Gold Supply Likely to Swamp Demand

A report augurs poorly for the yellow metal and related stocks.
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An increasing surplus of bullion relative to demand could mean bad news for gold bulls, if the predictions of a new report prove accurate.

Although the supply of gold looks set to drop by 159 metric tons for 2007, demand will plummet even faster, lower by 313 tons when compared to revised estimates for the whole of 2006, according to a new study scheduled for publishing Monday morning by Fortis Bank. The report was authored by a team of analysts led by veteran gold market watcher Jessica Cross, CEO at Virtual Metals, a London-based specialty consulting firm.

Gold prices will likely fall to $580 an ounce by year-end and then to around $550 in 2007, says Matt Turner, commodities analyst at Virtual Metals and a co-author of the report. "A lot will depend on the dollar," he cautions, noting that a weaker greenback could bolster prices.

Turner's forecast compares with a spot price of $596.25 an ounce recorded Friday afternoon by the London Bullion Market Association and a multi-year high of $725.25 reached May 12. Many highly respected gold analysts who have been calling for a fall rally beyond the May high, and perhaps even above $800, may find the new report sobering.

Virtual Metals says the major factors break down as follows: increased mine output (up 21 tons) will be more than offset by lower official-sector/central banks sales (down 51 tons), lower hedging (off 12 tons) and reduced recycling (dipping 117 tons).

Demand will decline faster than that, however, with a rise in jewelry fabrication (up 47 tons) and electronics manufacture (higher by 31 tons), being overwhelmed by weaker ETF off-take (down 108 tons), zero central bank purchases (a decline of 100 tons) and a fall in de-hedging of 186 tons. Other uses, such as for making coins, will be approximately 3 tons higher.

The result will be an overhang, or market surplus, of 219 tons of gold compared to a revised forecast of an overall surplus of 64 tons for 2006. Virtual Metals had originally predicted an excess supply over demand of 422 tons for 2006 in March. However, higher-than-expected central bank purchases and producer de-hedging led by

Barrick Gold

(ABX)

overcame dramatically lower-than-expected jewelry demand to leave the market more in balance.

However, the supply/demand balance will be only a part of the price question. "A lot will depend on the dollar," cautions Turner, noting the fact that the price of the yellow metal is inextricably linked with that of the greenback.

Perhaps sobered by the discrepancy between the actual market supply/demand balance compared to that predicted earlier this year, the report gives the following warning: "Forecasting anything is playing hostage to fortune, not least when it comes to such an emotionally charged commodity as gold."

Still, if the supply/demand predictions are correct, the resulting excess supply could become a dead weight on the bullion market. That would push down prices of the exchange-traded funds that hold the metal,

iShares Comex Gold Trust

(IAU) - Get Report

and

streetTracks Gold Shares

(GLD) - Get Report

, as well as producers such as Barrick,

Newmont Mining

(NEM) - Get Report

and

Yamana Gold

(AUY) - Get Report

.