Ken Hoffman: Best and Worst COVID-19 Scenarios for Gold

Giving a keynote address from home for the World Gold Forum, an online event put on by the Denver Gold Group, Ken Hoffman of McKinsey emphasized the uncertainty the global pandemic has added to markets and the gold sector.

“As a matter of fact, there have been a number of days over recent weeks where intraday gold prices have moved at least US$100,” said Hoffman in his pre-recorded presentation, dated April 13.

Currently the yellow metal is holding above US$1,700 per ounce, at US$1,726.96.

In a brief overview of the whirlwind of activity the space has seen over the last two months, the client development executive highlighted gold’s ascent past US$1,700 in early March, which he said was backed by Chinese economic stimulus.

The yellow metal subsequently dropped a week later during a mass selloff.

“As markets completely imploded in March, there were investors looking for any source of liquidity, and they sold gold to try to get as much cash as possible as the markets fell by more than 30 percent,” said Hoffman. “As markets have recovered, and all ultimate quantitative easing has occurred, we can see that the gold price has headed up much, much higher.”

Another factor that is benefiting the currency metal is the degradation of other asset classes and sectors.

“One thing that’s been positive for the gold industry is the decline of foreign exchange (FX) and energy prices. We believe at this point in time around a 4 percent increase in the gold price could occur with energy and FX prices,” he explained.

Miners hit hardest by COVID-19 restrictions

While these factors have been motivational, prolonged mine closures and difficulties moving people and goods in out of countries will be a headwind for the gold sector.

Hoffman referenced Peru’s extended shutdown and mining restrictions as an example, and went on to say McKinsey sees roughly 12 percent of global supply at stake this year — a number that could grow if COVID-19 lockdowns and project shutterings are extended.

The virus is creating logistics and production concerns for miners, from the inability to transport the gold they produce to not being able to fly in specialists.

“We’ve seen roughly 10 million ounces or so being impacted by the shutdowns and the slowdowns that we’re seeing at many mines sites around the world — it’s a pretty significant change,” he said.

According to the data, Hoffman expects aboveground mines to be impacted by a roughly 5 percent increase in cost structure, faring better than underground mines.

Subterranean mines will likely incur a 15 percent increase to cost structure, with those in South Africa being impacted most.

In a worst-case scenario that sees the coronavirus lingering into the second half of 2020, Hoffman believes an additional 5 million to 6 million ounces could be impacted.

“A lot of this will depend at the end of the day on (if) we see these mines really operate at full capacity for the entire year,” he said. “Mines could restart and then there could be another wave of coronavirus infections, and then the mines may shut down again — and then they can restart and we could have a very difficult (period) for the whole year.”

Mines are not designed for intermittent stopping and starting, and this situation could lead to increased costs related to machinery and parts that may not even be accessible due to supply chain constraints.

Massive demand spike leaves gold supply drained

The inability to move physical gold around the world is one supply issue that has recently presented itself, leading to a shortage of coins, a predicament Hoffman finds interesting and worth watching.

“Many sources, including the Perth Mint, have said they’ve completely run out of gold coins. As a matter of fact, there’s been some shifting of gold inventories from London to New York; (the latter) caught itself rather short with its gold supply”

Scarcity has resulted in huge differences between current contracts and June contracts.

Unrelated to COVID-19, a serious future supply issue may be coming down the pipeline. Hoffman and his colleagues believe the world is “currently near peak gold production,” which would result in a 5 percent annual decline going forward.

He repeatedly referenced “high grading,” the practice of leaving lesser-grade ore stockpiled while higher-grade material is processed; this results lower-quality material being processed later.

This has gone on for quite some time in the mining industry, said Hoffman, and will ultimately result in a decrease in output. “Some mines have been high grading their ore relative to their stated ore grades, and we think this is something that will have an impact long term,” he said.

“You know, trying to lower your costs by high grading is great, but it can only last so long. The mine grade is the mine grade at the end of the day, and that average mine grade should be met over the course of the life of the mine; therefore, we could be coming to a standpoint where we could see significantly lower production from certain mines because of their past high-grading efforts.”

To conclude his presentation, Hoffman reiterated that economic stimulus would benefit gold, as would the push by hedge funds to hoard the yellow metal due to its safe haven nature.

High grading and output declines are also tailwinds that will drive the sector over the long term.

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Securities Disclosure: I, Georgia Williams, hold no direct investment interest in any company mentioned in this article.

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