Business

What’s behind the drop in gold and platinum?

The simple answer to the question why gold is falling is the strength of the US dollar, up nearly 10% against the Euro since February this year. That, and the resilience of the US stock market. The S&P 500 index regained nearly 6% in the last two months after a nasty sell-off in January, proving the doomsayers wrong yet again.

Perhaps the real question is why the dollar is so strong? The US economy is on a tear. Corporate profits are the best they’ve been in seven years due to tax cuts, encouraging jobs reports and resilient consumer spending. That has hurt gold’s vaunted status as a hedge against risk, though technical analysts point out that it remains within the lower ranges of a rising wedge formation and should bounce. If it breaks below this level, there could be further sharp drops. Another reason gold is low is the prospect of higher US interest rates, which raises the opportunity cost of buying gold.

The gold price hit US$ 1 276 an ounce last Wednesday (June 20), a drop of nearly 6% since April. More concerning is the nearly 17% drop in platinum prices to US$ 861/oz since January. Palladium traded at US$961/oz, marginally up over the same period.

David Shapiro, deputy chairman at Sasfin Securities, says the strength of the US dollar, which has an inverse correlation to commodity prices, is one of the reasons for the drop in the gold price.

“The gold price has been relatively flat for nearly five years now and no-one has really got to the bottom of it,” he says. “Gold is supposed to be a hedge against crisis, but there are so many other hedges out there now. We’ve had a number of financial crises in recent years and gold still hasn’t responded.”

Platinum and palladium face an entirely different set of challenges. South African platinum producers are being squeezed on both sides: they have a low dollar platinum price to contend with, and high unit costs, says Victor von Reiche, portfolio manager at Citadel. “As a result the majority of the SA producers are cash burning at current spot prices. Above-inflation wage increases, high electricity prices and a lack of investment in the industry over a number of years have all taken their toll on the miners.”

As price takers, SA platinum producers are beholden to the ruling market price, squeezed lower by the growing threat of low-cost supply from Russia and Zimbabwe. Other factors weighing on the price are the continued growth in recycled platinum group metals (PGM) supply, growth in the market share of electric cars over PGM-consuming diesel cars (the latter are big consumers of platinum, which is used in catalytic converters to reduce noxious emissions), and changes in consumer trends.

“A key factor has been concern regarding future demand for platinum used in diesel vehicle emission control, given the negativity surrounding the VW emission fraud scandal,” says von Reiche. “This has come to the fore in the past two weeks as Audi chief executive Rupert Stadler has been arrested for fraud, and Daimler boss Dieter Zetsche has been summoned for talks.”

A recent German court case allows cities to ban diesel cars in certain areas (due to environmental concerns). The World Platinum Investment Council quarterly report issued last month shows diesel car sales entering a slump. Platinum demand for the automotive sector declined 4% year-on-year with Western Europe, the world’s biggest market, suffering the biggest reductions.

The report states: “The UK continues to be a drag on sales, with overall car registrations down 16% year-on-year in March 2018, but diesel sales underperformed the market, down 37% year-on-year.”

Diesel’s share of the UK car market fell from 43.5% in March 2017 to 32.4% in March 2018. That’s worrying for diesel car makers. Another aggravating factor is the decline in platinum content in cars as platinum group metal-free Selective Catalytic Reduction (SCR) systems replace older technologies.

Peter Major, director of mining at Cadiz Corporate Solutions, believes platinum shares offer good value based on the metal’s lower than average long-term price. Mining stocks are highly cyclical, but are now still 50% of their 2011 peak. “SA has roughly 70% of the world’s platinum group metals supply, but the sector expanded too quickly after government nationalised all mineral rights in 2004,” Major told Moneyweb. “That pushed up production and depressed market prices.”

Von Reiche believes the platinum sector is speculative at best and will only turn the corner if further output is removed from the market and if the demand side of the equation becomes clearer.

Perhaps one of the more shocking outcomes of the slump in metal prices is the effect on mining stocks. Implats’s market cap has halved to R23 billion since December last year, making it a relatively insignificant player on the JSE. Northam Platinum’s market cap is down by a third over the same period. Amplats is down nearly 40% since October 2017, but it is in a healthier position than its cash-turning peers thanks to its low cost open-pit mine operation Mogalakwena.

Global platinum mining supply is forecast to dip 3% this year, while recycling expands 3%. Autocatalyst recycling continues to trend higher, although growth is expected to slow to 5% from 9% in 2017, reaching 1 405 koz, and this outweighs a 2% dip in jewellery recycling, says the World Platinum Investment Council (WPIC).

SA platinum production is expected to drop 1% this year, and Zimbabwe by 5%. “Shafts in ramp-up phase are scheduled to add around 105 koz this year,” says the WPIC report, “but last year’s mine closures and pipeline lock-up from a furnace outage mean refined production will be lower overall compared to 2017.

“Compared to last quarter, projected South African output in 2018 has been revised up to take account of a more stable production environment and producers’ efforts to maximise mining and processing efficiencies in response to low platinum prices.”

Investment case for gold and platinum

Says von Reiche: “Gold and platinum equities are low for a reason and do not offer value to investors. These two sectors should only be considered if one has a high conviction that the dollar prices of the metals will rise significantly. The shares are highly leveraged to the commodity prices so substantial profits could be made (and lost), given significant movement in prices. The caveat is that the prices need to recover, and we do not envisage that occurring soon.”

Gold versus SP 500