies

the USD, EUR, GBP, and JPY has its own

drawbacks. This makes gold a widely accepted

surrogate currency and emerging-marketcurrencies a viable alternative for investors.

If history is any judge, the decade-long gold rally

will not end until the Federal Reserve changes

current accommodative policies, the USD

stabilizes, and progress is made on reducing the

US government budget deficit and restraining

growth in the debt-to-GDP ratio. Lower

commodity prices and a reduction in geopolitical

tensions also would help take the steam out of the

gold market. Conversely, any further decline in

investor confidence regarding monetary and fiscalpolicies is likely to translate into higher gold

prices. Also, as commodity prices resume their

advance and geopolitical risks remain elevated,

investors are likely to return to gold, we believe.

Commitments of Traders reports stillshow a commitment to goldIn the Commitments of Traders reports issued bythe Commodity Futures Trading Commission, net

speculative long positions in gold, in our view,

have been a reliable barometer of investor

attitudes toward the metal. Speculators have been

net long gold on the Comex since the genesis of the

bull market in 2001. Despite being overall net long,

Gold tends to move positively with good currencies

96

100

104

108

112

116

120

124

Jan-09 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Aug-10 Oct-10 Dec-1096

100

104

108

112

116

120

124Ugly contest currencies (USD, EUR, GBP and JPY)

Good currencies (AUD, NZD, CAD, NOK, SEK and CHF)

Good versus Ugly currencies trade weighted (Jan 1 2009=100)

96

100

104

108

112

116

120

124

Jan-09 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Aug-10 Oct-10 Dec-1096

100

104

108

112

116

120

124Ugly contest currencies (USD, EUR, GBP and JPY)

Good currencies (AUD, NZD, CAD, NOK, SEK and CHF)

Good versus Ugly currencies trade weighted (Jan 1 2009=100)

Source: HSBC currency research, Bloomberg


20/64

20


ab c

positions are often subject to considerable volatilityand fluctuations, which can visibly affect gold

prices. We believe this helps explain golds

price volatility.

Net long speculative activity in 2010 reflected

price movements for that year. Net long positions

hit a low for the year of 21.3moz in the week of 9February. This coincided with the low for gold

prices that year of USD1,043/oz, touched on 5

February. Both prices and net long speculativepositions recovered notably thereafter. Net long

speculative positions reached 30.3moz just

800,000oz below the record high the week after

gold hit a then-record high of USD1,270/oz on 21

June. Long positions fell to 21.9moz by late July,

in line with a drop in price below USD1,200/oz to

USD1,157/oz. Net long positions rebuiltthereafter, peaking at 30.3moz in late September.

Long speculative positions eased moderately in

the following months but remained historicallyhigh, touching 27.9moz when gold hit the then-

record high of USD1,430/oz in early December.

Early this year, changes in net long speculative

positions reflected the steep drop in prices. Net

positions fell throughout January, dropping to

19.3moz by the end of the month, just as gold hit

its year-to-date low of USD1,308/oz. Since then,

net speculative long positions have grown bymore than 6.6moz to 26.6moz, as prices surged to

all-time highs toward the end of April. The latest

data showed a reduction in net longs to 24.0moz

as of 3 May, as gold prices retraced more than

USD100/oz, after reaching a record high.

Net long speculative positions represent about

c747t of gold, a little less than one-third of global

mine output. Net long positions have beenhistorically high for many months, staying well

above 20moz since July 2009, with the exception

of just two weeks in January this year. As net longspeculative positions remain at such high levels,

the sheer weight of long positions may encourage

speculative liquidation. Between early December2009 and early February 2010, net long

speculative positions fell from a record 30.8moz

to 21.3moz, a decline of 9.5moz in just three

months. This is equivalent to 295t of gold, more

than the annual output of Australia, the worlds

second-largest gold producer. The liquidation

helped drive gold from a then-record high of

USD1,226/oz to below USD1,150/oz. A similarliquidation occurred between November 2010 and

January this year with a commensurate effect onprices. Net long speculative positions fell from

30.3moz to 19.3moz, a decline of 10.7moz, as

prices dropped from a high of USD1,430/oz in

early December to USD1,308/oz by the end of

January. More recently, a 2.7moz in net long

speculative positions from 19 April to 3 May

helped knock gold off its record highs and down

cUSD100/oz.

Even with the recent decline in net long positions,the sheer size of these speculative positions may

invite further temporary bouts of liquidation, with

the commensurate effect on prices, the long-

running accumulation of long positions clearly

coincides with the multiyear bull market. We

believe the increase in net longs has played an

important role in golds record-breaking rally, isconsistent with an increase in demand for safe-

haven assets, and reflects heightened investor

uncertainty. The following chart shows thecombined ETF and net long speculative positions.

Gold: ETF and net speculative positions

A p r - 0

4

O c t - 0

4

A p r - 0

5

O c t - 0

5

A p r - 0

6

O c t - 0

6

A p r - 0

7

O c t - 0

7

A p r - 0

8

O c t - 0

8

A p r - 0

9

O c t - 0

9

A p r - 1

0

O c t - 1

0

A p r - 1

1300

500

700

900

1100

1300

1500

1700

0

20

40

60

80

100

120

Spec position in COMEX (RHS) Gold in ETFs (RHS)Gold Price Usd per oz (LHS)

A p r - 0

4

O c t - 0

4

A p r - 0

5

O c t - 0

5

A p r - 0

6

O c t - 0

6

A p r - 0

7

O c t - 0

7

A p r - 0

8

O c t - 0

8

A p r - 0

9

O c t - 0

9

A p r - 1

0

O c t - 1

0

A p r - 1

1300

500

700

900

1100

1300

1500

1700

0

20

40

60

80

100

120

300

500

700

900

1100

1300

1500

1700

0

20

40

60

80

100

120

Spec position in COMEX (RHS) Gold in ETFs (RHS)Gold Price Usd per oz (LHS)

Source: HSBC, Gold Bullion, ETF Securities, CF TC


21/64

21


ab c

ETFs: Dont be fooled by liquidationA notable feature of the gold market has been the

popularity of gold exchange-traded funds (ETFs)

with investors. Despite liquidation this year, the

ETFs continue to hold a substantial amount of

bullion. Of the 10 gold ETFs that we monitor,

combined off-take as of 6 May stood at 2,040.4t

of gold, or c80% of the worlds annual productionof gold. This is down c28t from the all-time high

of 2,068.4t in ETF holdings reached near the end

of 2010. The low in ETF holdings year-to-date is

1,980.5t, plumbed on 24 February.

A feature of the gold ETFs this year is an increase

in volatility. We do not view the liquidation in

ETF holdings modest as it is as necessarily

bearish. We believe some of the liquidation maybe attributed to investors switching into allocated

accounts and other forms of bullion holdings.

Thus, the declines in the ETFs do not represent an

overall drop in gold investment.

Despite an increase in volatility, swings in

holdings from the gold ETFs are still modest by

comparison with the Comex. Traditional futures

and options trading is typically more volatile and

more subject to short-term fluctuations than ETF

trading. This can make swings on the Comex

more influential in determining short-term pricemovements than the ETFs, despite the Comexs

considerably smaller market position.

ETF holdings notably overshadow long positions

on the Comex. Comex longs are little changed on

the year and account for about 747t, while ETF

demand is down c28t at 2,040.4t from the

beginning of the year. Though the pace of demand

may be slackening, gold ETFs still account for theequivalent of more than c80% of global annual

mine output. In aggregate, the ETFs also are the

sixth-largest holders of gold in the world, behind

the central banks of the US, Germany, France, andItaly, and the International Monetary Fund.

Combined ETF and Comex holdings are theequivalent of 2,787t of gold, or about the level of

annual mine output. We anticipate that demand

for allocated gold and other sources of bullion

may limit any increase in ETF off-take to c230t

this year. After increasing to a record 1,360t in

2009, total investment demand in 2010 edged

down to 1,297t, by our calculation. We forecast

this may fall to USD1,100t this year. Despite thedecline, investment demand remains high on a

historical basis. We believe that based on investorconcerns, demand for ETFs and coins and bars

will be sufficient to help usher gold prices higher

this year. That said, at substantially higher gold

prices, demand for these products could moderate,

and this should help cap rallies.

Trends in supply and demandGold supply: Producers dig high pricesWith gold prices significantly above costs of

production and likely to remain so for the

foreseeable future, we believe producers have

an enormous financial incentive to increase

output. Despite a more than doubling in the gold

price in less than four years, production onlyrecently surpassed that in the banner year of 2001.

According to the GFMS precious metals

consultancy, gold production in 2001 totaled

2,646t. In the most recent World Demand

Trends produced by GFMS for the World Gold

Council, 2010 output was tabulated at 2,659t. We

estimate that additional gains this year will push

production further above 2001 levels.

Producers have had to contend with challenges

contributing to sluggish output. We have

examined these obstacles in greater detail inprevious editions of our Precious Metals Outlook .

They include a chronic shortage of skilled and

technical personnel, notably geophysicists,

geologists, and mining engineers; long waitingtimes for essential equipment; declining ore

grades and dwindling reserves in the mature


22/64

22


ab c

producers; and longer permitting and regulatoryprocesses. Power constraints and a lack of fresh

water also are curbing production notably but

not exclusively in South Africa. Although the

global financial and economic crisis has helped

contain certain cost pressures, prices of key

inputs, notably cement, steel, power, and fuel, are

rising again.

Prices remain comfortably ahead of costs. This

has allowed producers to absorb increases incosts, while maintaining production at higher

levels than would otherwise have been the case.

Projects that would have been rejected as too

expensive just a few years ago were deemed

feasible as gold prices climbed to new highs.

Despite these obstacles, we anticipate further gold

output gains this year. More production is

scheduled to come on stream, as investmentsmade earlier in the mining cycle translate into

greater output. Until now, the long lag time

between investment and output has prevented a

meaningful production response to high prices.

High gold prices also have led to the restart of

operations that were on care-and-maintenance

schedules and have encouraged producers to bring

forward production schedules wherever possible.

Based on available company data, we expect

production this year will grow by c90t, or c4%, to2,750t. This represents a 25t increase from our

previous 2010 forecast of 2,725t. We believe there

are sufficient projects in the works to boost gold

mine output until 2014. The chart above right

shows gold mine production.

In previous editions of our Precious MetalsOutlook, we examined work by Sabrina

Grandchamps and Lucia Marquez, HSBC equityresearch analysts in metals and mining, on the

effect of higher prices in investment and reserves

replacement. According to these analysts report,Global Metals & Mining: From Safari to Siberia

(28 March 2009), declining trends in traditional

gold-producing regions have spurred a new wave

of investment in other regions, leading to growingmine supply in other parts of the world.

Furthermore, in their 4 May 2010 report, African

& CIS gold miners: Takeaways from reserve

replacement trends in 2009, the analysts found

that a majority of gold mining companies in and

outside of HSBCs gold equities coverage have

been able to replace ounces mined with the help

of higher gold prices.

The renaissance in production is likely to be

temporary, we believe. Producers still have to

contend with a host of challenges that willinevitably limit production. Based on current mine

production schedules, global production is likely

to peak around 2014 and ease gradually thereafter.

Long-term declines in output due to falling

reserves will be most pronounced in the mature

and developed producers, notably South Africa,the US, Canada, and Australia.

A slow climbAccording to US Geological Survey (USGS) data,

the majority of all the gold ever produced has

been mined since 1900, with the bulk of this

production coming from just four countries: South

Africa, the US, Canada, and Australia. A feature

of the market has been the relative decline in

production in these traditional producers. In

particular, falling grades and difficulties in

replacing reserves have limited output from these

Gold mine production (metric tons)

2200

2300

2400

2500

2600

2700

2800

2001 2003 2005 2007 2009 2011f

Source: GFMS, WGC, HSBC
http://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=xbdnjfjfiy&name=266755.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=xbdnjfjfiy&name=266755.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=xbdnjfjfiy&name=266755.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=xbdnjfjfiy&name=266755.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=xbdnjfjfiy&name=266755.PDFhttp://www.research.hsbc.com/midas/Res/RDV?p=pdf&ao=20&key=xbdnjfjfiy&name=266755.PDF


23/64

23


ab c

traditional producers. In the next couple of years,we believe, aggregate world production will rise;

this includes production from some traditional

producers. Following is a discussion of the near-

term outlook for some of the larger producers.

US: The USGS survey estimates that US gold

mine production in 2010 grew c3% to 230t,compared with 223t in 2009. This marked the first

increase in domestic production since 2000.

Increased production from new mines in Alaskaand Nevada and from existing mines in Nevada

accounted for much of the increase. These

increases were partly offset by decreases in

production from mines in Montana and Utah. US

production may increase c2% this year to c235t,

as production from Barrick Golds Cortez Hills

project in Nevada approaches full capacity.

South Africa: Output in South Africa, formerlythe worlds largest gold producer, fell 6.4% in

2010 to 191,833.7 kg, according to the South

African Chamber of Mines. Production costs are

relatively high due to the strong ZAR and the

expenses involved in running the worlds deepest

mines, some of which are 4 km below the surface.

Additionally, grades are generally low, compared

to most other large producers, and labor costs are

high by international standards.

Safety-related stoppages have also hindered

production. Recent calls for the nationalization of the mines by the youth wing of the ruling African

National Congress (ANC) although rejected by

the senior party leadership has nonetheless had

an adverse impact on international investment in

the gold mining industry. New production at deep

mines in the Free State and West Rand will offset

closures from aging facilities this year. Accordingto Statistics South Africa, gold production in

February declined 2.3% annually, following 3.2%

growth in January. Statistics South Africa issueschanges only in percentage terms. Despite

evidence that output is bottoming, it will be

difficult for the industry to arrest the long-runningtrend of output declines.

Russia: Russian gold companies produced 19.98t

of gold in the first two months of 2011, up 13.9%

from a year earlier, according to the Gold

Industrialists Union. Mined output in January-

February increased 12.6% from the year-earlierperiod to 16.38t. Output of gold as a byproduct of

other metals increased by a substantial 95.1% to

12.27t, while refining from scrap was essentiallyunchanged at 2.37t, according to the

Industrialists Union. Output in 2010 fell 1.4% to

201.3t, but the union has indicated that production

will recover this year to 205-207t, based on

increases in new projects.

Australia: The Australian Bureau of Agricultural

and Resources Economics (Abare) has forecast an

increase in domestic gold mine production of 14%this year to 274t. Growth will be supported by the

ramping up of Newmonts Boddington mine,

which, according to the Abare, may produce 25t

of gold this year. Several other new projects are

forecast to contribute to production. Abares

forecast for 2012 grows 3% to c282t. Several

midsize operations in Western Australia are

expected to boost domestic output. This new

output should more than offset declines from

some operations that nearing the ends theirlifespans.

Abare is optimistic about production in 2013 and

2014, which it expects to rise to 291t and 314t,

respectively. This is based on the projected start-

ups of large-scale projects in Queensland and the

Northern Territories. Production is expected to

flatten in 2015 and 2016 at 315t for each year, as

lower production from existing facilities offsetsincreases from new projects.

China: China extended its position as the worlds

largest gold producer in 2010. According to the

China Gold Association, domestic gold


24/64

24


ab c

production increased 8.57% last year to a recordhigh of 340.88t. As discussed in our previous

editions of Precious Metals Outlook, China

appears unlikely to hold on to its top position in

the longer term. Although numerous, Chinas gold

mines are small by international standards, and

they have relatively short lifespans.

The Chinese gold producing industry has gone

through a bout of government-sponsored

consolidation. Chinas top 10 gold producersaccounted for nearly half of total output last year.

Meanwhile, the number of gold producers has

fallen to slightly more than 700 from 1,200 in

2009. According to the USGS, China has less than

two-thirds of the gold reserves of the US, despite

producing two-thirds more gold than the US in

2010. This implies that China does not have asufficiently large reserve base to sustain

production at current levels for the longer term.

The lack of well-defined reserves and the paucityof world-class projects make it likely that Chinese

production will peak in 2012-13 and begin to

decrease thereafter.

Peru: Perus gold production in February fell

16.% from a year earlier to 12.5m grams,

according to the of energy and mining ministry.

The decrease was attributed to lower production

from some larger producers, including MineraBarrick Misquichica, Minera Yanacocha, and

Compaa Minera Ares; their production fell 51%,

29%, and 20%, respectively, year-on-year,

according to the mining ministry. These declines

make it likely that 2011 output will come in below

2010 levels.

Official sector: The pendulum swingsAfter many years as heavy net sellers of gold, the

official sector has swung from an important

contributor to supply to a source of net demand.

Based on data from the Bank for InternationalSettlements and our own estimates, we believe

that the official sector in 2010 was a net buyer of

gold for the first time in more than two decades,absorbing c50t. This compares to net sales of

c30t, according to the Bank for International

Settlements (BIS).

According to BIS data, the signatories to the third

Central Bank Gold Agreement once significant

sellers sold only 7.1t in the first year of CBGA3,which ended 26 September 2010. This did not

include the sale of a small amount of bullion for the

minting of gold coins. For the CBGA3s secondyear so far, the signatories have sold less than 1t.

This is a significant turnaround in policy from sales

patterns just a few years ago. Combined sales from

the first two CBGA agreements from 26 September

1999 to 26 September 2009 totaled 3,884t of gold,

or an average of 388.4t per year. This was more

gold than the annual output of South Africa, theworlds largest gold miner at the time. The lack of

appetite for sales within the CBGA in the last two

years is an important bullish development for gold.

Under the rules of the agreement, the CBGA

signatories have a sales quota of 500t annually.

Given the paucity of sales to date and statements

by the two largest holders of bullion in the

CBGA, Germanys Bundesbank and the Swiss

National Bank, that they have no intentions to sell

any more gold, it is unlikely that the signatories

will collectively sell anything more than a verymoderate amount of gold this year.

Although official sector sales were already

slowing ahead of the global financial crisis, we

believe that its onslaught and golds strong price

performance during that period led reserve

managers to reassess their gold sales intentions.

We see little likelihood that the signatories of the

CBGA will resume any level of meaningful salesin the foreseeable future. Other large official-

sector holders of gold, including the US and

Japan, also have said that gold sales are off-limits.


25/64

25


ab c

The International Monetary Fund replaced centralbanks as the main supplier of official sector gold in

2010. The IMF executive board approved sales of

gold that the IMF had acquired following the second

amendment of its articles of agreement in April

1978. This amounted to 403.3t, about one-eighth of

the IMFs total holdings at the time of approval.

In November 2009, the IMF sold 200t to the

Reserve Bank of India, followed by 2t and 10t to

the central banks of Mauritius and Sri Lanka,respectively. The IMF announced in February 2010

that phased sales of gold on the market would be

initiated to dispose of the remaining 191.3t. If

another official-sector buyer could not be found,

the gold would be sold on the open market through

the CBGA. On 7 September 2010, the IMF sold 10t

to the Bangladesh Bank. This reduced the amountof gold that needed to be placed on the market. In

December 2010, the IMF concluded the gold sales

program, with total sales of 403.3t. The IMF has nofurther plans to sell gold.

With no further sales forthcoming from the IMF

and the likelihood of only moderate sales from the

CBGA, any significant purchases of gold by

central banks would result in net purchases of

bullion by the official sector.

Outside the CBGA, the main purchases reported

in 2010 were from Russia. According to BIS data,

the Russian central bank purchased 139.8t of gold.A handful of other countries, including the

Philippines, Venezuela, and Thailand, also

accumulated gold. China may also have

accumulated gold from domestic sources, but this

has not been reported to the BIS. In early May,

data from the Mexican central bank showed its

purchase of 3moz of gold in Q1 as part of itsforeign exchange reserves.

With the exception of the Mexican purchase,official data show little official-sector activity so

far this year. We consider it likely that the data

have not yet caught up with some of the

transactions. Emerging-market central banks are

likely to increase gold holdings, both as a means

to diversify away from the USD and as an overall

strategy of portfolio diversification, we believe.

The continuing rapid accumulation of USDs intheir foreign exchange reserves by many

emerging-market central banks may acceleratethis process.

We believe that central banks around the world are

adopting an increasingly favorable attitude to gold

and may therefore absorb a significant amount of

bullion this year from the international markets.

The Chinese monetary authorities will likely refrainfrom making any direct international gold

purchases for fear of dislocating the market, in our

view. Rather, we believe, China will quietlyaccumulate gold from domestic production, which

the central bank is not obliged to report to the BIS.

The rapid growth in foreign exchange reserves,

mostly in US dollars in emerging nations, implies

that central banks will have to buy gold if they

wish to maintain their current balance of gold to

foreign exchange holdings. In the absence of any

major sellers, we estimate that the official sectorcould absorb net 300t of gold this year.

Scrap: A major source of supplyThe absence of official sector sales leaves the

scrap market as the most important source of

secondary gold supply. Scrap supplies have

tended to rise in tandem with gold prices. The

scrap market grew from c600t in 2000 to c1,653tin 2010, according to data compiled for the World

Gold Council by the GFMS precious metals

consultancy.


26/64

26


ab c

Although the bulk of recycled gold traditionallycomes from the emerging world, supplies from

the OECD nations have risen as a proportion of

market share in the last few years. According to

data compiled by GFMS for the World Gold

Council, scrap supply in 2010 was c20t below the

2009 level of 1,672t. Thus, scrap supply was

largely unchanged, despite a 29% increase in the

average price of gold in to USD1,225/oz fromUSD973/oz in 2009. This argues against the

notion that scrap supplies are purely a function of the gold price.

A modest improvement in employment in much

of the OECD world may be limiting distress scrap

sales. More important in the midst of still-high

gold prices, merchants and other scrap market

participants may be holding on to material in thehope of resurgent prices. This may explain why in

the face of high prices, the market was not

deluged with additional scrap supplies.

The scrap market traditionally performs an

important function as a balancing mechanism in

the physical markets. Merchants typically

mobilize bullion stocks during periods of

escalating prices, thereby increasing supply, and

they reduce scrap supplies when prices are low.

We credit the appearance of substantial amounts

of scrap in 2008, 2009, and 2010 with helping tosupply bullion to the growing investment markets,

notably the ETFs. Without the contribution of

scrap, the physical markets would be in a

significant deficit, according to our

supply/demand model.

High prices eventually will stimulate additional

supply, in our view. Also, while merchants may

have been holding supply back from the market asprices rose, the recent correction may trigger a

flood of scrap as holders rush to secure still-high

prices. We forecast scrap supply this year atc1,650t, similar to the level in 2010. This

represents a c350t increase in scrap volume from

our previous estimate of 1,300t for 2011.Additional scrap supplies are likely to play a role

in tempering the rally, in our view.

Gold demand: Back from the brinkDehedging: The final act

A long-running feature of the gold market hasbeen the industry trend toward dehedging, the

process whereby producers buy back or otherwise

close out previously established hedges.

Producers reversal in hedging policies dates back to the beginning of the current bull cycle in 2001-

02. The pace of producer buybacks is slowing

markedly as a greatly diminished global hedge

book leaves producers with little in the way of

hedge positions to close out.

According to the Fortis subsidiary Virtual Metals

Gold Hedging Report, the global hedge book inQ4 2010 declined 1.7moz to 4.7moz from the

year-earlier quarter. For the entire year, the global

hedge book fell from 8moz to 4.7moz, a drop of

nearly 40% from 2009. The decline would have

been greater had it not been for the initiation of a

significant hedge by the Mexican miner Minera

Frisco that was initiated toward the end of 2010

but that was not reported until early this year.

Anglogold Ashanti reported in October 2010 that

it had eliminated the remainder of its hedge book,

which stood at 2.4moz. Other smaller hedges were

also wound down by other producers.

The global hedge book is unlikely to be

eliminated entirely. Gold hedges in 2010

increased for the second year in a row, albeit

moderately. It may be too early to herald a change

in producer attitudes toward hedging. But with

prices well above marginal costs and some new

projects requiring some form of hedging to attainproject financing, we may see a small recovery in

hedging going forward.


27/64

27


ab c

As producer dehedging slowly fades, an importantsource of demand is gradually being removed from

the market. To this extent, reduced dehedging is

gold-bearish. Despite the initiation of some new

hedges in 2010, the industry remains collectively

bullish, and most mining companies continue to

embrace an antihedging philosophy. Consequently,

we expect new hedges to be modest. Dehedging

will inevitably be a dwindling source of demand, webelieve, simply because at less than 5moz, there is

little left in the way of hedges outstanding to closeout. After contributing c116t of new demand in

2010 and given the small size of the hedges

outstanding, dehedging will contribute just c25t to

demand this year, we expect.

Fabrication demand recove

hsbc precious metals outlook

Documents