The gold supply chain was largely shut down as the COVID-19 pandemic spread around the world. However, things are starting to open back up, and production is beginning again. The World Gold Council studied the gold supply chain, how it was impacted by the pandemic, and how the disruption of the supply chain has affected investment demand for the yellow metal.
Q1 2020 hedge fund letters, conferences and more
Disruption to the gold supply chain
The World Gold Council said the gold supply chain is entirely global because the metal is mined on evert continent except Antarctica and refined in numerous countries before distribution around the world. The wide geographical dispersion provides stability for the gold market and enables supply to keep up with demand for the metal.
The COVID-19 pandemic disrupted the gold supply chain in ways that are entirely different from any other event in modern history. All parts of the chain were affected from mining to consumption, result in some distortions in some parts of the market. However, the supply chain remained relatively resilient despite the major disruption.
Many projects were cut back or halted during the first quarter. Lockdowns curtailed activities in China, South Africa, Peru and other countries, reducing production dramatically. Production in some parts of the world remained somewhat consistent, but the disruption was widespread.
Declines in gold production
Total gold production was down 3% year over year during the first quarter, which was the lowest production level since 2015 and the biggest year-over-year decline since the first quarter of 2017. However, the World Gold Council describes the first-quarter fall as “relatively modest given the scale of the pandemic.”
Lockdowns in many countries continued into the second quarter, although they are gradually being lifted, and some mining operations that were impacted are ramping production back up. Recycling activity was also impacted during the fourth quarter, falling 4% year over year to its lowest level in two years. Recycling typically generates 25% to 30% of the world’s gold supply.
Gold’s downstream capacity was also impacted as some refineries halted operations during the first quarter. PAMP, Argor-Heraeus and Valcambi, three of the biggest refineries in the world, suspended operations in March due to the pandemic. As a result, global refining capacity was reduced, which meant that coins and bars couldn’t be produced as quickly as needed.
The Rand Refinery in Africa temporarily shuttered its smelting plant and reduced its capacity. Fabricators also took a hit. The U.S. Mint temporarily suspended production of gold Eagle and Buffalo coins at its West Point facility last month.
On the other hand, refineries that were unaffected by the pandemic, like the Perth Mint, increased their production capacity to handle some of the excess demand. Early this month, Rand Refinery, Argor-Heraeus and Valcambi announced that they were restoring their operations, helping to ease pressure on the gold supply chain.
Logistics also impacted the gold supply chain
Travel restrictions also greatly impacted the gold supply chain. The World Gold Council explained that dore produced at a mine must then be transported to refiners, who ship refined gold to markets that have demand.
Many countries shut their borders or dramatically restricted commercial flights, greatly impacting the flow of gold. Since the number of available flights was down dramatically, there was much greater competition for any available cargo space.
Essential goods like medical equipment were generally prioritized over goods such as gold. It became much more expensive to transport gold between the hubs, leaving the supply chain looking for other methods of transportation like chartering cargo-only aircraft.
Since it became difficult to move gold to where it needed to be, distortions were created in several markets. The council said that in March, imports to India were down due to supply-side disruptions, which widened the local discount to about US$70 per ounce. Over the last two months, this discount has remained above US$25 an ounce.
The organization also cites logistical issues as one of the main reasons for the widening differential between the London spot price in the over-the-counter market and the COMEX futures price.
The World Gold Council also explained the distinction between the supply chain problems caused by logistical problems and liquidity in the gold market. Although logistical issues impacted the movement of gold, resulting in localized liquidity problems, overall liquidity in the gold market has remained robust.
Investment demand divergence
The pandemic drove a surge in investment demand for gold, but pressure within the supply chain caused a divergence in the supply of LGD and retail bars and coins. Within the wholesale market, LGD bars’ liquidity and availability was largely unaffected by the issues. Trading volumes in the London over-the-counter market were strong in March with an 85% increase year over to more than $1.5 trillion. Volumes have since come back down, but they remain healthy while the dislocation between the London and COMEX prices widened.
Gold futures on COMEX are linked to 1kg bars, but most gold-backed exchange-traded funds are linked to LGD gold bars, which means they have benefited from the ample supply. During the first quarter, inflows to gold ETFs amounted to 298 tons, the highest level in four years. The strong inflows have continued over the last two months.
Then when gold volatility increased during the first quarter, the supply of LGD bars helped maintain liquidity in the wholesale gold market. However, at the retail level, large supplies of small bars weighing 1KG or less were stuck in Eastern markets, where demand was constrained throughout the quarter due to the pandemic Problems transporting that gold quickly to meet demand in other parts of the world caused supply issues.
The council added that the availability of small gold bars and coins was stretched even further due to their more complex supply chain. These products are distributed to retailers and consumers around the globe, while LGD bars are usually sent to LBMA-approved vaults in London.
Demand for gold coins in particular skyrocketed 80% year over year. In March, the U.S. Mint reported sales of 151,500 troy ounces of Eagle coins, which was the highest monthly total since July 2015. The Perth Mint also reported a strong increase in gold bar and coin sales in March and April.
Dealer inventories were depilated due to the supply and logistical problems, resulting in long wait times and high premiums for many gold investors. However, problems in the gold supply chain have been easing, so those high premiums should narrow significantly.
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