Standard Chartered: Gold to Reach $5,000 Due to Supply Shortage

on June 14 2011 3:04 PM
Gold Bars
Gold bars are seen in this picture illustration taken at the Czech National Bank in Prague Reuters

Standard Chartered came out with a report today making a case for Gold to reach $5,000/oz based on 3 main factors; 1) limited gold production, 2) buying by central banks, and 3) increasing demand by India and China.

All three factors can potentially drive the gold price to $5,000/oz.

If gold can reach $5,000, I'm sure the US Dollar will continue it's depreciation and reach all-time new lows.

Here is an excerpt from their report:

We are bullish on gold. Most market commentary on gold has centered on the direction of US dollar movements or inflation/deflation issues. We go beyond this to examine future mine supply, which we think is just as important a driver. Our comprehensive study of 375 gold projects supply suggests a very limited production growth profile for the next five years. A ten-year bull market in gold has done little to drive gold production. The gold miners are running to stand still. A lack of funding from equity markets and a shortage of large gold mines makes it difficult for the industry to compensate for the depletion caused by aging mines and falling grades. In our base case, our 375-mine supply model shows net production growth of 3.6% pa. over the next five years.

Our IRR analysis shows that for the major gold projects under construction, for which the acquisition cost of gold resources has already been spent, the gold price would need to be US$1,400/oz in order to generate a 20% IRR, which is usually the minimum return requirement. For greenfield projects going forward, the gold price would need to be nearly US$2,000/oz to produce an IRR of 20%. We believe this daunting hurdle will likely further delay gold production. The limited supply comes at a time when central banks have completely changed their tune on selling down their gold stocks and now appear likely to accelerate their net buying programmes. China is way behind the curve. Currently, only 1.8% of China's foreign exchange reserves is in gold; if the country were to bring this proportion in line with the global average of 11%, it would have to buy 6,000 more tonnes of gold, equivalent to more than 2 years of gold production.

We believe that these factors - limited gold production, buying by central banks and increasing demand from India and China - can potentially drive the gold price to US$5,000/oz, as highlighted in our commodity team's earlier report, Gold - Super-cycle to extend above US$2,100/oz (17 April 2011). We believe the best ways to invest in the gold cycle are buying physical gold (a safe asset) or investing in junior gold miners (highest leverage to the gold price) that are 1-2 years away from production. We are cautious about the gold majors. Project plans of the big five gold producers by market cap suggest an average production CAGR of only 4% in the next five years. They need to depend on expensive acquisitions in order to grow further. As a form of affirmation, the share price index we constructed for the gold majors underperformed the gold price by 147ppt over 1995-2011.