You'd have to be very brave to be bearish on gold if the conclusion of one London analyst's supply/demand-focused report is anything to go by. Ambrian Partners, a mining-aligned financial services company, predicts the gold price to remain above $600 an ounce for the remainder of the year, with potential for upside spikes again breaking through the $700 level into 2007 and testing $800 in the next two years.

The main drivers of the gold price, says Ambrian, will be: low growth in new production, steady or declining central bank sales, continued producer de-hedging, exchange-traded fund (ETF) demand and gold's attraction as a hedge against a devaluing US dollar and as a safe haven.

Total gold demand exceeded supply in 2004 by 4%, says Ambrian. In 2005, there was a surplus in supply of 4.7%, showing a finely balanced market. A supply deficit of 2.7% is predicted for 2006, which indicates continuing support for the gold price.
Supply

Ambrian notes that there are three prime sources of supply: mine supply (61%), gold scrap (22%) and central bank sales (17%). The key point to note here, says author David Coates, is that mine production alone cannot supply global gold demand – nearly 40% of total supply comes from existing gold stocks held by central banks or from gold scrap.

Coates expects mine supply growth to remain steady or decrease during the rest of 2006. "Our review of Reuters' 2006 survey of the major global gold mines indicates a net increase in gold production of 86t, or between 3-4% over the year and we see this as an optimistic forecast," says Coates.

"South African production levels have dropped to their lowest levels in 82 years, and in global terms no major new mines are coming on line," he notes. "The world's two largest mines, Grasberg in Indonesia and Yanacocha in Peru, are both predicting significant falls in output for 2006."

Ambrian expects scrap supply to remain strong, but only in conjunction with rising prices. "Scrap sales tend to rise with upward price movements, but then stabilise," it notes.

Meanwhile official sector sales are expected to remain steady or decline as a result of an agreement between 15 European Central Banks (the Eurozone plus Sweden, not including the Bank of England) to limit sales to 500 tonnes a year until September 2009. "Together with informal signatories (the US, Australia, Japan and the Bank for International Settlements), this agreement accounts for 85% of refined world gold stocks, says Ambrian.

The central banks of Russia and China, which are not aligned to the agreement are thought more likely to be net buyers than sellers of gold, says Ambrian.
Demand

The lion's share of gold demand is from the jewellery market, which accounts for about 71%. Investment in its various forms accounts for 18% and the remainder is industrial and dental demand. By country, India accounts for nearly a quarter of global demand, followed by the US (12.2%) and China (8.6%).

Jewellery demand is highly price sensitive, notes Ambrian. After strong growth through to the middle of 2005, demand has dropped off dramatically as the gold price rose over $500 an ounce. In the first quarter of 2006, jewellery demand slumped to a two year low. But Coates expects demand to recover as consumers adjust to higher prices. "The elasticity of jewellery demand should also give support to the gold price in the event of softening prices," he argues.

Investment demand has been a key driver in the gold price. The biggest growth is in exchange-traded funds, which have grown from virtually nothing in 2003, when they were introduced, to 496 tonnes at the end of the first quarter of 2006.

Coates expects investment demand in gold to continue growing as central banks seek to diversify their dollar reserves and retail investors take advantage of ETFs as a convenient (and previously unavailable) tool to protect themselves against inflation.

Industrial and dental demand is relatively insensitive to gold prices. Ambrian notes that global levels of consumption have remained within a 10% band over the past two years, increasing overall by 5% year-on-year in 2005. It expects a similar increase in 2006.
Hedging

Another phenomenon supporting the gold price is "de-hedging." Producers who sold gold in the futures market to protect against price decreases have been burnt by recent price increases. Major gold producers have embarked on a de-hedging trend which creates effective demand in the market.

Coates says that larger producers have taken the view that hedging is simply a way of subsidising a high-cost operation. "They think that if you're not mining at reasonable costs, you should be investing your money elsewhere," argues Coates. "I don't see hedging making a big comeback.