cs gold supply and demand update

DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. FOR OTHER IMPORTANT DISCLOSURES, visit www.csss-sa.com/researchdisclosures or call +27 11 384 2000. U.S. Disclosure: Credit Suisse Standard Securities (Proprietary) Limited does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may 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.

12 January 2010 EMEA/South Africa

Equity Research Precious Metals (Metals & Mining - Gold) / MARKET WEIGHT

Gold supply and demand update and price forecast

THEME

Gold set for a correction in 2010 Figure 1: Cumulative ETF purchases in 2009

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Investors seem to become resistant to invest in ETFs at gold prices over US$1000/oz

Source: Company data, Credit Suisse Standard Securities estimates

Our analysis of the gold market leads us to take a bearish stance with regard to the gold price in 2010. In 2009 we reasoned that the main drivers of the gold price were significantly linked to the trade weighted dollar, increased investment demand, central bank purchases and market sentiment. The increase in investment demand for gold ETFs, in our view, had an “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold which resulted in upward pressure on the gold price which rose 24.6% during 2009. We do not expect the 2009 rate of investment in ETFs to continue at the same pace in 2010.

We are of the view that the gold market will likely be dominated mainly by the demand side of the equation in 2010. We believe that the likely decline in investment demand for ETFs, year on year, will play a pre-eminent role as a swing factor in our supply-and-demand balance in 2010. Jewellery, industrial and dental demand will likely strengthen marginally year on year. The secondary supply of scrap will depend on the gold price but will likely remain above 50% of mine supply. Central banks will likely become net purchasers while de-hedging will reduce significantly as the major players in this arena accelerate their 2009 de-hedging activities. Our calculations show a large oversupply of around 420 tonnes in our supply-and-demand equation for 2010.

In summary, we believe that the steam has run out of investment demand as the economic environment has and is changing to the positive. Muted investment demand coupled with a change in market sentiment and a projected large oversupply in the supply equation all point to a downward correction in the gold price from the highs reached at the end of 2009

Research Analysts

Dr David Davis 27 11 384 2104

[email protected]

12 January 2010

Gold supply and demand update and price forecast 2

Table of contents Table of contents 2

Executive summary 3 Revised gold forecast for 2010 3 Exchange rate forecast USD/ZAR 4 Forward curve 4

The gold price in 2009 5 What were the main drivers of the gold price in 2009? 5 Gold and the TWI USD in 2009 5 Investment demand for ETFs in 2009 7 Central bank purchases in 2009 8

The gold price in 2010 9 What will be the gold price drivers in 2010? 9 Gold and the TWI USD in 2010 9 Investment demand for ETFs in 2010 10 Central bank purchases in 2010 11

Gold supply and demand 12 Supply 12 Primary supply: Global mine supply 12 Secondary supply: Central banks 13 Secondary supply: Scrap supply 14 Demand 17

Revised gold forecast for 2010 19 Exchange rate forecast USD/ZAR 20 Forward curve 21 Risks to the down side 22

12 January 2010


Executive summary

Revised gold forecast for 2010

We believe that the steam has run out of investment demand as the economic environment has and is changing to the positive. Muted investment demand coupled with a change in market sentiment and a projected large oversupply in the supply equation all point to a downward correction in the gold price from the highs reached at the end of 2009, even in an environment of a weaker US dollar.

Figure 2: Revised gold price and USD/ZAR exchange rate forecast (January 2010)

Gold price and exchange Q1F Q2F Q3F Q4F 2010F Q1F Q2F Q3F Q4F 2011F 2012F 2013F 2014Frate USDZAR forecast 2010 2010 2010 1010 Year 1 2011 2011 2011 2011 Year 2 Year 3 Year 4 Year 5Gold US$/oz 1090 990 980 1040 1025 1035 980 970 1010 1000 1010 1090 1120USD/ZAR 7.17 7.20 7.47 7.50 7.33 7.7 8.0 8.3 8.5 8.1 8.5 8.5 8.5Gold R/kg 251267 229170 235362 250775 241556 256225 252061 258845 276014 260421 276014 297876 306075

Long term after 2014 US$820/oz Source: Credit Suisse Standard Securities estimates

Figure 3: Previous gold price and USD/ZAR exchange rate forecast (January 2009) Gold price and exchange rate Q1F Q2F Q3A Q4F 2009F 2010F 2011F 2012F 2013F USD/ZAR forecast 2009 2009 2009 2009 Year 1 Year 2 Year 3 Year 4 Year 5Gold US$/oz 870 860 900 960 900 960 1000 1090 1120

USD/ZAR 9.08 9.19 9.31 9.44 9.25 9.26 9.19 9.43 9.68

Gold R/kg 253892 254164 269324 291236 267747 285820 295451 330496 348508 Source: Credit Suisse Standard Securities estimates

Our analysis of the gold market leads us to take a bearish stance with regard to the gold price in 2010. In 2009 we reasoned that the main drivers of the gold price were significantly linked to the trade weighted dollar, increased investment demand, central bank purchases and market sentiment. Investment demand increased over 100% year on year to around 650 tonnes from 321 tonnes in 2008. We do not expect the 2009 rate of investment in ETFs to continue at the same pace in 2010 for the following reasons: � The global economic environment has changed and is improving which, in turn, will

result in a slowing down of the “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold, and the upward pressure on the gold price.

� Investment demand will likely be muted should the gold price remain over US$1 000/oz. (i.e. upside potential is limited ceteris paribus). At gold prices below US$1 000/oz we believe that annual investor demand for ETFs could return to levels between 300 tonnes and 350 tonnes in 2010. In the three years prior to 2009 the average annual investment in ETFs was around 280 tonnes.

� Investment demand will also likely be muted or decline should divestment gain momentum in 2010. We can see signs of institutional investor divestment in ETFs, particularly in the ETF SPDR (NYSE). Institutional investment sales have been offset by non-institutional purchases, which mitigate downward pressure on the gold price. There is, however, an increasing risk on the downward price should the pace of institutional and non-institutional sales increase. We estimate that institutional divestment has the potential to release between 200 tonnes and 300 tonnes in 2010.

The increase in demand for gold ETFs, in our view, had an “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold which resulted in upward pressure on the gold price which rose 24.6% during 2009.

12 January 2010


We are of the view that the gold market will likely be dominated mainly by the demand side of the equation in 2010. We believe that the likely decline in investment demand for ETFs, year on year, will play a pre-eminent role as a swing factor in our supply-and-demand balance in 2010. Jewellery, industrial and dental demand will likely strengthen marginally year on year. The secondary supply of scrap will depend on the gold price but will likely remain above 50% of mine supply. Central banks will likely become net purchasers while de-hedging will reduce significantly as the major players in this arena accelerate their 2009 de-hedging activities.

Our calculations show a large oversupply of around 420 tonnes in our supply-and-demand equation for 2010. This deficit remains to a greater or lesser extent until 2014 when we start seeing an ever-increasing deficit. We are of the view that the oversupply indicated by our model is sufficiently large to put downward pressure on the gold price. We believe that the TWI US dollar will remain relatively weak during 2010 which, in turn, will exert upward pressure on the gold price; this pressure will likely be outweighed by the downside pressures of muted investment demand.

Exchange rate forecast USD/ZAR

Carlos Teixeira, our economist, forecasts the rand’s nominal exchange rate against the US dollar at 7.00 on a 3-month horizon and 7.50 on a 12-month horizon. He forecasts a weakening of the rand in 2011, as the current account deficit widens further, global monetary tightening intensifies, flows to emerging markets moderate and the dollar appreciates. Implicit in our forecast for the rand in 2010, aside from general dollar weakness, is that the SARB’s FX policy remains unchanged: we expect that the SARB will add to FX reserves when market conditions allow, taking into account volatility, risk aversion and sterilisation costs.

Forward curve

Our revised forecast compares well with the forward curve obtained from Standard Bank South Africa. It is interesting to note that the forward curve is flat over the next three years when compared to previous years. This reflects the very low lease rates that currently persist and the risk appetite for gold going forward. The curve also suggests a bearish outlook for gold which supports our revised gold forecast.

Figure 4: Revised gold forecast compared to the forward curve.

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Gold price forecast (January 2010)

Source: Standard Bank, Credit Suisse Standard Securities estimates

Our calculations show a large oversupply of around 420 tonnes in our supply-and-demand equation for 2010. This deficit remains to a greater or lesser extent until 2014 when we start seeing an ever-increasing deficit.

Our economist forecasts the rand’s nominal exchange rate against the US dollar at 7.00 on a 3-month horizon and 7.50 on a 12-month horizon.

12 January 2010


The gold price in 2009

The gold price rose 24.6% during 2009 from US$879.85/oz at the beginning of the year to US$1 096.85/oz at the end of the year. Over 2009 gold averaged US$974.04/oz reaching a daily high of US$1 215.90/oz on 3 December 2009 and a low of US$811.30/oz on 14 January 2009. The 100-day and 200-day moving averages at the end of December were US$1059.67/oz and US$993.80/oz respectively.

Some important dates during 2009: The gold price rise broke through US$1 000/oz on 11 September, US$1 050/oz on 2 November and US$$1 100 on 9 November. The 10% price rise over this period was accompanied by a fall in the US dollar.

Figure 5: Daily gold price US$/oz

Source: I-Net bridge

What were the main drivers of the gold price in 2009?

Our calculations indicate the supply-and-demand equation started to exhibit a surplus in 2009 of around 376 tonnes compared with a 220 tonne deficit for 2008. In our view, the supply-and-demand equation was not the major determining factor with regard to the price.

We believe that the main drivers of the gold price in 2009 were a mix of market sentiment and a strong link between: � The strength of the USD; � Investment demand; and � Central bank purchases

Gold effectively reaffirmed its safe haven status in times of economic uncertainty in 2009.

Gold and the TWI USD in 2009

The relationship between the gold price and the trade weighted USD was relatively strong in 2009 but not as constant as expected. The relationship exhibited short-term periods which were statistically significant (see Figures 6, 7 and 8 below).

The gold price rose 24.6% during 2009 from US$879.85/oz at the beginning of the year to US$1 096.85/oz at the end of the year. Over 2009 gold averaged US$974.04/oz

We believe that the main drivers of the gold price in 2009 were a mix of market sentiment and a strong link between:

� The strength of the USD;

� Investment demand; and

� Central bank purchases

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Figure 6: USD trade weighted and gold price

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Figure 7: USD trade weighted and gold price 2009

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The trade weighted dollar is now hovering just above the lows recorded at the height of the credit crisis in July 2009.

In the short to medium term the gold price will be driven mainly by a weakening of the USD

12 January 2010



y = -37.17x + 3871R2 = 0.8322

y = -23.209x + 2905.1R2 = 0.7205

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Investment demand for ETFs in 2009

Investment demand by way of ETFs was significant in 2009 when compared to 2008. We calculate that global investment in ETFs in 2009 increased around 84% to some 590 tonnes in 2009 compared to 321 tonnes in 2008.

We calculate global ETF holdings reached about 1 813 tonnes in 2009. We believe ETFs have become the “People’s Central Bank” – a force to be reckoned with. When benchmarked against central bank holdings global investment in ETFs now rank sixth behind France, which stands at 2 445 tonnes (as at the end of September, according to the World Gold Council).

Investment in ETFs in 2009 was also characterised by an increase in institutional fund activity, in particular institutional investment in the largest ETF, the SPDR (NYSE). The ETF SPDR (NYSE) currently holds about 1 113 tonnes of gold, which represents 62% of total ETF holdings. Institutional investors now hold about 40% or 450 tonnes of SPDR (NYSE). This is a significant amount of gold and begs the question: just how “sticky “are gold ETFs? We noted in our research report dated 15 December that institutional investors in the ETF SPDR (NYSE) are starting to show signs of profit taking. (Research report Gold and precious metal investments in ETFs and coins - 15 December 2009).

We note that investment demand for ETFs meets resistance above US$1 000/oz (Figure 10). This observation is of significance as it could be interpreted that in the current environment investment in ETFs may be limited should the gold price remain above US$1 000/oz. If this holds it will impact on the supply-and-demand dynamics going forward.

The relationship between the gold price and the trade weighted USD was relatively strong but not as constant as expected throughout 2009. The relationship exhibited short-term periods which were statistically significant

We calculate global ETF holdings reached about 1 813 tonnes in 2009. We believe ETFs have become the “People’s Central Bank” – a force to be reckoned with.

12 January 2010


Figure 9: Annual purchases of gold ETFs

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ETF holdings:Accumulated 590 tonnes in 2009.giving a total holding of 1813 tonnes


Figure 10: Cumulative ETF purchases in 2009

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Investors seem to become resistant to invest in ETFs at gold prices over US$1000/oz

Source: Company data, I-Net bridge, Credit Suisse Standard Securities estimates

Central bank purchases in 2009

We believe that central banks are likely to become net purchasers of gold in 2009, if the purchase of 200 tonnes of gold from the International Monetary Fund (IMF) by the Reserve Bank of India (RBI) is taken into account.

The IMF announced on 2 November that it had sold 200 tonnes (6.43 million ounces) of gold to the RBI taking its holdings from 382.5 tonnes to 582.5 tonnes. This sale seemed to give impetus to the gold price as it increased from US$1 050/oz to over US$1 100/oz during the next seven days. It is important to note the RBI’s motive behind its purchase of 200 tonnes of gold. We report that India’s switch to gold out of the USD is significant. It conveys a strong message to the market that all is not well with the USD and that it is predicted to decline further and therefore the purchase of gold was a risk diversification exercise.

A similar message has and is being sent to the market by the significant investment in gold ETFs by institutional and non-institutional investors over the past year. Therefore, gold has reaffirmed its safe haven status in times of economic uncertainty.

ETF securities accumulated 590 tonnes in 2009.

We note that investment demand for ETFs meets resistance above US$1 000/oz. This observation is of significance as it could be interpreted that in the current environment investment in ETFs may be limited should the gold price remain above US$1 000/oz. If this holds it will impact on the supply-and-demand dynamics going forward.

We believe that central banks are likely to become net purchasers of gold going forward

12 January 2010


Russia and China have announced that they added to their central bank holdings in 2009. Using World Gold Council estimates we calculate that Russia purchased around 101.5 tonnes in 2009 taking its holdings to around 621.1 tonnes. China bought to account 454.1 tonnes which it purchased over the past six years taking its holdings to 1054.1 tonnes.

We believe that Russia, China and India’s central banks will likely continue to increase their purchases as their gold reserves are well below 10% at around 4.6%, 1.5% and 4.1% respectively.

The gold price in 2010

What will be the gold price drivers in 2010?

In 2009 we reasoned that the main drivers of the gold price were linked significantly to the trade weighted dollar, increased investment demand, central bank purchases and market sentiment.

In our view, there are a number of key questions concerning these factors and thus the gold price in the short term: � Will the US dollar remain weak during 2010 and, if so, how much weaker will it get?

Alternatively, will the US dollar strengthen during 2010? � Will the rate of investment in ETFs continue? Will investors start to divest in gold given

the improvements in the US economic environment and, under these circumstances, what will be the likely quantum of divestment?

� Will central banks become net purchasers of gold?

Gold and the TWI USD in 2010

As we have seen, the US dollar is critically linked to the gold price. Our Global Strategy team believes the trade weighted dollar is 22% cheap on a PPP (EURUSD). However, there is very strong market consensus that the dollar will continue to weaken. Net speculative positions are deeply short on the dollar. The trade weighted dollar is now hovering at levels just above the lows recorded at the height of the credit crisis in July 2009. Our European FX Daily Research (dated 6 November 2009) projects the US dollar to weaken against the euro, with a 3- and 12-month view of 1.53 and 1.55 respectively. Under these circumstances, we may see the gold price in 3 months at around US$1 130/oz and in 12 months at around US1 160/oz. On the other hand, we note that the TWI US dollar gold price relationship has varied considerably over the past two years but in the short term is statistically significant over ranges of gold price and TWI US dollar levels. In this regard we draw attention to Figure 11 which represents the gold price/TWI US dollar relationship at the lowest recorded levels of the TWI US dollar at the height of the credit crisis. Under these circumstances and should the TWI US dollar fall to levels of around 71, we may see the gold price around US$950/oz to US1 000/oz.

We believe that the TWI US dollar will remain relatively weak during 2010 which, will in turn, exert upward pressure on the gold price.

Our discussion surrounding the gold price/TWI US dollar relationship and its short- term variability illustrates that the gold price is also driven by a number of other factors. In our view, investment demand and divestment will start to play a dominant role in influencing the gold price in 2010.

In 2009 we reasoned that the main drivers of the gold price were linked significantly to the trade weighted dollar, increased investment demand, central bank purchases and market sentiment.

US dollar is critically linked to the gold price.

We believe that the TWI US dollar will remain relatively weak during 2010 which, will in turn, exert upward pressure on the gold price.

12 January 2010



y = -23.291x + 2602.9R2 = 0.7676

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Investment demand for ETFs in 2010

As we have indicated, there are a number of key questions concerning investment demand for gold ETFs. We noted above that investment in gold ETFs in 2009 increased significantly (by around 84%) to 590 tonnes from 321 tonnes in 2008.The flight to investment in gold ETFs in 2009 was, in our view, stimulated by the fallout from the credit crisis, which resulted in the weak global economic environment. The increase in demand for gold ETFs, in our view, had an “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold which, in turn, resulted in an upward pressure on the gold price. We note also that the traditional high seasonal demand for ETFs at the end of year was muted in 2009; we suspect this was due mainly to high gold prices of over US$1 000/oz (see Figure 10).

What’s changed?

We do not expect the 2009 rate of investment in ETFs to continue at the same pace during 2010 for the following reasons: � The global economic environment has changed and is improving which, in turn, will

result in a slowing down of the “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold, and the upward pressure on the gold price.

� Investment demand will likely be muted should the gold price remain over US$1 000/oz (i.e. upside potential is limited ceteris paribus, see Figure 6). At gold prices below US$1 000/oz we believe that annual investor demand for ETFs could return to levels between 300 tonnes and 350 tonnes in 2010. In the three years prior to 2009 the average annual investment in ETFs was around 280 tonnes.

� Investment demand will also likely be muted or decline should divestment gain momentum in 2010. We can see signs of institutional investor divestment in ETFs, particularly in the ETF SPDR (NYSE). However, institutional investment sales have been offset by non-institutional purchases, which mitigate downward pressure on the gold price. There is, however, an increasing risk on the downward price should the pace of institutional and non-institutional sales increase. We estimate that institutional divestment has the potential to release between 200 tonnes and 300 tonnes in 2010.

Figure 11 represents the gold price/TWI US dollar relationship at the lowest recorded levels of the TWI US dollar at the height of the credit crisis.

We do not expect the 2009 rate of investment in ETFs to continue at the same pace during 2010.

12 January 2010


Under these circumstances, we believe the risk is to the downside with regard to investment demand for ETFs during 2010 and as a result we are likely to experience downward pressure on the gold price. We note the 100- and 200-day moving average levels are currently at US$1 040/oz and USD982/oz respectively.

Central bank purchases in 2010

We believe that central banks are likely to become net purchasers of gold in 2010. Figure 12 illustrates global gold holdings in tonnes and as a percentage of total reserves by country (World Gold Council as at September 2009). We note that Russia, China and India’s central bank holdings are well below their Western economic counterparts, at around 4.6%, 1.5% and 4.1% respectively. Almost all of their Western counterparts record levels of well above 10% of total reserves.

Under these circumstances, we believe that Russia, China and India’s central banks will likely continue to increase their gold holdings going forward.

Figure 12: World gold holdings by country and as a percentage of total reserves (September 2009)

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We believe that Russia, China and India’s central banks will likely increase their gold holdings going forward.

12 January 2010


Gold supply and demand The 2009 gold market was unusual both for supply and demand. On the supply side, it was secondary scrap volumes that surprised on the upside. On the demand side, it was investment demand, particularly for ETFs which dominated as jewellery industrial and dental demand softened.

As mentioned above, our calculations indicated the supply-and-demand equation started to exhibit a surplus in 2009 of around 376 tonnes compared with a 220 tonne deficit in 2008. In our view, this surplus was in the main (excluding de-hedging and central bank sales) brought about by: � A year-on-year increase in supply from mining operations and scrap supply

amounting to some 300 tonnes, brought about mainly as a result of an increase in the gold price; and

� A year-on-year decrease in demand, mainly as a result of a significant drop in jewellery demand of around 475 tonnes It should be noted that the year-on-year increase in ETF demand of around 269 tonnes was not sufficient to offset the drop in jewellery demand.

In our view, the supply-and-demand equation was not the major determining factor with regard to the gold price in 2009; it was all about the US dollar, investment demand, central bank purchases and market sentiment.

We believe that should current trends persist during 2010 the supply-and-demand fundamentals will start to impact the gold price. We believe that the balance could be tipped into an increasing and significant oversupply scenario in 2010 which, in turn, could result in downward pressure on the gold price. We believe that muted investment demand will likely play a pre-eminent role as a swing factor and contribute to a significant oversupply in 2010.

In the following section we discuss the quantums and show how this scenario is likely to unfold.

Supply

Primary supply: Global mine supply

For a long time we have held the opinion that global mine supply is declining by about 2% to 3% a year. However, we deem that the decline in global mine supply will be temporarily halted over the next three to five years, before continuing its downward trend. The main reason for this can be attributed to the increase in the gold price and growth linked to major new projects due to be brought on line. This quantum could add around 100 tonnes to global mine production (based on 2008 global mine production of 2 416 tonnes, as reported by GFMS).

The 2009 gold market was unusual both for supply and demand

In our view, the supply-and-demand equation was not the major determining factor with regard to the gold price in 2009; it was all about the US dollar, investment demand, central bank purchases and market sentiment.

For a long time we have held the opinion that global mine supply is declining by about 2% to 3% a year. However, we deem that the decline in global mine supply will be temporarily halted over the next three to five years, before continuing its downward trend.

12 January 2010


Secondary supply: Central banks

We have – and still believe – central banks’ sales are waning and they could become net buyers of gold. The GFMS recently reported that central banks were net buyers in the first half of 2009.

As indicated in our previous reports, a new Central Bank Gold Agreement (CBGA3) came into effect on 27 September 2009. This agreement was approved by 19 signatory members of the European central banks. In this new agreement we predict that sales will fall from an average of 372 tonnes per annum (CBGA2) to less than 100 tonnes per annum over a five-year period. (Figure 13)

We believe that central banks are likely to become net purchasers of gold in 2010. As indicated previously, we are of the view that Russia, China and India’s central banks will likely continue to accumulate gold.

Figure 13: European central bank agreements on gold sales CBGA 1 CBGA 2 CBGA 3 Limit 2000 tonnes Limit 2500 tonnes Limit 2000 tonnesSeptember: 1999 September: 2004 September: 2009September: 2004 September: 2009 September: 2012

Sold 2000 Sold 1863 0Central Banks utilised Sales to June 2009 agreement IMF could sell a further around sales to the limit ends 27 September 2009 203 tonnes during this period

currently 638 tonnes short In addition, we do not expect central of the limit banks to exceed average sales of

100 tonnes per annum

Source: World Gold Council ,

It is important to note the significance of central banks becoming net purchasers of gold in the supply-and-demand equation. Over the past 20 years central banks have sold around 8025 tonnes of gold at an average rate of around 400 tonnes per annum. This represents some 16.6% of global mine supply (48 458 tonnes) over the same period. Almost all of the central banks’ sales were absorbed into the market.

To illustrate this point we stripped out central bank sales and hedging in our supply-and-demand equation and found that over the past 20 years, apart from three occasions the supply of gold has been in deficit (Figure 13). Over time the primary deficit has been masked by the secondary supply of gold into the market from central bank and producer hedging (Figure 14).

Under these circumstances, it would be reasonable to expect that if there were no central bank sales over this period the gold price would reflect the deficit by exerting upward pressure on the price. We are now approaching the situation where central banks are becoming net purchasers of gold which in the long term (five years) will likely lead to upward pressure on the gold price, given demand returns to the levels experienced in the first half of the decade. Furthermore, this situation will likely be exacerbated should central banks purchase gold from primary mine supply.

We have – and still believe – central banks’ sales are waning and they could become net buyers of gold.

It is important to note the significance of central banks becoming net purchasers of gold in the supply-and-demand equation. Over the last twenty years central banks have sold around 8025 tonnes of gold at an average annual rate of around 400 tonnes per annum.

12 January 2010


Figure 14: Primary supply and demand surplus and deficit, and forecast

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Figure 15: Primary supply and demand surplus and deficit, central bank sales and forecast

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Secondary supply: Scrap supply

GFMS estimated that global scrap supply rose by 27% in 2008 to about 1 218 tonnes from 977 tonnes in 2007. We believe that as a result of the fallout from the credit crisis coupled with high gold prices, global scrap supply will likely continue to increase and exceed the levels recorded in 2008.

Over time the primary deficit has been masked by the secondary supply of gold into the market from central bank and producer hedging.

Over time the primary deficit has been masked by the secondary supply of gold into the market from central bank and producer hedging.

12 January 2010


Scrap supply is strongly linked to the gold price and we expect scrap supply to increase by around 15.7% to 1 416 tonnes in 2009 (Figure 16).

Figure 16: Relationship between the gold price and scrap supply since 2002

y = 0.6922x + 600.77R2 = 0.7889

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.Source: GFMS, I-Net Bridge

The key question is: will the supply of scrap continue to increase with a rising gold price or will it reach saturation?

As we have seen, scrap supply is sensitive to the gold price (Figure 16): however, we note also that scrap supply has been on the increase when compared to global mine production (Figures 17 and 18). Figure 17 illustrates the increase in scrap supply as a percentage of mine production since 1989. It is of significance to note that since 1989 scrap supply, as a percentage of mine production has increased from 19% to over 50% in 2008. We forecast that scrap supply could reach around 60% of mine production by 2015.

Figure 17: Scrap supply as a percentage of global mine production and gold price

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Scrap supply is strongly linked to the gold price and it may reach 1 416 tonnes in 2009 based on an average gold price of US$974/oz for 2009 (Figure 12).

It is of significance to note that since 1989 scrap supply, as a percentage of mine production has increased from 19% to over 50% in 2008. We forecast that scrap supply could reach around 60% of mine production by 2015

12 January 2010


Figure 18: Global mine and scrap supply

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Under these circumstances, we believe that scrap supply has become a significant swing factor in gold supply-and-demand dynamics as scrap can now be seen as not only increasing gold supply but also competing with mine supply. Furthermore, increasing scrap supply will, to a greater or lesser extent, offset the effect of central bank sales on gold supply.

Figure 19 below illustrates the enormity of the potential to draw scrap from above-ground stocks which in 2008 were estimated to be around 163 000 tonnes (after GFMS).

Figure 19: Gold transfers to and from global above-ground stocks, 2008

Lending3%

Mine production64%

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Mine productionLendingOld scrap

2416(112)12183522 tonnes total

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Private Investment

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Official Holdings18% Jew ellery

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Jew elleryOfficial HoldingsPrivate InvestmentOther FabricationUnaccounted

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Private investmentOther FabricationJew ellery

93843621593522 tonnes total

To Stocks 3522 tonnes

Old Scrap 1218 tonnes

Oofficial sector sales plus lending (112 tonnes)

835002870027300197003600

163000 tones total

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Gold Transfers (net) to and fromAbove -Ground Stocks 2008

GFMS data

Source: GFMS

We believe that scrap supply has become a significant swing factor in gold supply-and-demand dynamics as scrap can now be seen as not only increasing gold supply but also competing with mine supply

12 January 2010


Demand

Jewellery

GFMS recently reported that global jewellery fabrication demand declined by about 9% or 220 tonnes in 2008. Our figures reflect a 200% decline to around 1 740 tonnes in 2009 from 2 186 tonnes in 2008. We forecast a modest recovery of around 6% in 2010 to around 1812 tonnes. We are of the view that jewellery consumption will only return to the level seen in 2008 by 2013. It should be noted that there is a reasonable relationship between the gold price and jewellery consumption although not statistically significant it does show a general trend downward as the gold price rises (Figure 20).

Figure 20: Relationship between jewellery consumption and gold price

y = -0.3021x + 771.83R2 = 0.3532

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Jew ellery consumption by quarter since 2003 tonnes

Source: GFMS, I-Net Bridge

Investment in ETFs

As we have indicated above, we believe investment demand will likely be muted should the gold price remain over US$1 000/oz. (i.e. upside potential is limited ceteris paribus, see Figure 6). We believe that investor demand for ETFs will likely fall off, mainly as a result of high gold prices. We could expect investment demand to improve at levels below US$1 000/oz and, under these circumstances; we could see annual investment between 300 tonnes and 350 tonnes in 2010. In the three years prior to 2009 the average annual investment in ETFs was around 280 tonnes.

Investment demand will also likely be muted or decline should divestment gain momentum in 2010. As we have previously indicated, we can see signs of institutional investor divestment in ETFs, particularly in the ETF SPDR (NYSE). There is, however, an increasing risk on the downward price should the pace of institutional and non-institutional sales increase. Under these circumstances, we believe the risk is to the downside with regard to investment demand for ETFs during 2010 and as a result we are likely to experience downward pressure on the gold price. We estimate that institutional divestment has the potential to release between 200 tonnes and 300 tonnes in 2010 (Figure 21).

We forecast a modest recovery of around 6% in 2010 to around 1812 tonnes. We are of the view that jewellery consumption will only return to the level seen in 2008 by 2013. Much, however, depends on the gold price.

Investment demand will also likely be muted or decline should divestment gain momentum in 2010.

12 January 2010


Figure 21: Annual purchases of gold ETFs

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ETF holdings:Accumulated 585 tonnes in 2009.giving a total holding of 1813 tonnes


Supply and demand

The 2010 the gold market will likely be dominated mainly by the demand side of the equation. We believe that the possible decline in year-on year-investment demand for ETFs will play a pre-eminent role as a swing factor in our supply-and-demand balance in 2010. Jewellery, industrial and dental demand will likely strengthen marginally year on year. The secondary supply of scrap will depend on the gold price but will likely remain above 50% of mine supply. Central banks will likely become net purchasers while de-hedging will reduce significantly as the major players in this arena accelerated their de-hedging activities in 2009.

Our calculations show a large over-supply in our supply-and-demand equation for 2010 (Figure 22). This deficit remains to a greater or lesser extent until 2014 when we start seeing an ever-increasing deficit.

We are of the view that the large oversupply indicated by our model has now become sufficiently large to put downward pressure on the gold price.

We estimate that institutional divestment has the potential to release between 200 tonnes and 300 tonnes in 2010.

We report that scrap supply as well as ETF and jewellery demand now play a pre-eminent role as swing factors in our supply-and-demand balance.

12 January 2010


Figure 22: Gold supply-and-demand forecast 2009 to 2015

2004 2005 2006 2007 2008 2009F 2010F 2011F 2012F 2013F 2014F 2015F

SupplyMine Supply 2492 2550 2486 2476 2416 2516 2500 2500 2500 2475 2450 2400

Old Scrap Supply 849 886 1126 977 1215 1416 1330 1310 1318 1382 1407 1431Primary Supply 3341 3436 3612 3453 3631 3932 3830 3810 3818 3857 3857 3831

Mine Supply y-on-y% change -4.9% 2.3% -2.5% -0.4% -2.4% 4.1% -0.6% 0.0% 0.0% -1.0% -1.0% -2.0%Primary Supply y-on-y% change -6.3% 2.8% 5.1% -4.4% 5.2% 8.3% -2.6% -0.5% 0.2% 1.0% 0.0% -0.7%Demand 0 0 0 0 0 0 0 0 0 0 0 0Jewellery 2614 2707 2284 2401 2186 1709 1812 1920 2035 2158 2287 2424

Chinese additional demand 0 0 0 0 0 0 0 0 0 0 0 0Other:Industrial/dential 414 432 459 462 436 374 385 397 409 421 434 447Total Fabrication 3028 3139 2743 2863 2622 2083 2197 2317 2444 2579 2721 2871

Annual Total Fabrication growth 5.8% 3.7% -12.6% 4.4% -8.4% -20.6% 5.5% 5.5% 5.5% 5.5% 5.5% 5.5%Bar Hoarding/Coins/Medals 338 384 402 400 838 706 727 749 771 795 818 843Exchange Traded Funds 133 208 260 251 321 590 350 380 400 450 500 500

Primary Demand 3499 3731 3405 3514 3781 3379 3274 3446 3616 3823 4039 4214

Annual Growth Primary Demand 9.6% 6.6% -8.7% 3.2% 7.6% -10.6% -3.1% 5.3% 4.9% 5.7% 5.6% 4.3%Primary Surplus/(Deficit) -158 -295 207 -61 -150 553 556 364 202 34 -182 -383

CBGA Official Sector Supply 0 612 317 435 246 153 100 70 70 60 50 50Official Sector Supply other (IMF) 0 63 53 46 50 5 5 5 5 5 5 5Official Sector purchases 90 120 80 85 90 95 100

Total Official Sector Supply 469 674 370 481 296 68 (15) (5) (10) (25) (40) (45)Net hedging/de-hedging (422) (86) (410) (446) (358) (245) (100) (80) (25) 0 0 0

Net Surplus/(Deficit) (111) 293 167 (26) (212) 376 441 279 167 9 (222) (428)Gold Price US$/oz 409 445 604 695 872 974 1025 1000 1010 1090 1120 1150 Source: GFMS, World Gold Council, Credit Suisse Standard Securities estimates

Revised gold forecast for 2010 Our analysis of the gold market leads us to take a bearish stance with regard to the gold price in 2010. In 2009 we reasoned that the main drivers of the gold price were significantly linked to the trade weighted dollar, increased investment demand, central bank purchases and market sentiment. Investment demand increased over 100% year on year to around 650 tonnes from 321 tonnes in 2008. The TWI US dollar was volatile during 2009 but lost only 3.8% over the year.

The increase in demand for gold ETFs, in our view, had an “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold which resulted in upward pressure on the gold price which rose 24.6% during 2009 from US$879.85/oz at the beginning of the year to US$1 096.85/oz at the end of the year. Over 2009 gold averaged US$974.04/oz reaching a daily high of US$1215.90/oz on 3 December 2009 and a low of US$811.30/oz on 14 January 2009. The 100-day and 200-day moving averages at the end of December 2009 were US$1 059.67/oz and US$993.80/oz respectively.

We do not expect the 2009 rate of investment in ETFs to continue at the same pace in 2010 for the following reasons: � The global economic environment has changed and is improving which, in turn, will

result in a slowing down of the “accelerating and reinforcing effect”” on market sentiment and the safe haven status of gold, and the upward pressure on the gold price.

Our analysis of the gold market leads us to take a bearish stance with regard to the gold price in 2010.

The increase in demand for gold ETFs, in our view, had an “accelerating and reinforcing effect” on market sentiment and the safe haven status of gold which resulted in upward pressure on the gold price which rose 24.6% during 2009.

12 January 2010


� Investment demand will likely be muted should the gold price remain over US$1 000/oz. (i.e. upside potential is limited ceteris paribus, see Figure 6). At gold prices below US$1 000/oz we believe that the annual investor demand for ETFs could return to levels between 300 tonnes and 350 tonnes in 2010. In the three years prior to 2009 the average annual investment in ETFs was around 280 tonnes.

� Investment demand will also likely be muted or decline should divestment gain momentum in 2010. We can see signs of institutional investor divestment in ETFs, particularly in the ETF SPDR (NYSE). Institutional investment sales have been offset by non-institutional purchases, which mitigate downward pressure on the gold price. There is, however, an increasing risk on the downward price should the pace of institutional and non-institutional sales increase. We estimate that institutional divestment has the potential to release between 200 tonnes and 300 tonnes in 2010.

Under these circumstances, we believe the risk is to the downside with regard to investment demand for ETFs during 2010 and, as a result, we are likely to experience downward pressure on the gold price. We believe that the TWI US dollar will remain relatively weak during 2010 which, in turn, will exert upward pressure on the gold price; this pressure will likely be outweighed by the downside pressures of muted investment demand.

We are of the view that the gold market will likely be dominated mainly by the demand side of the equation in 2010. We believe that the likely decline in investment demand for ETFs, year on year, will play a pre-eminent role as a swing factor in our supply-and-demand balance in 2010. Jewellery, industrial and dental demand will likely strengthen marginally year on year. The secondary supply of scrap will depend on the gold price but will likely remain above 50% of mine supply. Central banks will possibly become net purchasers while de hedging will reduce significantly as the major players in this arena accelerate their 2009 de-hedging activities.

Our calculations show a large oversupply of around 420 tonnes in our supply-and-demand equation for 2010. This deficit remains to a greater or lesser extent until 2014 when we start seeing an ever-increasing deficit. We are of the view that the oversupply indicated by our model is sufficiently large to put downward pressure on the gold price.

In summary, we believe that the steam has run out of investment demand as the economic environment has and is changing to the positive. Muted investment demand coupled with a change in market sentiment and a projected large oversupply in the supply equation all point to a downward correction in the gold price from the highs reached at the end of 2009 even in an environment of a weaker US dollar.

Exchange rate forecast USD/ZAR

Carlos Teixeira, our economist, forecasts the rand’s nominal exchange rate against the US dollar at 7.00 on a 3-month horizon and 7.50 on a 12-month horizon. He forecasts a weakening of the rand in 2011, as the current account deficit widens further, global monetary tightening intensifies, flows to emerging markets moderate and the dollar appreciates. Implicit in our forecast for the rand in 2010, aside from general dollar weakness, is that the SARB’s FX policy remains unchanged: we expect that the SARB will add to FX reserves when market conditions allow, taking into account volatility, risk aversion and sterilisation costs.

We do not expect the 2009 rate of investment in ETFs to continue at the same pace in 2010. Under these circumstances, we believe the risk is to the downside and as a result, we are likely to experience downward pressure on the gold price.

We believe that the steam has run out of investment demand as the economic environment has and is changing to the positive. Muted investment demand coupled with a change in market sentiment and a projected large oversupply in the supply equation all point to a downward correction in the gold price from the highs reached at the end of 2009 even in an environment of a weaker US dollar.

Our economist forecasts the rand’s nominal exchange rate against the US dollar at 7.00 on a 3-month horizon and 7.50 on a 12-month horizon.

12 January 2010


Figure 23: Revised gold price and USD/ZAR exchange rate forecast (January 2010)

Gold price and exchange Q1F Q2F Q3F Q4F 2010F Q1F Q2F Q3F Q4F 2011F 2012F 2013F 2014Frate USDZAR forecast 2010 2010 2010 1010 Year 1 2011 2011 2011 2011 Year 2 Year 3 Year 4 Year 5Gold US$/oz 1090 990 980 1040 1025 1035 980 970 1010 1000 1010 1090 1120USD/ZAR 7.17 7.20 7.47 7.50 7.33 7.7 8.0 8.3 8.5 8.1 8.5 8.5 8.5Gold R/kg 251267 229170 235362 250775 241556 256225 252061 258845 276014 260421 276014 297876 306075Long term after 2014 US$820/oz Source: Credit Suisse Standard Securities estimates

Figure 24: Previous gold price and USD/ZAR exchange rate forecast (January 2009) Gold price and exchange 2010F 2011F 2012F 2013Frate USDZAR forecast Year 1 Year 2 Year 3 Year 4Gold US$/oz 960 1000 1090 1120

USD/ZAR 9.3 9.2 9.4 9.7Gold R/kg 285820 295451 330496 348650

Source: Credit Suisse Standard Securities estimates

Figure 25: Percentage change between revised and previous forecast Precentage change between 2010F 2011F 2012F 2013Frevised and previous forecasts Year 1 Year 2 Year 3 Year 4Gold US$/oz 6.8 0.0 -7.3 -2.7

USD/ZAR -20.8 -11.9 -9.9 -12.2

Gold R/kg -15.5 -11.9 -16.5 -14.6 Source: Credit Suisse Standard Securities estimates

Forward curve

Figure 26 compares our revised gold price forecast with the forward curve obtained from Standard Bank South Africa. It is interesting to note that the forward curve is flat over the next three years when compared to previous years. This reflects the very low lease rates that persist and the risk appetite for gold going forward. The curve also suggests a bearish outlook for gold which supports our revised gold forecast.

It should be noted that the lease rates used in the forward curve are expressed as annual effective interest rates, and not in the simple discount format of the gold forward rates quoted in the market. Lease rates represent the profit to be made by bullion banks borrowing metal from central banks at the gold forward offer (GOFO) rate, selling the metal and investing the proceeds at a rate close to Libor. The market convention quotes gold lease rates (GLRs) as a simple interest rate: GLR = LIBOR - GOFO.

Negative lease rates do not necessarily mean that banks are lending gold and paying the consideration to borrowers, as bullion banks normally charge a premium above the lease rate. The forward market for gold is still in contango, as gold interest rates are still lower than dollar interest rates, giving a positive figure for the gold forward rate, meaning that forward prices are still at a premium to spot.

It is interesting to note that the forward curve is flat when compared to previous years. This reflects the very low lease rates that persist and the risk appetite for gold going forward. The curve also suggests a bearish outlook for gold which supports our revised gold forecast.

12 January 2010


Figure 26: Revised gold forecast compared to the forward curve.

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Forw ard curve (6 January 2010)

Gold price forecast (January 2010)

Source: Standard Bank, Credit Suisse Standard Securities estimates

Risks to the down side

A fall in investment demand accompanied by year-on-year divestment would very likely lead to a fall in the gold price.

The key question is by how much would the gold price have to fall before the supply-and-demand dynamics reverse once again?

In answering this question, we turn to the global average notional cash expenditure (NCE) of the gold mining industry. The NCE represents the all in costs associated with gold mining, including capital and brownfields exploration expenditure. The NCE per ounce of gold produced may be defined as: operating costs plus capital expenditure and brownfields exploration. The NCE determines how much free cash flow is generated to pay interest, tax, dividends and greenfields exploration and is therefore a good measure of the minimum gold price level the industry can sustain without deferring future production.

We have estimated the industry NCE expenditure for 2008 from a sample of 54 gold mining companies which represent some 57% of global production. These figures were then escalated at 3.1% to represent an estimated NCE cost for the industry in 2009. It should be noted that this escalation rate was obtained from GFMS estimates for year-on-year cost escalation. Note also that NCE costs are dependent upon annual capital expenditure which may change due to the completion or start of growth projects.

Figure 27 below, illustrates our estimated NCE costs for the sample of 54 gold mining companies for 2009. Figure 27 below, illustrates our estimated NCE cost curve for the industry with sensitivity to projected annual inflation rates of 3%, 5% and 10% per annum. Our curve implies a global NCE cost for 50% of production in 2009 is in the order of US$722/oz with cash costs, capital and brownfields exploration amounting to some US$476/oz and US$246/oz respectively. The NCE costs escalated to 2015 by 3%, 5% and 10% per annum are estimated at US$ 870/oz, US$968/oz and US$1250/oz.

These gold price estimates give insight to the industry’s breakeven costs going forward depending on the annual inflation rate.

We can now give an answer to the question: by how much would the gold price fall before the supply-and-demand dynamics reverse once again?

The key question is by how much would the gold price have to fall before the supply-and-demand dynamics reverse once again?

Our curve implies a global NCE cost for 50% of production in 2009 is in the order of US$722/oz with cash costs, capital and brownfields exploration amounting to some US$476/oz and US$246/oz respectively

12 January 2010


Figure 27: Notional cash expenditure for a sample of 54 gold mining companies

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12 January 2010


We believe Figure 28 attempts to answer this question in so far as it reflects the average breakeven position in US$/oz for at least 50% of global mine production. Should the yearly average gold price fall below our lower NCE forecast we would expect mines which produce 50% of global production to experience significant margin squeeze and possibly closure? Under these circumstances, upward pressure on the gold price will likely arise in the event of slowing mine supply. We note, however, that the supply-and-demand dynamics will also change with the likelihood of increased demand for jewellery at depressed gold prices.

Under these circumstances, the likely downside to the gold price is around US$722/oz

Figure 28 also attempts to answer another conundrum which prevails in financial circles: what should the long-term gold price be? Clearly, it should not be below the break even total cost of production for any length of time (ceteris paribus). Under these circumstances, we believe gold mining companies will likely cut back on capital projects and exploration. For 2010, 2012 and 2014 we calculate the long-term gold price should be US$745/oz, US$770/oz and US$820/oz respectively (based on an annual inflation rate of 3%).

Under these circumstances, we believe the risk is to the downside with regard to investment demand for ETFs during 2010 and, as a result, we are likely to experience downward pressure on the gold price. We believe that the TWI US dollar will remain relatively weak during 2010 which, in turn, will exert upward pressure on the gold price; this pressure will likely be outweighed by the downside pressures of muted investment demand.

We are of the view that the gold market will likely be dominated mainly by the demand side of the equation in 2010. We believe that the possible decline in investment demand for ETFs, year on year, will play a pre-eminent role as a swing factor in our supply-and-demand balance in 2010. Jewellery, industrial and dental demand will likely strengthen marginally year on year. The secondary supply of scrap will depend on the gold price but will likely remain above 50% of mine supply. Central banks will likely become net purchasers while de-hedging will reduce significantly as the major players in this arena accelerate their 2009 de-hedging activities. Our calculations show a large oversupply of around 420 tonnes in our supply-and-demand equation for 2010.

In summary, we believe that the steam has run out of investment demand as the economic environment has and is changing to the positive. Muted investment demand coupled with a change in market sentiment and a projected large oversupply in the supply equation all point to a downward correction in the gold price from the highs reached at the end of 2009.

We calculate that the likely downside to the gold price is around US$722/oz

12 January 2010


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12 January 2010 EMEA/South Africa

Equity Research

Gold Supply and Demand and forecast - 12 Jan 2010.doc

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