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1、March 25,2009 Commodities:Frameworks Goldman Sachs Global Economics,Commodities and Strategy Research 1 March 25,2009 Commodities:Frameworks Forecasting gold as a commodity Gold as a commodity This report introduces a new framework for analyzing the influence of monetary demand and gold supply on th
2、e price of gold.Based on this framework,we present a new approach for forecasting the price of gold based on the monetary demand for gold(specifically,the buying by gold-ETFs and the selling by central banks)and on the crucial role of the real interest rate in determining the opportunity cost of min
3、ing.Low real interest rates expected to support gold prices above current levels This“gold as a commodity”framework suggests that gold prices have strong support at and above current levels,should the current low real interest rate environment persist.Specifically,assuming real interest rates stay n
4、ear current levels and the buying by gold-ETFs slows to last years pace,we would expect to see gold prices near$930/toz over the next six months,rising to$962/toz on a 12-month horizon.Should real interest rates move lower or buying by gold-ETFs continue at its current torrid pace,however,the upside
5、 risk to prices would be significant.David Greely(212)902-2850| Goldman,Sachs&Co.Jeffrey Currie+44(20)7774-6112| Goldman Sachs International The Goldman Sachs Group,Inc.does and seeks to do business with companies covered in its research reports.As a result,investors should be aware that the firm ma
6、y have a conflict of interest that could affect the objectivity of this report.Investors should consider this report as only a single factor in making their investment decision.For important disclosures,see the text preceding the disclosures or go to Goldman Sachs Group,Inc.Goldman Sachs Global Econ
7、omics,Commodities and Strategy ResearchMarch 25,2009 Commodities:Frameworks Goldman Sachs Global Economics,Commodities and Strategy Research 2 Table of contents Forecasting gold as a commodity 3 The historical behavior of supply,demand and physical inventories,and the economics of the gold market 5
8、Forecasting gold prices 13 Real interest rates and the pricing of gold as a currency 21 Disclosures 23 March 25,2009 Commodities:Frameworks Goldman Sachs Global Economics,Commodities and Strategy Research 3 Forecasting gold as a commodity The monetary demand for gold has played a significant part in
9、 the large swings in gold prices of the past decade,with the selling of gold from government central bank reserves in the late 1990s depressing gold prices and the buying of gold for private investmentincluding the new gold exchange traded funds(gold-ETFs)sending gold prices through$1,000/toz twice
10、during the current financial crisis(Exhibit 1).Because the monetary demand for gold has had such a significant influence on gold prices over the past decade,it is tempting to view gold prices as driven simply by the vagaries of government policy and the investors view of financial distress;however,w
11、hen viewed within the larger historical context,the past decades rise in gold prices falls within a longer cycle in gold prices,driven more by the economics of gold supply.This report introduces a framework for understanding the influence of both monetary demand and the economics of gold supply on t
12、he price of gold.Based on this framework,we present a new approach for forecasting the price of gold based on the monetary demand for gold(specifically,the buying by gold-ETFs and the selling by central banks)and on the crucial role of the real interest rate in determining the opportunity cost of mi
13、ning.Exhibit 1:Gold prices have increased four-fold over the past decade,and have become substantially more volatile over the past year USD/toz 0.00200.00400.00600.00800.001000.001200.00Mar-99Mar-00Mar-01Mar-02Mar-03Mar-04Mar-05Mar-06Mar-07Mar-08Gold Price Source:Commodities Exchange(COMEX).This“gol
14、d as a commodity”framework suggests that gold prices have strong support at and above current price levels should the current low real interest rate environment persist.Specifically,assuming real interest rates stay near current levels and the buying from gold-ETFs slows to last years pace,we would
15、expect to see gold prices stay near$930/toz over the next six months,rising to$962/toz on a 12-month horizon.However,should real interest rates move lower or gold-ETF buying continue at its current torrid pace,the upside risk to gold prices would likely be significant.This report is the first in our
16、 new Frameworks series.This series of occasional reports is intended to explore in greater detail the frameworks necessary for developing views and forecasts for commodity market fundamentals and prices.In this first Frameworks report,we outline an approach to forecasting gold prices and fundamental
17、s from the framework of“gold as a commodity”based on the economic and financial determinants of gold supply,demand,and inventories.Historically,we have viewed gold more as a currency than a commodity(see our February 4,2009 report“Gold:The currency of last resort”),March 25,2009 Commodities:Framewor
18、ks Goldman Sachs Global Economics,Commodities and Strategy Research 4 valuing gold(in US dollars)in relation to the US dollar price(or exchange rate)of a basket of currencies.We view the approach in this report as complementing,not replacing,the currency approach,with each framework providing a valu
19、able perspective on gold pricing.In terms of the approach to gold pricing,these frameworks can be described as follows:Currency framework:Gold priced in relation to the price of potential substitutes for use as a store of value and medium of exchange.Key price drivers:Exchange rates,financial risk a
20、s measured by credit default swap rates on high-risk sovereigns and financials.Commodity framework:Gold priced in relation to the marginal cost of supply and to the marginal willingness of consumers to pay.Key price drivers:Real interest rates,the overall price level as measured by the consumer pric
21、e index(CPI),and movements in monetary demand for gold.The“gold as a commodity”framework explains three key“stylized facts”of gold prices in terms of the influence of real interest rates,inflation,and monetary demand for gold on the supply and demand for gold.Three stylized facts of gold prices:Long
22、-term stability of purchasing power:The real(inflation-adjusted)price of gold has been stable over extremely long periods of time(Exhibit 2).More specifically,over the past 100 years,the real price of gold(in 2008 dollars)has averaged roughly$420/toz,with an ounce of gold having the same purchasing
23、power in 2005 as it did in 1900.Negative correlation with real interest rates:While stable over extremely long periods of time,real gold prices tend to move in long cycles,which are negatively correlated with the level of real interest rates.Positive correlation with financial distress:Gold prices t
24、end to spike upward during financial crises,as the demand for monetary gold increases.Exhibit 2:The real price of gold has been quite stable over the long term,with long cycles related to real interest rates 2008 USD/toz 0.00200.00400.00600.00800.001000.001200.001400.001600.0019001910192019301940195
25、019601970198019902000Real Gold PriceAverage Source:US Geological Service(USGS),GFMS and GS Global ECS Research.March 25,2009 Commodities:Frameworks Goldman Sachs Global Economics,Commodities and Strategy Research 5 Interestingly,the historical behavior of supply,demand,and physical inventories in th
26、e gold market suggest that the first two“stylized facts”arise from the economics of gold supply,not gold demand,while the third arises from the monetary demand for gold.In particular,the following historical behavior is evident.Historical behavior of gold fundamentals:World gold mine production has
27、historically moved in roughly 30-year cycles over the past century or more,with mine production growing at a faster pace during periods of high real interest rates and at a slower pace during periods of low real interest rates.Monetary demand for goldthe demand for physical inventories of gold bulli
28、on and coinincreases in periods of financial distress such as the current one.Non-monetary demandthe demand for gold to be used in the creation of jewelry,art,electronics,and dentistry,is relatively stable over time,reacting primarily to the movements in real gold prices,with increasing real gold pr
29、ices decreasing the non-monetary demand for gold.As discussed in detail below,these three“stylized facts”of gold prices and the historical behavior of gold supply,demand,and physical inventories are consistent withand can be seen as arising fromthe following view of the economics of the gold market.
30、On the supply-side,the marginal cost of extracting gold from the ground consists of the realized cost of extracting the gold plus the opportunity cost of not leaving the gold in the ground to be extracted in the future.The fact that real gold prices are stable over extremely long periods of time sug
31、gests that the realized cost of extraction increases with the price level of the overall economy.The fact that the rate of world gold mine production increases with the real interest rate suggests that,as the real interest rate increases,the opportunity cost of extracting gold declines,leading to gr
32、eater gold extraction today.To take an extreme example,imagine that the real rate of interest is extremely high,such that one does not care at all about the future;then one would want to extract as much gold today as possible,given the realized cost of extraction.On the demand-side,monetary demand f
33、or physical inventories of gold bullion and coin increase with perceived financial distress.Increased monetary demand for gold must be met by increasing prices to motivate greater mine production or reduced non-monetary demand.Non-monetary demandprimarily jewelry demandlargely accommodates movements
34、 in gold supply and monetary demand,with higher real gold prices reducing non-monetary demand for gold and even inducing the scrapping of gold jewelry.In the next section of this report,the historical behavior of gold prices and fundamentals outlined above is discussed in more detail,providing the b
35、ackground for the conceptual framework of the economics of the gold market.In the section following,this conceptual framework is used as the basis for a new approach to forecasting gold prices.In the third and final section,the relationship between the frameworks of“gold as a currency”and“gold as a
36、commodity”is discussed.The historical behavior of supply,demand and physical inventories,and the economics of the gold market Gold mine supply:the economics of extraction and real interest rates Since the beginning of the twentieth century,the production of gold from the worlds mines has ebbed and f
37、lowed in long cycles extending over the span of decades.As seen in Exhibit 3,world gold production has exhibited a fairly regular cycle,with roughly 30 years March 25,2009 Commodities:Frameworks Goldman Sachs Global Economics,Commodities and Strategy Research 6 between each peak.Interestingly,real g
38、old prices have been strikingly stable over this more than a century of history,although they have tended to be low when world gold production is near a peak and high when world gold production is near a trough,suggesting that it is the movements in supply that are driving real gold prices over thes
39、e long cycles.If supply is driving the price of gold,then the question becomes what is driving supply?As seen in Exhibit 4,changes in the rate of world gold mine production tend to move with the level of real interest rates,with high real interest rates leading to faster growth in gold mine producti
40、on.Exhibit 3:Gold mine production has ebbed and flowed in 30-year cycles over the past century MT(left axis),1998 USD/toz(right axis)Exhibit 4:with mine production growth increasing with real interest rates%change(left axis),ex-post US real interest rate(right axis)0500100015002000250030001900191019
41、20193019401950196019701980199020000.00200.00400.00600.00800.001000.001200.001400.00USAAustraliaCanadaSth AfricaOtherReal Price-50.00-30.00-10.0010.0030.0050.0070.0019051915192519351945195519651975198519952005-8.00-6.00-4.00-2.000.002.004.006.008.0010.0012.00Gold Production GrowthReal Interest RateBo
42、th series are smoothed by taking a 5-year moving averageSource:Data provided courtesy of Gavin Mudd1.Source:USGS,Robert Shiller2,and GS Global ECS Research.Exhibit 4 suggests that higher real interest rates increase the rate of gold mine production while lower real interest rates slow the rate of mi
43、ne production.This is consistent with the economics of an extraction industry.The marginal cost of extracting today is not only the actual cost of mining,but the opportunity cost of not having the same gold to mine in the future.This suggests that higher interest rates lead one to discount the futur
44、e more heavily,driving down the opportunity cost and leading one to extract at a faster rate.To take an extreme example,if one did not care at all about the future(i.e.,an extremely high interest rate),one would extract the gold as quickly as possible.It is important to note,however,that the above e
45、conomic behavior does not require that gold be viewed as an exhaustible resource.In fact,the economics of extraction can be seen as the mirror image of the economics of investment.It is conventional economic wisdom that high real interest rates discourage investment,as they increase the cost of capi
46、tal.Consequently,one expects to see less investment in factories and manufacturing plants in high real interest rate environments.For a gold mine,however,extraction offers a secondmore rapidway to divest,by pulling the gold out of the ground today.Viewed in this way,the economics of extracting from
47、an existing gold mine is the mirror image of the economics of investing in a new one.A high real interest rate reduces the motivation to 1 Mudd,Gavin M.Global trends in gold mining:Towards quantifying environmental and resource sustainability?Resources Policy 32(2007)42-56.2 Shiller,Robert J.Market
48、Volatility.MIT Press.Cambridge,MA 1989.March 25,2009 Commodities:Frameworks Goldman Sachs Global Economics,Commodities and Strategy Research 7 invest and increases the motivation to extract.Consequently,higher real interest rates lower the marginal cost of extraction,which leads to greater supply an
49、d lower prices.Monetary demand:Central bank reserves,gold-ETFs,and COMEX inventories Once gold is extracted from the mine and refined,it can be used to satisfy both monetary and non-monetary forms of demand.The monetary demand for gold consists primarily of demand from the official sector for centra
50、l bank gold reserves,from the private sector for holdings of gold bullion and coins(including those held by the gold-ETFs),and from the demand for warehouse stocks on the gold futures exchanges,principally the Commodity Exchange(COMEX).When discussing the monetary demand for gold,it is important to