The Covid-19 pandemic has disrupted the gold supply chain unlike any other event in modern history, the World Gold Council (WGC) said in a market update on May 28.
With all elements of the chain affected, from mining operations to consumption, this has resulted in some distortions within parts of the market but it has also “allowed the supply chain to demonstrate its resilience”.
Both gold mining and recycling activities were curtailed owing to lockdown restrictions in the first quarter of the year, but these declines were “modest” in comparison to the scale of disruption to other industries globally, the WGC noted.
The council also reported a reduction in downstream capacity with a small number of refiners halting operations, as well as challenges in transporting physical gold owing to fewer commercial flights.
However, despite all the supply and logistical issues, the council said overall liquidity in the gold market “remains robust which clearly highlights the strength of the gold market”.
The Covid-19 outbreak also increased investor uncertainty against the existing global backdrop of low and negative interest rates, as well as anaemic growth outlook, which fuelled a surge in gold investment demand in the first quarter.
“We find that while gold’s supply chain has not escaped unscathed, it has demonstrated resilience in the face of these challenges, highlighting a key strength of the market,” the council said.
The gold supply chain, with all its components, enables the smooth functioning of the gold market and allows gold to flow to where it is needed and in its desired form. According to the WGC, considering that gold mining is geographically diverse (occurring on all continents except Antarctica), “the industry was unlikely to escape the impact of the pandemic entirely”.
This dispersion, however, helped to shield the primary supply of gold from more severe outcomes, the council said.
Following national and local government measures aimed at countering the outbreak, several projects worldwide reduced or halted operations in the first quarter, and key mining nations, such as China, South Africa and Peru, all saw mining activities curtailed owing to lockdown restrictions.
These declines in production were somewhat offset by more consistent production levels in other major mining regions that had experienced little or no disruption to normal operations.
While total gold production fell by 3% year-on-year in the first quarter, representing the lowest level of production since 2015 and the largest year-on-year fall since the first quarter of 2017, the council said this decline was “relatively modest” given the scale of the pandemic.
Although lockdown measures in several mining countries have extended into the second quarter, these are gradually easing, with affected mining operations beginning to ramp up production.
Recycling activity, which typically generates between 25% and 30% of gold supply, was also affected in the first quarter and fell by 4% year-on-year to its lowest level for two years.
However, given the price-sensitive nature of gold recycling, the WGC noted that, under normal conditions, the 6% rise in the dollar gold price during the first quarter would have drawn out near-market supply.
As lockdown measures begin to ease, gold recycling levels are likely to rise as consumers look to manage the economic impact of Covid-19.
Meanwhile, downstream capacity was also reduced and operations at a number of refineries were halted during the first quarter. The consequent reduction in global refining capacity (about 1 500 t/y of gold) meant that bars and coins could not be produced in the necessary forms as quickly as needed.
In contrast to this squeeze on the supply chain, unaffected refineries elsewhere in the world increased production capacity in order to meet some of the excess demand, especially for non-London Good Delivery (LGD) gold bars.
Supply chain disruption has not been focused solely on the sourcing and refining of gold, as stringent travel restrictions imposed by governments globally to combat the spread of Covid-19 impeded the flow of gold along the chain.
As travel restrictions have taken hold fewer flights have meant a significant drop in available cargo space, which has led to intense competition for that space, with essential goods, such as medical equipment, often being prioritised.
Consequently, the cost of transporting gold between various hubs has substantially increased and left the supply chain looking for alternative means of transportation, including chartering cargo-only aircraft.
As a result, gold struggled to get to where it was needed, leading to distortions in several markets.
However, the WGC drew a distinction between the supply chain issues caused by logistical challenges and the liquidity in the gold market. “While the logistical issues have caused disruption to the free movement of gold, and thus resulted in some localised liquidity issues, overall liquidity in the gold market remains robust,” the council commented.
Meanwhile, against the existing global backdrop of low and negative interest rates, as well as an anaemic growth outlook, the sudden Covid-19 outbreak took investor uncertainty to new highs and this fueled a surge in gold investment demand in the first quarter as investors sought safe-haven assets, especially in Western markets such as the US and Europe.
Under normal circumstances this demand could be met through a variety of sources. But in the current environment, a divergence in the supply of LGD and retail bars and coins emerged.
In the wholesale market, the availability and liquidity of LGD bars was relatively unaffected by the supply chain issues. Trading volumes in the London over the counter (OTC) market remained strong in March, up 85% year-on-year, at over $1.5-trillion.
While volumes have fallen back since mid-March, they remained healthy even as the dislocation between London and Comex began to widen.
In contrast to gold futures on Comex, which are linked to 1 kg bars, most gold-backed exchange-traded funds (ETFs) are linked to LGD gold bars and these have benefited from the ample supply.
In the first quarter of the year, inflows into gold ETFs totalled 298 t, the highest level of quarterly inflows for four years. And the strong flows have continued through April and May.
According to the council this was supported by the large stock of LGD bars. At the end of January, a record 8 263 t of gold was held in London, valued at a record $426-billion.
The stock of LGD bars enabled gold ETFs to source the gold required to back the large volume of newly created shares.
As gold volatility increased in the first quarter, the standardisation and deep stock of LGD bars helped maintain liquidity in the wholesale gold market, benefiting individual and institutional investors alike, the council noted.
Meanwhile at the retail level, where there is market fragmentation, the story was markedly different. Significant stocks of small bars (1 kg or less) and coins were stranded in Eastern markets where demand was subdued throughout the quarter owing to Covid-19.
Difficulties in transporting this gold easily and quickly to meet heightened demand in Western markets caused supply issues.
Additionally, the availability of small gold bars and coins was further stretched owing to their more complex supply chain. Small bars and coins need to be distributed throughout the globe to retailers and consumers. By contrast, LGD bars are, typically, sent to LBMA-approved vaults in London using established routes and frequent flights.
Coin demand, in particular, jumped 80% year-on-year, with several mints reporting robust sales.
The supply and logistical issues caused depletion of some dealer inventories and left many investors facing long wait times and high premiums, and it was reported that premiums for American Eagle one-ounce gold coins jumped to over $130/oz (8% above spot), the highest level for six years, compared to an average of $25/oz (2% above spot) over the first two-and-a-half months of this year.
But as issues in the gold supply chain begin to ease such elevated premiums should narrow substantially, and anecdotal evidence seems to confirm this, the WGC said.