HSBC-2011-05-10-PM-Outlook by stojeipatrze


                                                                                                            Global Research

Precious Metals                                               For gold, unease about monetary and
                                                               fiscal policies should rekindle the rally;
Outlook                                                        supply is likely to rise modestly

Bound to rebound; raising our price                           For silver, strong industrial demand and
forecasts                                                      a recovery in investor appetite should
                                                               offset mine and scrap supply growth

                                                              Industrial demand is boosting PGM off-
                                                               take; ETFs hold sizeable metal; eroding
                                                               Russian stocks may buoy palladium

                                                             We are raising our average price forecasts for gold, silver,
                                                             and the platinum group metals and introducing forecasts
                                                             for 2013 (see the table below). The bull markets remain
                                                             essentially intact for gold and the PGMs, and although silver is
                                                             priced closer to its equilibrium value, its near-term bias is
                                                             upward, in our view.

                                                             Gold: Prices have retreated from record highs. But they should
                                                             remain buoyed by investor concerns about the global economy,
                                                             geopolitical risks, high commodity prices, easy monetary
                                                             policies, and fiscal profligacy. Increased mine output, ample
                                                             scrap supplies, and moderate jewelry demand are freeing up
                                                             metal for the investment sector.

                                                             Silver: Prices have corrected sharply from 31-year highs near
10 May 2011
                                                             USD50/oz. Higher mine and scrap supplies are being absorbed
James Steel
                                                             by robust industrial off-take. Investors have favored silver and
HSBC Securities (USA) Inc.                                   coin sales, but prices appear high, especially relative to gold.
+1 212 525 6515
                                                             PGMs: Moderating growth in auto demand and robust
                                                             industrial off-take are offsetting slow growth in mine supply.
                                                             Platinum jewelry demand is moderating. PGM ETFs hold
                                                             considerable amounts of metal. Widespread belief that Russian
                                                             stockpiles are near exhaustion supports palladium prices.

                                                             HSBC precious metals average price forecasts (USD/oz)
                                                                            ___2011 ____ ___ 2012 ____      ___2013 ____ _ Long term __
                                                                             Old    New    Old    New        Old New        Old    New
                                                             Gold           1,450   1,525   1,300   1,500     —   1,450   1,050   1,250
View HSBC Global Research at:   Silver            26      34      20      29     —      24      15      20
                                                             Platinum       1,750   1,850   1,650   1,750     —   1,650   1,600   1,625
                                                             Palladium        750     825     650     750     —     725     600     700
Issuer of report:   HSBC Securities (USA) Inc.               Source: HSBC

Disclaimer & Disclosures
This report must be read with the
disclosures and the analyst certifications
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
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    10 May 2011


Bound to rebound                      3   Platinum                                     40
                                          Raising our platinum price forecasts         40
HSBC gold outlook                     9   Heading moderately higher                    40
Boosting our gold forecasts           9
                                          Driving moderately higher                    41
An ill wind blows good for gold       9
                                          Supply trends: Looking flat                  42
Gold should rebound                  10
                                          Demand trends                                46
Geopolitics and gold                 12

Macroeconomic influences             14   Palladium                                    52
Trends in supply and demand          21   Increasing our palladium price forecasts     52

                                          Already high but may go higher               52
Silver                               30   Start and stop                               53
Lifting our silver price forecasts   30
                                          Supply trends                                53
Back to earth                        30
                                          Demand trends: Shifting gears                57
Recovery phase                       31

Supply trends                        34   Disclosure appendix                          62
Demand trends                        37
                                          Disclaimer                                   63

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   10 May 2011

Bound to rebound
 Despite the steep pullback in gold, concerns about the inflationary
   impact of highly accommodative monetary polices, deficit
   spending, and high commodity prices should rekindle the rally
 Silver has retreated; investor sentiment will be crucial to price
   direction; strong industrial demand is more than offsetting mine
   supply growth but greater scrap supply may help weigh on prices
 PGMs are benefiting from growth in global auto production and
   robust industrial demand; ETFs hold considerable metal

Gold                                                    economic and financial crisis, which began in
                                                        mid-2007, and the subsequent unprecedented
Increasing our gold price forecasts
                                                        monetary and fiscal responses. Investors’ appetite
Given the prevailing macroeconomic conditions and
                                                        for gold was increased by inflationary concerns
gold’s proven utility as an inflation hedge, a safe-
                                                        that were prompted by highly accommodative
haven instrument, and a portfolio diversifier, we are
                                                        monetary policies, including quantitative easing
raising our forecasts of average gold prices for:
                                                        and huge fiscal spending increases throughout
 2011 to USD1,525/oz from USD1,450/oz.                 member states of the Organization for Economic
                                                        Cooperation and Development (OECD), and a
 2012 to USD1,500/oz from USD1,300/oz.
                                                        flight to safe-haven investments.
 The long term (five years) to USD1,250/oz
                                                        Easy accommodative monetary policies by the US
  from USD1,150/oz.
                                                        Federal Reserve stimulated already high demand
For 2013, we are introducing an average price           for commodities, notably – but not exclusively –
forecast of USD1,450/oz.                                in the emerging world. In addition to higher oil
                                                        prices, agricultural prices surged, which prompted
Cocktail of factors ushers gold to new                  the UN’s Food and Agricultural Organization to
highs                                                   declare a global food crisis earlier this year.
The 10-year gold rally remains intact, despite the      Commodity price rises fanned inflation fears and
recent steep pullback in prices. Prices had reached     stimulated demand for hard assets, including gold.
a new high of USD1,575/oz as investors                  The eruption of popular discontent in the Middle
continued to seek out bullion for its inflation         East, in particular the civil war in Libya, with
hedge and safe-haven qualities. The most virulent       implications for oil supply disruptions, raised the
phase of the gold rally can be traced to the global     global geopolitical risk thermometer, which

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    10 May 2011

further buoyed gold. A report by the World             about 2,040.4t of gold, or c80% of the world’s
Economic Forum this year warned of rising global       annual production. This is down c28t from the all-
geopolitical risks, growing income disparity,          time high of 2,068.4t in ETF holdings reached
increasing food prices, and the inability of the       near the end of 2010. Should investors choose to
world’s governments and institutions to fend off       liquidate even a fraction more of these holdings, a
another economic crisis with depleted resources.       substantial amount of bullion could appear in the
All of these factors supported gold.                   markets in a short period, with a commensurate
                                                       impact on price.
US fiscal profligacy also supported gold prices.
Continued heavy US government deficit spending         The growth in investor demand also is evident
and warnings by the credit rating agency Standard      from the rapid rise in net long speculative
& Poor’s that the US must restrain its fiscal          positions on the Comex. Although Comex longs
spending have further galvanized investor demand       are down from the high for the year to date of
for hard assets, including gold.                       26.7moz reached in mid-April, they still exceed
                                                       24moz. Heavy long positions also hold the
Gold prices moved in an almost unbroken upward
                                                       potential for further investor liquidation, with a
trajectory for much of this year. A pullback in
                                                       threat to the near-term gold price. Demand for
early May was triggered by a correction in
                                                       coins and small bars have been very strong for
commodity prices, notably oil, which, along with
                                                       many quarters. Even accounting for the recent
a bounce in the USD and heavy liquidation by
                                                       pullback in prices, we question whether retail
investors, clipped cUSD110/oz off record-high
                                                       investors will continue to purchase coins and bars
gold prices by the end of the first week of May.
                                                       in such heavy volume. High prices appear likely
Though steep, the pullback in prices dented rather     limit the retail demand for gold in this segment.
than reversed the gold rally, in our view. Longer-
                                                       After many years as a contributor to supply,
term, we expect an eventual return to some type
                                                       central banks have swung to being net buyers. We
of economic normalcy, and the consequent
                                                       believe this is an important development that will
winding down of heavy deficit spending and easy
                                                       support prices going forward. The signatories of
monetary policies could signal an end to the gold
                                                       the third Central Bank Gold Agreement (CBGA)
rally. Nonetheless, we believe that gold will
                                                       sold little gold in the compact’s first year, through
remain at elevated levels for several years, as
                                                       end-September 2010. Central bank sales have
investors are likely to keep a portion of gold in
                                                       been similarly low so far this year. Most of the
their portfolios for its diversification properties.
                                                       major holders of gold in the CBGA, such as
Investor demand now is the main driver for gold        Germany’s Bundesbank and Swiss National Bank,
pricing, while traditionally important physical        have signaled a reluctance to sell. Meanwhile,
supply and demand components, such as jewelry          some emerging-market central banks have shown
demand and mine supply, have recently exerted          an increased appetite for gold. The International
little influence on day-to-day moves in the gold       Monetary Fund announced an end to their sales
price. The bulk of current investor demand for         program at the end of 2010.
gold has been channeled into gold exchange-
                                                       High prices are also having an effect on more-
traded funds (ETFs). Despite modest liquidation
                                                       traditional participants in the gold market,
this year, the ETFs still hold considerable
                                                       encouraging an increase in recycled gold supplies
amounts of bullion. The major gold ETFs contain
                                                       and creating significant financial incentives for

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   10 May 2011

producers to increase output wherever possible.        Silver prices gained noticeably on gold for much of
High prices may also curb jewelry demand, which        the past year. The silver/gold ratio moved from 68:1
is still recovering from a near-collapse of demand     at end-April 2010 to 30:1 one year later, marking the
in 2009. Moderate jewelry demand and increases         lowest point since the early 1980s. The recent
in scrap and mine supplies will free up                correction in silver which drove prices back down to
considerable amounts of bullion for the                USD34/oz, also buoyed the ratio back to 42:1.
investment markets, we believe. This should also       Although this indicated a growing preference among
eventually help cap any further rallies.               some investors for silver over gold, we believe that
                                                       the ratio is likely to increase as investors recognize
                                                       that silver has become too expensive relative to gold
Increasing our silver price forecasts                  and reverse their positions. Indeed, the silver/gold
We are raising our forecasts of average silver         ratio increased at the beginning of May to 42:1.
prices for:                                            Meanwhile, in early May, silver prices pulled back
                                                       to USD34/oz in the days after the CME Group, the
 2011 to USD34/oz from USD26/oz.
                                                       Comex operation, announced margin increases,
 2112 to USD29/oz from USD20/oz.                      which triggered heavy long liquidation, and a wider
                                                       retreat in commodity prices.
 The long term (five years) to USD20/oz
  from USD15/oz.                                       The earlier surge in silver prices came in tandem
                                                       with a modest increase in holdings by silver
For 2013, we are introducing an average price
                                                       exchange-traded funds (ETF). The combined
forecast of 24/oz.
                                                       holdings of all three ETFs – the Barclays iShares
Silver roller coaster                                  and the smaller ETF Securities and the Zurich
Before retracing heavily at the beginning of May,      Kantonalbank Bank (ZKB) – increased by
silver had rallied from USD18/oz in September          c9.0moz to 467moz on 30 April 2011 from
2010 to 31-year highs near USD50/oz by late            457.9.6moz on 1 January 2011. Since then,
April 2011. Just as the case for gold, silver prices   investors liquidated a substantial 16moz, taking
have benefited from demand for hard assets             ETF holdings down to 451moz. Sales of coins and
stemming from the 2007-09 financial crises and         small bars remain vigorous, following on from
the monetary and fiscal responses. The most            robust levels in 2010.
recent phase of the silver rally coincided with the    We forecast that the silver market will be in
Fed’s signal in August 2010 that it would              surplus this year due in large part to increases in
reintroduce quantitative easing, in which lending      scrap and mine supplies. Substantial investments
programs are financed by the Fed’s balance sheet,      in silver mine projects earlier in the mining cycle
essentially creating and using cash to finance         are bearing fruit. Also, a greater supply of base
lending facilities.                                    metals will increase the silver byproduct supply,
For investors interested in hard assets, such as       we believe. In addition to growing mine output,
gold, silver has a similar attraction based on         increased scrap recycling will contribute to silver
growing inflation concerns, higher commodity           supply. As long as prices remain above
prices, and elevated geopolitical and sovereign        USD30/oz, we expect both individuals and
risks have spurred demand.                             manufacturers to supply considerably more scrap
                                                       metal for recycling than in recent years.

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Increases in mine and scrap supplies will be offset    from this decline, prices weakened again in early
by robust industrial demand, we believe. More          May in tandem with a broad-based pullback by
than half of the annual silver supply is regularly     commodities. We believe this latest platinum
consumed by industrial sectors. High prices have       price decline was triggered more by weakness in
not yet deterred industrial demand for silver.         other precious metals, notably gold and silver,
Based on HSBC’s macroeconomic forecasts for            rather than a change in platinum’s underlying
global industrial production, we forecast              fundamentals.
substantial increases in silver purchases by
                                                       Based on our supply/demand model, we expect the
industries this year.
                                                       platinum market to remain in deficit this year. A
Photographic demand for silver, meanwhile,             production/consumption deficit seems to be the
appears likely to extend its decline, as traditional   normal state of affairs for the platinum market.
photography continues lose market share to less        According to our supply/demand model, the market
silver-intensive digital cameras. The decline in       has been in deficit every year in this decade except
silver for photography has led to a corresponding      for 2006 and 2009, when auto and industrial
decline in recycled silver nitrates.                   demand almost collapsed due to the global
                                                       economic crisis. As deficits continue, we expect the
The recent pullback by silver prices is a closer
                                                       platinum price to be increasingly well-bid.
reflection of the underlying fundamentals, in our
opinion. Conditions in the global economy may keep     The listing of a US platinum group metals (PGM)
silver prices elevated and well above historical       exchange-traded fund (ETF) has been a notable
averages this year and next year, in our view.         success, absorbing a significant amount of
                                                       platinum since its launch at the beginning of the
                                                       2010. Last year, the combined holdings of the
Raising our platinum price forecasts                   four major platinum ETFs jumped by 555,000oz
We are increasing our forecasts of average             to 1.126moz. This year so far, combined platinum
platinum prices for:                                   ETF demand is up by 145,000oz to 1.271moz.
                                                       The demand has been driven by the same factors
 2011 to USD1,850/oz from USD1,750/oz.
                                                       that propelled investor interest in hard assets in
 2012 to USD1,750/oz from USD1,650/oz.                general, namely, concerns about potential
                                                       inflation, the direction of the USD, heavy deficit
 The long term (five years) to USD1,625/oz
                                                       spending by governments, loose monetary
  from USD1,600/oz.
                                                       policies, and geopolitical tensions. Despite the
For 2013, we are introducing an average forecast       recent pullback in the platinum price, these factors
of USD1,650/oz.                                        appear likely to support platinum ETF demand for
                                                       the rest of this year. If appetite for the ETFs
Driving higher
                                                       should dim and investors choose to liquidate even
Platinum prices rallied from a year-to-date low of     a fraction of their holdings, the market could
USD1,654/oz on 17 March 2011 to a high of              move into surplus, according to our
USD1,884/oz on 2 May. The price decline earlier        supply/demand model, with a commensurate
in the year was prompted by the earthquake and         impact on prices.
tsunami in Japan and anxiety that global auto
production would be significantly disrupted,
limiting the need for platinum. After recovering

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The automotive industry is the single largest        Palladium
demand source for platinum, where the metal is a
                                                     Raising our palladium price forecasts
necessary input in construction of autocatalysts
                                                     Following many years of heavy supply/demand
and particulate filters. The industry’s demand for
                                                     surpluses, the palladium market has moved into
platinum soared in 2010 in line with the global
                                                     deficit, where we believe it is likely to remain.
recovery in auto production following a near-
                                                     This will have a pronounced psychological impact
collapse in 2009. Based on HSBC equity research
                                                     on the market, in our view, and will sustain higher
by the automotive team, we expect platinum
                                                     prices. Based on this, we are raising our forecasts
demand from the auto industry to increase at a
                                                     of average palladium prices for:
more modest pace this year as growth in auto
production decelerates. HSBC equity analysts          2011 to USD825/oz from USD750/oz.
forecast that growth in global auto output will
                                                      2012 to USD750/oz from USD650/oz.
slow in 2011 but remain positive.
                                                      The long term (five years) to USD700/oz
Other forms of industrial demand for platinum,
                                                         from USD600/oz.
including electronics, glass, chemicals, and
petroleum refining, are growing at a brisk pace.     For 2013, we are introducing an average price
Based on HSBC macroeconomics forecasts of a          forecast of USD725/oz.
continued recovery in global industrial demand in
                                                     Higher on tight supply
2011, we expect industrial demand for platinum to
remain robust but to grow at slightly lower          After recovering from a drop below USD380/oz
percentage rates, compared with 2010 levels.         in early February 2010, palladium prices surged to
                                                     just above USD800/oz by the end of 2010. Prices
We believe that demand for platinum jewelry in       continued to climb this year, rising to a high of
2011 will decline modestly, based on high prices.    USD859/oz by late February. They subsequently
China accounts for the bulk of demand for            dropped to a year-to-date low of USD690/oz on
platinum jewelry, which remains very popular.        17 March in response to the earthquake and
Chinese consumer income is rising rapidly, and       tsunami in Japan, which caused the suspension of
we believe that some demand response to high         that country’s auto production and cast doubt on
prices is likely. In addition, we expect that high   the auto industry’s demand for palladium.
prices will encourage jewelry recycling.             Influenced by a pullback in commodity prices
Meanwhile, producers in South Africa face            generally, palladium prices tumbled to
obstacles and challenges in raising platinum mine    USD697/oz by 5 May.
output. These include power constraints,             Palladium has benefited from the recovery in
availability of fresh water, labor costs, a strong   global auto production. The industry traditionally
ZAR currency, and a variety of geological and        absorbs more than half of annual palladium
technical problems. High prices above marginal       production, required for production of
costs and investment earlier in the cycle will       autocatalysts and particulate filters. Gasoline-fired
support a modest increase in production.             engines require substantially more palladium in
Similarly, we expect Russian platinum output to      their PGM loadings than diesel-fueled vehicles.
increase modestly. A recovery in North American      Gasoline vehicles are favored in most of the
output following poor production levels in 2010      emerging world, notably China and India, as well
will help boost mine supply.                         as in North America, where demand has been

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HSBC economic and metals price forecasts
                                 2003    2003     2004     2005        2006     2007      2008     2009      2010     2011f   2012f Long term
G-7 IP                   % pa      1.0     1.0      2.6      1.9        3.5       3.5      -2.2    -12.9       6.9      4.1     4.2
Global IP                % pa      4.6     4.6      6.3      5.3        6.3       6.3       1.5      -6.1     12.4      6.4     6.3
Aluminum                USD/t    1,433   1,433    1,270    1,886      2,557     2,557    2,571     1,587     2,160    2,534   2,600     2,204
Copper                  USD/t    1,768   1,768    2,866    3,682      6,702     6,702    6,965     4,930     7,339    8,970   7,493     5.069
Nickel                  USD/t    9,634   9,634   13,845   14,749     24,052    24,052   21,070    14,727    21,665   25,434   22,04    15,428
Zinc                    USD/t      772     838    1,058    1,389      3,263     3,263    1,873     1,543     2,072    2,181   2,314     1,741
Aluminum                USc/lb      61      65       78       86        116       116      117         72       98      115     118       100
Copper                  USc/lb      71      81      130      167        304       304      316       224       333      407     340       230
Nickel                  USc/lb     307     437      628      669      1,091     1,091      956       668       983     1154    1000       700
Zinc                    USc/lb      35      38       48       63        148       148        58        70       94       99     105        79
Gold                   USD/oz      210     364      410      445        604       604      872       990     1,225    1,525   1,500     1,250
Silver                 USD/oz     4.60    4.88     6.66     7.29      11.55     13.55    14.97     14.80     19.00    34.00   29.00     20.00
Platinum               USD/oz      539     692      846      897      1,139     1,106    1,574     1,210     1,725    1,850   1,750     1,625
Palladium              USD/oz      337     200      230      202        319       356      351       265       525      825     750       700
IP = Industrial production
Source: HSBC

relatively better than in the primary diesel-fueled                The launch of a US-listed PGM exchange-traded
markets of Europe. The US and Chinese auto                         fund (ETF) by ETF Securities last year was highly
markets, together, account for the bulk of                         successful and is absorbing a significant amount
palladium autocatalyst demand worldwide. Based                     of available above-ground stock. Palladium ETF
on HSBC research forecasts of auto production,                     demand has been static this year. Industrial
we expect that auto industry growth in palladium                   demand has been robust, in keeping with the
consumption this year will moderate considerably                   recovery in global industrial production. Based on
from 2010 but remain positive.                                     HSBC macroeconomic forecasts of continued
                                                                   industrial expansion this year, we believe that
The overwhelming bulk of palladium mine
                                                                   industrial off-take for palladium will increase. The
production is derived as a byproduct of platinum
                                                                   combination of industrial demand and reduced
production in the case of South Africa and nickel
                                                                   Russian stockpile sales has the potential to tighten
output in the case of Russia. Together, these
                                                                   underlying supply/demand balances and maintain
countries make up the vast bulk of global
                                                                   high prices for the rest of the year, we believe.
palladium mine production. By our calculations
and based on producer comments, both regions
should increase palladium output this year. Such
increases appear likely to be modest, however, as
producers face a variety of challenges, including
falling ore grades, inadequate infrastructure, and
constraints on power and fresh water. Also,
concern about the level of Russian palladium
stockpiles, and therefore the potential for a large
decrease in Russian exports, remains a factor.
Prices are well in excess of marginal costs of
production, however, and producers are making
every effort to increase output wherever possible.

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HSBC gold outlook
 Gold pulls back on commodity price correction after hitting record
    highs on concerns about highly accommodative monetary
    policies, deficit spending, USD weakness, and elevated
    geopolitical risks
 Prices should remain elevated as investor demand offsets impact
    of increased mine and scrap supplies and weak jewelry demand
 We are raising our average gold price forecasts and introducing
    an estimate for 2013

Boosting our gold forecasts                                              An ill wind blows good for gold
We are raising our forecasts of average gold                             Despite the recent pullback in gold prices, we
prices for:                                                              remain positive on the metal going forward. Gold
                                                                         prices will be determined largely by the interplay
 2011 to USD1,525/oz from USD1,450oz.
                                                                         between monetary policy, inflation expectations,
 2012 to USD1,500/oz from USD1,300/oz.                                  the direction of commodity prices, the evolving
                                                                         sovereign debt crisis in the euro zone, similar
 The long term (five years) to USD1,250/oz
                                                                         concerns regarding US debt levels and fiscal
  from USD1,050/oz.
                                                                         policy, and geopolitical risks.
For 2013, we are introducing a forecast of

 Gold prices, 1971-present (USD/oz)                                       Gold prices, 2005-present (USD/oz)
 1800                                                                     1,800
 1600                                                                     1,600
 1400                                                                     1,400
 1200                                                                     1,200
 1000                                                                     1,000
  800                                                                       800
  600                                                                       600
  400                                                                       400
  200                                                                       200
    0                                                                         0














 Source: Reuters                                                          Source: Reuters

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How confident investors will be in government to        The main source of physical supply, mine output,
remedy global economic and geopolitical                 is set to increase this year and next year, as high
challenges, and the direction of the foreign            prices encourage greater output and producers
exchange markets, also will be important factors        increase reserves. Dehedging, an important source
in determining gold prices. In this atmosphere,         of demand for a decade, is all but disappearing.
traditional supply/demand factors including mine        The official sector turned into a net buyer of gold
supply, producer hedging policies, and jewelry          in 2010 after two decades of heavy sales. Central
and industrial demand may take a second place to        banks appear likely to increase net purchases this
macroeconomic and geopolitical influences and           year in an effort to diversify their foreign
investment demand on gold. We believe that on           exchange holdings. This may be an important
balance, these factors will keep demand for gold        bullish development for gold.
elevated for the rest of the year.
                                                        Gold’s status as a safe haven and portfolio
As outlined by the HSBC macroeconomics team,            diversifier has been confirmed by the increase in
US monetary policy is likely to remain                  investor demand since the beginning of the
accommodative, even after the end of the Fed’s QE2      economic crisis. However, if US monetary policy
program, scheduled for June. Meanwhile, inflation       were to be tightened and commodity prices ease
fears based on surging commodity prices and loose       and geopolitical tensions fall, the rationale for
US monetary policy are increasing inflationary          owning gold would fall with a commensurate
pressures in the emerging world. This is supportive     impact on prices. The balance of factors argues
of gold. Although core inflation is not rising in the   for higher, rather than lower, prices over much of
OECD nations, commodity inflation to which gold is      this year, in our view.
sensitive is increasing sharply. The food crisis
                                                        For gold, we anticipate a wide trading range this
declared by the UN and popular uprisings in the
                                                        year of USD1,300-1,650/oz , with a possible spike
Middle East introduce a geopolitical dimension that
                                                        to USD1,700/oz. At prices above USD1,500/oz,
is further supportive of gold. Though the recent
                                                        we expect jewelry demand would weaken and
pullback in commodity prices was steep, this does
                                                        scrap supply increase. Conversely, we would
not indicate a reversal in the long-running
                                                        expect any price decline below USD1,300/oz to
commodity bull market, we believe.
                                                        encourage greater emerging-market demand for
Investment demand was firm for gold until May.          bullion. The new dynamics for investors have
We believe that high prices contributed to the          renewed their demand for gold as both a safe
decline in ETF and physical bullion demand. At          haven and a hedge against inflation. Eventual
lower gold prices, ETF demand should recover.           normalization of the global economy and ultimate
Also, demand for coins and small bars implies           tightening of monetary policies explain our view
that retail and institutional demand is still           on gradual price declines from 2012 onward.
underpinning the gold rally.
                                                        Gold should rebound
Jewelry demand has risen from multiyear lows.
                                                        In 2010, the gold price rose for a 10th consecutive
But the combination of high prices and economic
                                                        year. The rally was driven by a recovery in some
uncertainty will limit demand growth this year,
                                                        sectors of physical demand and continued global
we expect. The continued recovery in gold
                                                        economic uncertainty. The gold price rose 29%
demand in the emerging world may be tempered
                                                        y-o-y to USD1,405/oz after hitting what was then
by high prices.
                                                        an all-time high of USD1,430/oz on 7 December

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   10 May 2011

2010. The average price for the year was              since the onset of the subprime mortgage crisis in
USD1,225/oz, up from an average of USD973/oz          mid-2007. Gold benefited from its stature as a
in 2009. Gold also outperformed all other major       safe haven and its lack of counterparty and credit
asset classes and most other commodities. This        risk as the initial subprime mortgage crisis
year, prices corrected to USD1,308/oz, a year-to-     morphed in a full-blown credit and financial crisis
date low, on 28 January. We attribute this sharp      with the collapse of Lehman Brothers in 2008.
but brief drop to a shift in investor sentiment.
                                                      Gold benefited further as governments and
Well-received Portuguese and Spanish bond
                                                      monetary authorities across the globe slashed
auctions and positive comments about the US
                                                      interest rates, boosted spending, and implemented
economy by US Federal Reserve Chairman Ben
                                                      unprecedented measures such as quantitative
Bernanke increased investor appetite for “riskier”
                                                      easing. Investor concerns shifted from
investments and triggered a flow out of gold.
                                                      counterparty and credit risk to anxiety that highly
Long liquidation on the Comex and a decline in
                                                      accommodative monetary policies and rising
the holdings of the largest gold-backed exchange-
                                                      government debt levels would inevitably bring
traded funds (ETFs) were visible signs of the
                                                      back high inflation rates. Gold remained a popular
change in investor demand. Gold would have
                                                      alternative to paper assets throughout 2009 as
penetrated USD1,300/oz, we believe, were it not
                                                      investors sought out bullion for its inflation hedge
for robust physical demand in Asia. Heavy
                                                      properties. Gold investment remained robust as
exports globally of bullion to China, India, and
                                                      the economic crisis developed into a sovereign
other parts of Asia from December 2010 through
                                                      risk crisis in 2010. A second round of quantitative
February this year not only sustained the gold
                                                      easing by the Federal Reserve gave gold a second
market when Western investor sentiment dimmed,
                                                      wind later in the year, helping to propel gold
but helped push the metal price to new highs later
                                                      prices to new highs.
in the year.
                                                      More recently, fiscal concerns and events in the
Bullion prices recovered in February, spurred by
                                                      Middle East have helped push commodity prices
accelerating commodity prices, notably oil. Rising
                                                      up, buoyed further by rapacious demand for
petroleum prices were tied to unrest in North
                                                      commodities in much of the emerging world. This
Africa and the Middle East. Regime change in
                                                      momentum led the surge in gold prices to record
Tunisia and Egypt, demonstrations throughout
                                                      levels above USD1,575/oz by early April. A price
that region, and civil war in Libya amplified safe-
                                                      correction took gold back to USD1,462/oz in
haven demand for bullion. Underpinning the rally
                                                      early May.
were concerns that popular discontent in the
Middle East would disrupt the smooth flow of oil      The price correction has blunted – but not
from the region. A move into gold by investors        reversed – the gold rally, in our opinion. For the
also was triggered by the aftermath of the            rest of this year, we expect elevated geopolitical,
earthquake and tsunami in Japan in March, which       inflation, and sovereign risks to support bullion
caused widespread destruction and significant         prices. Longer-term, we anticipate an eventual
damage to nuclear plants that leaked radiation.       end to the current highly accommodative
                                                      monetary policies. This could gradually undercut
Until the Mideast upheavals began, gold prices
                                                      the gold market as real interest rates rise and the
reflected closely the course of the financial and
                                                      safe-haven bid for gold diminishes. Increased
economic crisis. Prices have more than doubled
                                                      fiscal restraint by the world’s major economies

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     10 May 2011

also should eventually curb gold rallies, but we               world to absorb any major new shocks or meet
believe that heightened sovereign risk worries will            global challenges.
buoy gold prices in the near term. A flattening of
                                                               In addition to reducing overall global economic
the US yield curve may be the most visible
                                                               resilience, the financial crisis has led to a rise in
expression of a tightening of monetary policy and
                                                               geopolitical tensions and raised global social
an easing by gold prices.
                                                               discontent, according to the WEF, increasing risks
The following chart shows how well gold                        across a range of economic, geopolitical, social
performed in relation to other asset classes during            and even climate categories. This is likely to mean
the economic crisis.                                           that economic and geopolitical events, even
                                                               relatively low-level events, may have an
 Gold: Safe haven among asset classes, 2008-end April 2011
                                                               exaggerated effect on gold prices, as governments
          Returns for Various Asset Classes 2008-Present
                                                               and institutions struggle to cope with fresh
 60.00%                                                        challenges when they have depleted resources in
 40.00%                                                        the wake of the financial crisis.
                                                               An additional factor addressed by WEF is the
-40.00%                                                        interrelationship between risks, and its report
-60.00%                                                        suggested that because of globalization, risks for
      Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11
        S&P 500 Gain (Loss)    Gold Gain (Loss)                contagion have grown significantly. This might
        T-Note Gain or Loss    Lipper Muni Index Gain (Loss)
                                                               hold important implications for gold prices.
 Source: Reuters
                                                               Increased contagion is likely to boost gold’s
                                                               sensitivity to global economic and geopolitical
Geopolitics and gold
                                                               events and to make gold prices more volatile than
In addition to reflecting the global economic and              would otherwise be the case. This helps explain
financial climate, gold is a barometer of                      our expectations of a relatively wide trading range
geopolitical and even social risks. We believe that            for gold prices this year of USD1,300-1,650/oz ,
the severity of these risks is increasing and is               with a possible spike to USD1,700/oz.
likely to have a commensurate effect on gold
prices for the rest of this year.                              The WEF report identified economic disparity and
                                                               global governance failures as significant risks to the
In our 14 January research note, Golden Risks:                 world economy. The was confirmed by the World
The World Economic Forum identifies major risks                Bank, which found that income inequality as
to the world economy that may influence gold                   measured by the Gini Index, a traditional economic
prices, we discussed a WEF report, Global Risks                measure of income inequality, over the past decade
2011, which outlined economic and geopolitical                 increased most rapidly in emerging economies,
risks facing the global economy as assessed by                 notably but not exclusively in India, China, and
580 world leaders and decision makers. These                   Indonesia. Income inequality also increased across
risks hold potential ramifications for gold. The               the OECD world for the same period.
WEF found that the financial crisis had greatly
weakened economic positions of governments,                    The growth in income inequality broadly
societies, and institutions, particularly in mature            coincides with the long-run rally in gold prices.
economies. This has reduced the capacity of the                During periods when income inequality is
                                                               relatively stable or narrowing, gold prices tend to

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   10 May 2011

weaken. This could be because growing inequality            The intensity of geopolitical challenges and how
is often associated with rapid economic growth,             they are faced will help dictate the direction of gold
rising commodity prices, and sometimes higher               prices. The US National Intelligence Council, a
inflation. Narrowing income inequality tends to             center for strategic thinking, and the European
occur against a backdrop of more-stable and less            Union’s Institute for Security Studies recently
inflation-prone periods.                                    concluded that current frameworks for international
                                                            cooperation leave the world ill-equipped to keep
Typically, economic disparity also is highly
                                                            pace with mounting geopolitical challenges without
connected to asset bubble collapses, fragile
                                                            extensive reform. This implies that geopolitical risks
governments, inefficient economies, corruption,
                                                            will continue to bolster gold prices.
and general social immobility. Data collected by
the WEF suggest that economic disparity and                 The golden ghost of Malthus
geopolitical conflict reinforce each other. Asset           The Reverend Thomas Malthus, a British scholar,
bubble collapses, in particular, stimulate interest         is regarded as one of the founders of political
in gold as a safe haven. According to the Council           economy. In “An Essay on the Principle of
on Foreign Relations, income disparity,                     Population” (1812), he postulated that population
corruption, and social immobility are the principal         growth was exponential but that agricultural
drivers of the wave of protests against                     growth was arithmetic. Thus, any sharp rise in
governments in the Middle East this year.                   population would eventually lead to a food
We found it interesting that gold prices dropped to         shortage, which would ultimately be self-
their low for this year of USD1,308/oz in mid-              correcting. To date, technological and scientific
January after well-received Spanish and Portuguese          advances and rising productivity have prevented
bond auctions reduced euro sovereign risk. Gold             Malthus’s prediction from coming true.
prices subsequently surged in response to the               Malthus’s theories have been amplified and
popular discontent that began in Tunisia and quickly        applied to natural resources, and they are
spread to much of the rest of North Africa and the          periodically revived, typically triggered by fears
Middle East. It is no coincidence that gold prices          of too-rapid depletion of world resources. These
have accompanied worries that the Libyan civil war          periods usually coincide with prolonged bull
and popular discontent in the oil-producing Gulf            markets for gold. The last such period was the
states would disrupt global oil supplies. The surge in      1970s, when the world was rocked by food and
oil prices was crucial in preventing gold from              energy crises. The Club of Rome, a global think
breaking below USD1,300/oz earlier this year. Oil           tank, produced in 1972 a now-famous report,
prices have spurred higher gold prices before,              “The Limits to Growth,” which attempted to
notably in the 1973-74 and 1979-80 energy crises.           model the consequences of a rapidly growing
We visit the impact of commodities on gold                  world population and finite resource supplies. The
throughout this report.                                     dominant thesis later in the 20th century was that
History has shown that gold prices are sensitive to         the market would always solve the problem – high
geopolitical and social dynamics, as well as                prices would encourage technological advances,
economic and financial events. The WEF report               and producers would find new sources of supply.
stated that the severity of these risks is increasing,      This view generally coincides with low or stable
and we believe this is likely to have a commensurate        gold prices.
effect on gold prices for at least the rest of this year.

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     10 May 2011

The rise in per capita commodity consumption in        The FAO also identified shortages of clean water
the developing world, brought on by rising             and fertilizer, high energy prices, and a lack of
prosperity, has led to unprecedented demand for        investment as chronic impediments to increasing
commodities. Fears of depletion of natural             food output. Any resource-driven crisis, even if it
resources again have taken center stage.               is one of a relatively small scale, typically is
Escalating commodity prices and worries that the       likely to be supportive of gold prices.
world is depleting the stock of natural resources is
                                                       An increasing share of global GDP is generated in
encouraging demand for hard assets, including
                                                       the emerging world. A feature of economic
gold. This is likely to remain the case for as long
                                                       growth in these nations is a growing appetite for
as commodity prices remain elevated, we believe.
                                                       commodities. As these nations continue in a
As gold is a commodity and a traditional hedge         commodity-intensive phase of development,
against inflation, its prices have been strongly       HSBC macroeconomics expects commodity
influenced by the steep rise in commodity prices.      demand to remain high. Meanwhile, increases in
The charts overleaf show how prices of metals          income are triggering a change in diets, notably a
and food have risen over the past few years. We        switch from carbohydrates and vegetable protein
believe that it is no coincidence that the increases   to animal protein. This is putting pressure on the
in prices of metals and foodstuffs have broadly        world’s grain supplies and increasing agricultural
coincided with the long-running rally by gold.         prices. We regard the rise in food and other
                                                       commodity prices as an important element in
Food price increases have created social discord
                                                       gold’s rally. And for as long as food prices are
and raised political tensions across the emerging
                                                       likely to remain high, they will be a bullish factor
world, where consumers spend a significantly
                                                       in determining gold prices, we believe.
higher proportion of their incomes on food than in
the developed OECD member states. This also is         Macroeconomic influences
a contributing factor in the outbreak of popular
                                                       Economic challenges good for gold
unrest in North Africa and the Middle East. The
                                                       In Global Economics Quarterly: An economic oil
combination of rapid increases in population and
                                                       slick (31 March 2011), HSBC chief economist
growing prosperity leading to higher per capita
                                                       Stephen King and the macroeconomics team
incomes is putting unsustainable pressures on the
                                                       stated that just as the global economy was picking
world’s resource base, according to the most
                                                       up steam, the world was presented with a new set
recent report by the UN’s Food and Agricultural
                                                       of challenges. Commodity-inspired price gains
Organization (FAO).
                                                       were threatening the economic recovery in the
The FAO earlier this year declared a global food       developed world while contributing to heightened
emergency, mostly in response to droughts in           political instability in parts of the emerging world.
Russia, Ukraine, and Kazakhstan, a suspension of       In our opinion, the combination of rising
grain exports from Russia, and flooding of grain-      commodity prices, increased inflationary
producing regions in Australia, all of which hurt      expectations, and elevated geopolitical risk is
grain harvests. The FAO had last declared a food       tailor-made for a gold rally, and largely explains
emergency in 2008. The withdrawal of food              that market’s ascent to new highs.
subsidies across much of the emerging world at
that time sparked food riots in more than a dozen
countries and coincided with a robust gold rally.

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   10 May 2011

 Metals prices have risen sharply                                       Foodstuffs: Recent price increases eclipsed those in 2008

  Index , 2004=100                                  Index , 2004=100     Index , 2004=100                                      Index , 2004=100
 450                                                            450       220                                                               220
 400                                                            400       200                                                               200
 350                                                            350       180                                                               180
 300                                                            300       160                                                               160
 250                                                            250       140                                                               140
 200                                                            200       120                                                               120
 150                                                            150       100                                                               100
 100                                                            100        80                                                               80
  50                                                            50         60                                                               60
   0                                                            0
                                                                               00         02        04        06          08      10
       00         02        04        06       08      10
                                      Metals                                                                 Foodstuffs

 Source: Thomson Reuters Datastream                                     Source: Thomson Reuters Datastream

One reason the commodity rally has had such a                          According to the HSBC economics team, this
bullish impact on gold is the timing of the                            approach has been partly successful. Asset prices
commodity upswing. Mr. King pointed out that                           have recovered, and consumer and business
never before had there been such a large increase                      confidence has risen. But while low interest rates
in the cost of raw materials so soon after the end                     and easy credit have led to a rebound in activity in
of a deep and protracted recession impacting most                      the developed world, it has stimulated far greater
of the Western world. The suddenness of the                            growth in the emerging world. Unlike the situation
commodity rally changed inflationary                                   in the developed world, emerging economies are
expectations, according to Mr. King, thereby                           not shackled by debt. As a consequence, they have
contributing to demand for gold as an inflation                        responded vigorously to easy global monetary
hedge. Such a large rise in commodity prices also                      conditions. The vitality of emerging nations,
could puncture business and consumer                                   combined with investor unease about the printing
confidence, Mr. King said. If so, we would expect                      of money, has led to increased demand for
gold to be a beneficiary. The recent pullback in                       commodities and other non-paper stores of value,
commodities, while steep, is not of sufficient                         such as gold. This helps explain the heavy demand
magnitude to allay inflation fears, especially if the                  for gold in both the emerging and developed
retreat proves to be short-lived in the near term.                     worlds and the resulting price rally.

Unorthodox policies help gold                                          The rise in commodity-led inflation has led
In an effort to stave off a repeat of the Great                        financial markets to begin to price in an increase
Depression and jump-start their economies,                             in interest rates. Some OECD central banks,
Western central banks have pursued highly                              including the European Central Bank, have raised
accommodative monetary policies. These include                         rates, and prospects have diminished for an
unconventional policies, including a huge increase                     extension of the second round of the Federal
in bond purchases via an expansion of central                          Reserve’s quantitative easing program, scheduled
bank balance sheets. Fear of the inflationary                          for 30 June, according to the HSBC economics
consequences of these policies has stimulated the                      team. Despite this, monetary policy in Western
demand for gold.                                                       economies remains highly accommodative and is
                                                                       still gold-supportive.

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     10 May 2011

The experience of emerging nations is different,            Oil prices are sensitive to small fluctuations in supply

according to Mr. King. The focus on inflation in            USD                          World oil price                   USD
                                                            140                                                             140
these countries is more pronounced, particularly                                                      Lower P ro duction
                                                            120                                                             120
given the effects of inflation on the less well-off. The
                                                            100                                                             100
rise in commodity prices has hastened a tightening                                                           Feb base
                                                             80                                                             80
of monetary policies in the emerging world.                  60                                                             60
Emerging nations have favored unconventional                 40                                                             40
tightening policies, including “quantitative                 20                                                             20
tightening” and a clampdown on domestic credit, in            0                                                             0
addition to conventional rate increases.                        2005        2007        2009     2011      2013     2015

The Chinese authorities have employed a                     Source: Oxford Economics, HSBC

combination of reserve requirement increases and
                                                           economic uncertainty. Oil prices are very
supply-side measures aimed at cooling food
                                                           sensitive even to slight disruptions in supply. The
prices, according to the HSBC economists. These
                                                           chart immediately above forecasts the effects of
authorities have repeatedly raised reserve
                                                           tight supply on prices.
requirement ratios in an effort to soak up excess
liquidity, and growth of the broad money supply            Between the rise in oil prices and the disaster in
and new loans has eased since the Chinese central          Japan, the biggest threat to the world economy is
bank began its tightening policy. Other emerging-          higher oil prices, according to the HSBC
market central banks are monitoring China’s                economics team. This is also positive for gold.
success in managing inflation and may follow               Higher oil prices lead to a redistribution of global
suit, according to the HSBC economics team. If             income away from oil-consuming but high-
the Chinese authorities fail to rein in inflation,         spending economies such as the US and toward
gold is likely to be a beneficiary.                        oil-exporting and high-saving nations such as
                                                           Saudi Arabia. The propensity in oil-consuming
The Middle East shock, oil, and gold
                                                           countries to purchase gold is high and increases
Unrest in North Africa and the Middle East has
                                                           with higher oil prices. More important, perhaps,
buoyed oil prices. As with other commodities, the
                                                           the wealth transfer from higher oil prices leaves
rapid rise in oil prices comes shortly after the end
                                                           oil producers with excess savings, which can be
of a stiff recession. Typically, oil prices do not
                                                           invested elsewhere in the world. In a period of
rise until years into an economic recovery. The
                                                           economic and political uncertainty, there is likely
recent correction in oil prices of USD10 per barrel
                                                           to be a flight to hard assets, including gold.
to USD95, though steep, still leaves prices
historically high.                                         Higher oil prices also lead to losses of business
                                                           and consumer confidence and changes in
According to the HSBC macroeconomics team,
                                                           inflation, which increase safe-haven demand for
the impact on oil prices, caused in part by the
                                                           gold. The rise in oil prices, which can act like a
uprisings in the Middle East and North Africa and
                                                           tax in oil-consuming nations, may lower incomes
the risk of economic dislocation following the
                                                           and curb discretionary spending on luxury items
earthquake and tsunami in Japan, threaten the
                                                           such as gold jewelry. In this regard, higher oil
world economy with a near “perfect storm.”
                                                           prices may be negative for gold demand.
These upheavals have greatly benefited gold by
increasing inflation concerns and elevating

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   10 May 2011

 Gold and the US Treasury yield curve                                                                               Gold and the US debt-to-GDP ratio (USD/oz)

 1600                                                                                                       3.5     1,800                                                                                                          90%
 1400                                                                                                       3.0     1,600
 1200                                                                                                       2.5     1,400
 1000                                                                                                       2.0     1,200                                                                                                          70%
  800                                                                                                       1.5     1,000
  600                                                                                                       1.0       800
  400                                                                                                       0.5       600                                                                                                          50%
  200                                                                                                       0.0       400
    0                                                                                                       -0.5      200
                                                                                                                        0                                                                                                          30%

             Gold (USD/oz) - LHS                                    10yr - 2yr (% ) - RHS
                                                                                                                                     Gold (LHS)                   US Gross Federal Debt as a % of GDP
 Source: Reuters
                                                                                                                    Source: Reuters, Congressional Budget Office

A monetary conundrum is good for                                                                                   Fiscal concerns are good for gold
                                                                                                                   We discussed the bullish impact of the eruption of
As discussed in previous editions of our Precious                                                                  the euro sovereign-risk crisis on gold in our 14
Metals Outlook, inflation expectations and                                                                         May 2010 report, Precious Metals Outlook:
monetary policy wield enormous influence on                                                                        Golden sovereign (risk). Gold is benefiting from
gold prices. Although the European Central Bank                                                                    deepening government deficits and accommodative
recently raised rates and countries in the emerging                                                                monetary policies. If investors believe the
world are pursuing various forms of quantitative                                                                   authorities are using fiscal policies excessively, this
tightening, the US Federal Reserve is unlikely to                                                                  poses a significant risk of rising uncertainty in the
tighten monetary policy, according to the HSBC                                                                     private sector. One channel for this uncertainty is
economics team, even if it does not extend its
                                                                                                                   likely to be the gold market.
second round of quantitative easing (QE2) and
chooses instead to maintain an accommodative                                                                       Concerns about mounting government debt levels
monetary policy for the foreseeable future for fear                                                                are not limited to the peripheral euro-zone
of setting off a recession in light of substantially                                                               nations. Gold has attracted significant safe-haven
higher oil and other commodity prices.                                                                             buying in the wake of action by Standard &
                                                                                                                   Poor’s; though S&P affirmed its AAA credit
The chart at upper left shows that as the US                                                                       rating on US sovereign debt, it revised its long-
Treasury yield curve steepened, gold prices had a                                                                  term outlook to negative from stable. Sovereign
tendency to rally.                                                                                                 risk concerns are supportive of gold prices. At the
The conundrum facing US monetary policymakers is                                                                   height of the Greek crisis in May 2010, German
that if they tighten policy, they may be criticized for                                                            banks sold a record number of gold coins, and
acting prematurely and possibly snuffing out                                                                       gold prices surged above USD1,200/oz. Even
economic recovery. If they leave interest rates low,                                                               small countries with sovereign debt problems can
they may be blamed for stirring up inflation and                                                                   have a positive effect on gold. With a GDP of
boosting commodity prices. Given the history of oil                                                                USD330.78bn, according to the latest national
price-related recessions in the US, the Fed is more                                                                figures, the Greek economy is roughly the size of
likely to choose to keep rates low for the foreseeable                                                             that of Washington state, which has a GDP of
future, according to HSBC Economics. This would                                                                    USD338.33bn, according to the latest US data.
likely extend further support to the gold rally.

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     10 May 2011

The chart at the top right of the previous page                 HSBC currency research team outlined the lack of
shows that as the US debt-to-GDP ratio moved                    a clear positive choice among the Big Four
above 60%, the gold rally accelerated. The chart at             currencies: the USD, EUR, GBP, and JPY.
the bottom of this page shows the increase in US
                                                                Gold seems to be one of the “Cinderellas” in the
government liabilities. A change in the credit
                                                                currency “ugly sister” contest. In a pre-crisis
rating of the US, the world’s largest economy and
                                                                world, the foreign exchange market would likely
home of the world’s reserve currency, could be
                                                                be looking to sell the USD, Mr. Bloom said, based
“risk-sapping event,” according to HSBC chief
                                                                on US economic fundamentals. However, the
US economist Kevin Logan and G-10 currency
                                                                situations in Portugal and Ireland, as well as
analyst Robert Lynch. In a research note, Messrs.
                                                                Greece, mean that it is difficult to turn naturally to
Logan and Lynch outlined the long-term fiscal
                                                                buy the EUR. Meanwhile, the UK has its own
problems faced by the US: The federal deficit is
                                                                fiscal problems. The JPY is not a good candidate
likely to average about 7% of GDP for the next
                                                                for purchase due to recent coordinated
three years. On current trends, the US debt-to-
                                                                intervention by the Group of 7 nations. The
GDP ratio will surpass 90% by the end of this
                                                                unintended consequences, the HSBC currency
decade. In addition, interest payments on debt
                                                                research team said, are that the market is bullish
outstanding are likely to rise to 20% of federal
                                                                on currencies of OECD and emerging-market
revenues, making any long-term solution to the
                                                                commodity-producing nations and the CHF. Gold
deficit problem that much more difficult to
                                                                and currencies of EM and OECD commodity-
achieve. It is the financial market’s reduced
                                                                producing countries have had a positive
confidence that a long-term solution to the debt
                                                                correlation going back well before the financial
problem will be found that has helped propel gold
                                                                crisis. In this climate, appreciation of these
to new highs.
                                                                currencies would benefit gold. Strength in these
The ugly sisters’ currencies and                                currencies also helps explain some of gold’s rally.
Cinderella’s golden slipper                                     The chart overleaf shows what the HSBC
In Currency Outlook: The ugly contest turns                     currency research team describes as the smaller
uglier (7 April 2010), David Bloom and the                      OECD “good currencies” versus the four major

 US government debt outstanding has doubled since 2004

   USD bn                                     US Gov ernment Debt Outstanding                                USD bn
 16,000                                                                                                        16,000
 14,000                                                                                                           14,000
 12,000                                                                                                           12,000
 10,000                                                                                                           10,000
     8,000                                                                                                        8,000
     6,000                                                                                                        6,000
     4,000                                                                                                        4,000
     2,000                                                                                                        2,000
        0                                                                                                         0
             1950 1954 1958   1962 1966 1970     1974 1978 1982 1986            1990 1994 1998   2002 2006 2010

 Source: Bloomberg, HSBC

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   10 May 2011

 Gold tends to move positively with “good” currencies

                                             Good versus Ugly currencies trade weighted (Jan 1 2009=100)
 124                                                                                                                               124
                        Ugly contest currencies (USD, EUR, GBP and JPY)
 120                    Good currencies (AUD, NZD, CAD, NOK, SEK and CHF)                                                          120

 116                                                                                                                               116

 112                                                                                                                               112

 108                                                                                                                               108

 104                                                                                                                               104

 100                                                                                                                               100

  96                                                                                                                               96
   Jan-09 Feb-09 Apr-09               Jun-09 Aug-09 Oct-09 Nov-09 Jan-10 Mar-10 May-10             Jul-10   Aug-10 Oct-10 Dec-10

 Source: HSBC currency research, Bloomberg

“bad currencies.” The team defines “good”                                    surrogate currency – and emerging-market
currencies as traditional safe havens and those of                           currencies a viable alternative for investors.
commodity-exporting countries and “bad”
                                                                             If history is any judge, the decade-long gold rally
currencies as the four most heavily traded OECD
                                                                             will not end until the Federal Reserve changes
currencies (see the chart immediately above).
                                                                             current accommodative policies, the USD
Even if the US economy begins to recover and the                             stabilizes, and progress is made on reducing the
Fed starts to unwind some of its ultra-                                      US government budget deficit and restraining
accommodative policies, a sustained USD rally                                growth in the debt-to-GDP ratio. Lower
should not be expected, Mr. Bloom said.                                      commodity prices and a reduction in geopolitical
According to the currency team’s analysis, if the                            tensions also would help take the steam out of the
US economic recovery accelerates, then the US                                gold market. Conversely, any further decline in
current account deficit will start to start to widen                         investor confidence regarding monetary and fiscal
again. This implies that overseas investors will                             policies is likely to translate into higher gold
acquire yet more US assets at an increasing rate,                            prices. Also, as commodity prices resume their
and it may well be that this can be achieved only                            advance and geopolitical risks remain elevated,
if US assets are made less expensive through a                               investors are likely to return to gold, we believe.
weaker dollar. Based on the historical dollar/gold
                                                                             Commitments of Traders reports still
inverse relationship, a weaker USD is a long-term
                                                                             show a commitment to gold
recipe for strong gold prices.
                                                                             In the Commitments of Traders reports issued by
Macroeconomic themes                                                         the Commodity Futures Trading Commission, net
The currency markets are supportive of gold.                                 speculative long positions in gold, in our view,
Each of the major four freely traded currencies –                            have been a reliable barometer of investor
the USD, EUR, GBP, and JPY – has its own                                     attitudes toward the metal. Speculators have been
drawbacks. This makes gold – a widely accepted                               net long gold on the Comex since the genesis of the
                                                                             bull market in 2001. Despite being overall net long,

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     10 May 2011

positions are often subject to considerable volatility   speculative liquidation. Between early December
and fluctuations, which can visibly affect gold          2009 and early February 2010, net long
prices. We believe this helps explain gold’s             speculative positions fell from a record 30.8moz
price volatility.                                        to 21.3moz, a decline of 9.5moz in just three
                                                         months. This is equivalent to 295t of gold, more
Net long speculative activity in 2010 reflected
                                                         than the annual output of Australia, the world’s
price movements for that year. Net long positions
                                                         second-largest gold producer. The liquidation
hit a low for the year of 21.3moz in the week of 9
                                                         helped drive gold from a then-record high of
February. This coincided with the low for gold
                                                         USD1,226/oz to below USD1,150/oz. A similar
prices that year of USD1,043/oz, touched on 5
                                                         liquidation occurred between November 2010 and
February. Both prices and net long speculative
                                                         January this year with a commensurate effect on
positions recovered notably thereafter. Net long
                                                         prices. Net long speculative positions fell from
speculative positions reached 30.3moz – just
                                                         30.3moz to 19.3moz, a decline of 10.7moz, as
800,000oz below the record high – the week after
                                                         prices dropped from a high of USD1,430/oz in
gold hit a then-record high of USD1,270/oz on 21
                                                         early December to USD1,308/oz by the end of
June. Long positions fell to 21.9moz by late July,
                                                         January. More recently, a 2.7moz in net long
in line with a drop in price below USD1,200/oz to
                                                         speculative positions from 19 April to 3 May
USD1,157/oz. Net long positions rebuilt
                                                         helped knock gold off its record highs and down
thereafter, peaking at 30.3moz in late September.
Long speculative positions eased moderately in
the following months but remained historically           Even with the recent decline in net long positions,
high, touching 27.9moz when gold hit the then-           the sheer size of these speculative positions may
record high of USD1,430/oz in early December.            invite further temporary bouts of liquidation, with
                                                         the commensurate effect on prices, the long-
Early this year, changes in net long speculative
                                                         running accumulation of long positions clearly
positions reflected the steep drop in prices. Net
                                                         coincides with the multiyear bull market. We
positions fell throughout January, dropping to
                                                         believe the increase in net longs has played an
19.3moz by the end of the month, just as gold hit
                                                         important role in gold’s record-breaking rally, is
its year-to-date low of USD1,308/oz. Since then,
                                                         consistent with an increase in demand for safe-
net speculative long positions have grown by
                                                         haven assets, and reflects heightened investor
more than 6.6moz to 26.6moz, as prices surged to
                                                         uncertainty. The following chart shows the
all-time highs toward the end of April. The latest
                                                         combined ETF and net long speculative positions.
data showed a reduction in net longs to 24.0moz
as of 3 May, as gold prices retraced more than            Gold: ETF and net speculative positions
USD100/oz, after reaching a record high.                  1700                                                                                                                                        120
                                                          1500                                                                                                                                        100
Net long speculative positions represent about            1300
c747t of gold, a little less than one-third of global     1100
mine output. Net long positions have been                                                                                                                                                             40
historically high for many months, staying well            500                                                                                                                                        20
above 20moz since July 2009, with the exception            300                                                                                                                                        0

of just two weeks in January this year. As net long
speculative positions remain at such high levels,                        Spec position in COMEX (RHS)                                            Gold in ETFs (RHS)
                                                                         Gold Price Usd per oz (LHS)
the sheer weight of long positions may encourage
                                                          Source: HSBC, Gold Bullion, ETF Securities, CFTC

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   10 May 2011

ETFs: Don’t be fooled by liquidation                   Combined ETF and Comex holdings are the
A notable feature of the gold market has been the      equivalent of 2,787t of gold, or about the level of
popularity of gold exchange-traded funds (ETFs)        annual mine output. We anticipate that demand
with investors. Despite liquidation this year, the     for allocated gold and other sources of bullion
ETFs continue to hold a substantial amount of          may limit any increase in ETF off-take to c230t
bullion. Of the 10 gold ETFs that we monitor,          this year. After increasing to a record 1,360t in
combined off-take as of 6 May stood at 2,040.4t        2009, total investment demand in 2010 edged
of gold, or c80% of the world’s annual production      down to 1,297t, by our calculation. We forecast
of gold. This is down c28t from the all-time high      this may fall to USD1,100t this year. Despite the
of 2,068.4t in ETF holdings reached near the end       decline, investment demand remains high on a
of 2010. The low in ETF holdings year-to-date is       historical basis. We believe that based on investor
1,980.5t, plumbed on 24 February.                      concerns, demand for ETFs and coins and bars
                                                       will be sufficient to help usher gold prices higher
A feature of the gold ETFs this year is an increase    this year. That said, at substantially higher gold
in volatility. We do not view the liquidation in       prices, demand for these products could moderate,
ETF holdings – modest as it is – as necessarily        and this should help cap rallies.
bearish. We believe some of the liquidation may
be attributed to investors’ switching into allocated   Trends in supply and demand
accounts and other forms of bullion holdings.          Gold supply: Producers dig high prices
Thus, the declines in the ETFs do not represent an
                                                       With gold prices significantly above costs of
overall drop in gold investment.
                                                       production – and likely to remain so for the
Despite an increase in volatility, swings in           foreseeable future, we believe – producers have
holdings from the gold ETFs are still modest by        an enormous financial incentive to increase
comparison with the Comex. Traditional futures         output. Despite a more than doubling in the gold
and options trading is typically more volatile and     price in less than four years, production only
more subject to short-term fluctuations than ETF       recently surpassed that in the banner year of 2001.
trading. This can make swings on the Comex             According to the GFMS precious metals
more influential in determining short-term price       consultancy, gold production in 2001 totaled
movements than the ETFs, despite the Comex’s           2,646t. In the most recent “World Demand
considerably smaller market position.                  Trends” produced by GFMS for the World Gold
                                                       Council, 2010 output was tabulated at 2,659t. We
ETF holdings notably overshadow long positions
                                                       estimate that additional gains this year will push
on the Comex. Comex longs are little changed on
                                                       production further above 2001 levels.
the year and account for about 747t, while ETF
demand is down c28t at 2,040.4t from the               Producers have had to contend with challenges
beginning of the year. Though the pace of demand       contributing to sluggish output. We have
may be slackening, gold ETFs still account for the     examined these obstacles in greater detail in
equivalent of more than c80% of global annual          previous editions of our Precious Metals Outlook.
mine output. In aggregate, the ETFs also are the       They include a chronic shortage of skilled and
sixth-largest holders of gold in the world, behind     technical personnel, notably geophysicists,
the central banks of the US, Germany, France, and      geologists, and mining engineers; long waiting
Italy, and the International Monetary Fund.            times for essential equipment; declining ore
                                                       grades and dwindling reserves in the mature

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     10 May 2011

producers; and longer permitting and regulatory        Gold mine production (metric tons)

processes. Power constraints and a lack of fresh       2800
water also are curbing production notably – but        2700
not exclusively – in South Africa. Although the        2600
global financial and economic crisis has helped        2500
contain certain cost pressures, prices of key          2400

inputs, notably cement, steel, power, and fuel, are    2300

rising again.                                          2200
                                                              2001       2003    2005       2007   2009   2011f
Prices remain comfortably ahead of costs. This
                                                       Source: GFMS, WGC, HSBC
has allowed producers to absorb increases in
costs, while maintaining production at higher
                                                      gold-producing regions have spurred a new wave
levels than would otherwise have been the case.
                                                      of investment in other regions, leading to growing
Projects that would have been rejected as too
                                                      mine supply in other parts of the world.
expensive just a few years ago were deemed
                                                      Furthermore, in their 4 May 2010 report, African
feasible as gold prices climbed to new highs.
                                                      & CIS gold miners: Takeaways from reserve
Despite these obstacles, we anticipate further gold   replacement trends in 2009, the analysts found
output gains this year. More production is            that a majority of gold mining companies in and
scheduled to come on stream, as investments           outside of HSBC’s gold equities coverage have
made earlier in the mining cycle translate into       been able to replace ounces mined with the help
greater output. Until now, the long lag time          of higher gold prices.
between investment and output has prevented a
                                                      The renaissance in production is likely to be
meaningful production response to high prices.
                                                      temporary, we believe. Producers still have to
High gold prices also have led to the restart of
                                                      contend with a host of challenges that will
operations that were on care-and-maintenance
                                                      inevitably limit production. Based on current mine
schedules and have encouraged producers to bring
                                                      production schedules, global production is likely
forward production schedules wherever possible.
                                                      to peak around 2014 and ease gradually thereafter.
Based on available company data, we expect
                                                      Long-term declines in output due to falling
production this year will grow by c90t, or c4%, to
                                                      reserves will be most pronounced in the mature
2,750t. This represents a 25t increase from our
                                                      and developed producers, notably South Africa,
previous 2010 forecast of 2,725t. We believe there
                                                      the US, Canada, and Australia.
are sufficient projects in the works to boost gold
mine output until 2014. The chart above right         A slow climb
shows gold mine production.                           According to US Geological Survey (USGS) data,
                                                      the majority of all the gold ever produced has
In previous editions of our Precious Metals
                                                      been mined since 1900, with the bulk of this
Outlook, we examined work by Sabrina
                                                      production coming from just four countries: South
Grandchamps and Lucia Marquez, HSBC equity
                                                      Africa, the US, Canada, and Australia. A feature
research analysts in metals and mining, on the
                                                      of the market has been the relative decline in
effect of higher prices in investment and reserves
                                                      production in these traditional producers. In
replacement. According to these analysts’ report,
                                                      particular, falling grades and difficulties in
Global Metals & Mining: From Safari to Siberia
                                                      replacing reserves have limited output from these
(28 March 2009), declining trends in traditional

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   10 May 2011

traditional producers. In the next couple of years,   difficult for the industry to arrest the long-running
we believe, aggregate world production will rise;     trend of output declines.
this includes production from some traditional
                                                      Russia: Russian gold companies produced 19.98t
producers. Following is a discussion of the near-
                                                      of gold in the first two months of 2011, up 13.9%
term outlook for some of the larger producers.
                                                      from a year earlier, according to the Gold
US: The USGS survey estimates that US gold            Industrialists’ Union. Mined output in January-
mine production in 2010 grew c3% to 230t,             February increased 12.6% from the year-earlier
compared with 223t in 2009. This marked the first     period to 16.38t. Output of gold as a byproduct of
increase in domestic production since 2000.           other metals increased by a substantial 95.1% to
Increased production from new mines in Alaska         12.27t, while refining from scrap was essentially
and Nevada and from existing mines in Nevada          unchanged at 2.37t, according to the
accounted for much of the increase. These             Industrialists’ Union. Output in 2010 fell 1.4% to
increases were partly offset by decreases in          201.3t, but the union has indicated that production
production from mines in Montana and Utah. US         will recover this year to 205-207t, based on
production may increase c2% this year to c235t,       increases in new projects.
as production from Barrick Gold’s Cortez Hills
                                                      Australia: The Australian Bureau of Agricultural
project in Nevada approaches full capacity.
                                                      and Resources Economics (Abare) has forecast an
South Africa: Output in South Africa, formerly        increase in domestic gold mine production of 14%
the world’s largest gold producer, fell 6.4% in       this year to 274t. Growth will be supported by the
2010 to 191,833.7 kg, according to the South          ramping up of Newmont’s Boddington mine,
African Chamber of Mines. Production costs are        which, according to the Abare, may produce 25t
relatively high due to the strong ZAR and the         of gold this year. Several other new projects are
expenses involved in running the world’s deepest      forecast to contribute to production. Abare’s
mines, some of which are 4 km below the surface.      forecast for 2012 grows 3% to c282t. Several
Additionally, grades are generally low, compared      midsize operations in Western Australia are
to most other large producers, and labor costs are    expected to boost domestic output. This new
high by international standards.                      output should more than offset declines from
                                                      some operations that nearing the ends their
Safety-related stoppages have also hindered
production. Recent calls for the nationalization of
the mines by the youth wing of the ruling African     Abare is optimistic about production in 2013 and
National Congress (ANC) – although rejected by        2014, which it expects to rise to 291t and 314t,
the senior party leadership – has nonetheless had     respectively. This is based on the projected start-
an adverse impact on international investment in      ups of large-scale projects in Queensland and the
the gold mining industry. New production at deep      Northern Territories. Production is expected to
mines in the Free State and West Rand will offset     flatten in 2015 and 2016 at 315t for each year, as
closures from aging facilities this year. According   lower production from existing facilities offsets
to Statistics South Africa, gold production in        increases from new projects.
February declined 2.3% annually, following 3.2%
                                                      China: China extended its position as the world’s
growth in January. Statistics South Africa issues
                                                      largest gold producer in 2010. According to the
changes only in percentage terms. Despite
                                                      China Gold Association, domestic gold
evidence that output is bottoming, it will be

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     10 May 2011

production increased 8.57% last year to a record       gold for the first time in more than two decades,
high of 340.88t. As discussed in our previous          absorbing c50t. This compares to net sales of
editions of Precious Metals Outlook, China             c30t, according to the Bank for International
appears unlikely to hold on to its top position in     Settlements (BIS).
the longer term. Although numerous, China’s gold
                                                       According to BIS data, the signatories to the third
mines are small by international standards, and
                                                       Central Bank Gold Agreement – once significant
they have relatively short lifespans.
                                                       sellers – sold only 7.1t in the first year of CBGA3,
The Chinese gold producing industry has gone           which ended 26 September 2010. This did not
through a bout of government-sponsored                 include the sale of a small amount of bullion for the
consolidation. China’s top 10 gold producers           minting of gold coins. For the CBGA3’s second
accounted for nearly half of total output last year.   year so far, the signatories have sold less than 1t.
Meanwhile, the number of gold producers has            This is a significant turnaround in policy from sales
fallen to slightly more than 700 from 1,200 in         patterns just a few years ago. Combined sales from
2009. According to the USGS, China has less than       the first two CBGA agreements from 26 September
two-thirds of the gold reserves of the US, despite     1999 to 26 September 2009 totaled 3,884t of gold,
producing two-thirds more gold than the US in          or an average of 388.4t per year. This was more
2010. This implies that China does not have a          gold than the annual output of South Africa, the
sufficiently large reserve base to sustain             world’s largest gold miner at the time. The lack of
production at current levels for the longer term.      appetite for sales within the CBGA in the last two
The lack of well-defined reserves and the paucity      years is an important bullish development for gold.
of world-class projects make it likely that Chinese
                                                       Under the rules of the agreement, the CBGA
production will peak in 2012-13 and begin to
                                                       signatories have a sales quota of 500t annually.
decrease thereafter.
                                                       Given the paucity of sales to date and statements
Peru: Peru’s gold production in February fell          by the two largest holders of bullion in the
16.% from a year earlier to 12.5m grams,               CBGA, Germany’s Bundesbank and the Swiss
according to the of energy and mining ministry.        National Bank, that they have no intentions to sell
The decrease was attributed to lower production        any more gold, it is unlikely that the signatories
from some larger producers, including Minera           will collectively sell anything more than a very
Barrick Misquichica, Minera Yanacocha, and             moderate amount of gold this year.
Compañía Minera Ares; their production fell 51%,
                                                       Although official sector sales were already
29%, and 20%, respectively, year-on-year,
                                                       slowing ahead of the global financial crisis, we
according to the mining ministry. These declines
                                                       believe that its onslaught – and gold’s strong price
make it likely that 2011 output will come in below
                                                       performance during that period – led reserve
2010 levels.
                                                       managers to reassess their gold sales intentions.
Official sector: The pendulum swings                   We see little likelihood that the signatories of the
After many years as heavy net sellers of gold, the     CBGA will resume any level of meaningful sales
official sector has swung from an important            in the foreseeable future. Other large official-
contributor to supply to a source of net demand.       sector holders of gold, including the US and
Based on data from the Bank for International          Japan, also have said that gold sales are off-limits.
Settlements and our own estimates, we believe
that the official sector in 2010 was a net buyer of

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   10 May 2011

The International Monetary Fund replaced central        With the exception of the Mexican purchase,
banks as the main supplier of official sector gold in   official data show little official-sector activity so
2010. The IMF executive board approved sales of         far this year. We consider it likely that the data
gold that the IMF had acquired following the second     have not yet caught up with some of the
amendment of its articles of agreement in April         transactions. Emerging-market central banks are
1978. This amounted to 403.3t, about one-eighth of      likely to increase gold holdings, both as a means
the IMF’s total holdings at the time of approval.       to diversify away from the USD and as an overall
                                                        strategy of portfolio diversification, we believe.
In November 2009, the IMF sold 200t to the
                                                        The continuing rapid accumulation of USDs in
Reserve Bank of India, followed by 2t and 10t to
                                                        their foreign exchange reserves by many
the central banks of Mauritius and Sri Lanka,
                                                        emerging-market central banks may accelerate
respectively. The IMF announced in February 2010
                                                        this process.
that phased sales of gold on the market would be
initiated to dispose of the remaining 191.3t. If        We believe that central banks around the world are
another official-sector buyer could not be found,       adopting an increasingly favorable attitude to gold
the gold would be sold on the open market through       and may therefore absorb a significant amount of
the CBGA. On 7 September 2010, the IMF sold 10t         bullion this year from the international markets.
to the Bangladesh Bank. This reduced the amount         The Chinese monetary authorities will likely refrain
of gold that needed to be placed on the market. In      from making any direct international gold
December 2010, the IMF concluded the gold sales         purchases for fear of dislocating the market, in our
program, with total sales of 403.3t. The IMF has no     view. Rather, we believe, China will quietly
further plans to sell gold.                             accumulate gold from domestic production, which
                                                        the central bank is not obliged to report to the BIS.
With no further sales forthcoming from the IMF
and the likelihood of only moderate sales from the      The rapid growth in foreign exchange reserves,
CBGA, any significant purchases of gold by              mostly in US dollars in emerging nations, implies
central banks would result in net purchases of          that central banks will have to buy gold if they
bullion by the official sector.                         wish to maintain their current balance of gold to
                                                        foreign exchange holdings. In the absence of any
Outside the CBGA, the main purchases reported
                                                        major sellers, we estimate that the official sector
in 2010 were from Russia. According to BIS data,
                                                        could absorb net 300t of gold this year.
the Russian central bank purchased 139.8t of gold.
A handful of other countries, including the             Scrap: A major source of supply
Philippines, Venezuela, and Thailand, also              The absence of official sector sales leaves the
accumulated gold. China may also have                   scrap market as the most important source of
accumulated gold from domestic sources, but this        secondary gold supply. Scrap supplies have
has not been reported to the BIS. In early May,         tended to rise in tandem with gold prices. The
data from the Mexican central bank showed its           scrap market grew from c600t in 2000 to c1,653t
purchase of 3moz of gold in Q1 as part of its           in 2010, according to data compiled for the World
foreign exchange reserves.                              Gold Council by the GFMS precious metals

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     10 May 2011

Although the bulk of recycled gold traditionally      our previous estimate of 1,300t for 2011.
comes from the emerging world, supplies from          Additional scrap supplies are likely to play a role
the OECD nations have risen as a proportion of        in tempering the rally, in our view.
market share in the last few years. According to
                                                      Gold demand: Back from the brink
data compiled by GFMS for the World Gold
                                                      Dehedging: The final act
Council, scrap supply in 2010 was c20t below the
2009 level of 1,672t. Thus, scrap supply was          A long-running feature of the gold market has
largely unchanged, despite a 29% increase in the      been the industry trend toward dehedging, the
average price of gold in to USD1,225/oz from          process whereby producers buy back or otherwise
USD973/oz in 2009. This argues against the            close out previously established hedges.
notion that scrap supplies are purely a function of   Producers’ reversal in hedging policies dates back
the gold price.                                       to the beginning of the current bull cycle in 2001-
                                                      02. The pace of producer buybacks is slowing
A modest improvement in employment in much            markedly as a greatly diminished global hedge
of the OECD world may be limiting distress scrap      book leaves producers with little in the way of
sales. More important in the midst of still-high      hedge positions to close out.
gold prices, merchants and other scrap market
participants may be holding on to material in the     According to the Fortis subsidiary Virtual Metals’
hope of resurgent prices. This may explain why in     “Gold Hedging Report,” the global hedge book in
the face of high prices, the market was not           Q4 2010 declined 1.7moz to 4.7moz from the
deluged with additional scrap supplies.               year-earlier quarter. For the entire year, the global
                                                      hedge book fell from 8moz to 4.7moz, a drop of
The scrap market traditionally performs an            nearly 40% from 2009. The decline would have
important function as a balancing mechanism in        been greater had it not been for the initiation of a
the physical markets. Merchants typically             significant hedge by the Mexican miner Minera
mobilize bullion stocks during periods of             Frisco that was initiated toward the end of 2010
escalating prices, thereby increasing supply, and     but that was not reported until early this year.
they reduce scrap supplies when prices are low.
We credit the appearance of substantial amounts       Anglogold Ashanti reported in October 2010 that
of scrap in 2008, 2009, and 2010 with helping to      it had eliminated the remainder of its hedge book,
supply bullion to the growing investment markets,     which stood at 2.4moz. Other smaller hedges were
notably the ETFs. Without the contribution of         also wound down by other producers.
scrap, the physical markets would be in a             The global hedge book is unlikely to be
significant deficit, according to our                 eliminated entirely. Gold hedges in 2010
supply/demand model.                                  increased for the second year in a row, albeit
High prices eventually will stimulate additional      moderately. It may be too early to herald a change
supply, in our view. Also, while merchants may        in producer attitudes toward hedging. But with
have been holding supply back from the market as      prices well above marginal costs and some new
prices rose, the recent correction may trigger a      projects requiring some form of hedging to attain
flood of scrap as holders rush to secure still-high   project financing, we may see a small recovery in
prices. We forecast scrap supply this year at         hedging going forward.
c1,650t, similar to the level in 2010. This
represents a c350t increase in scrap volume from

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   10 May 2011

As producer dehedging slowly fades, an important         Gold jewelry demand (t)

source of demand is gradually being removed from         3500
the market. To this extent, reduced dehedging is         3000
gold-bearish. Despite the initiation of some new         2500
hedges in 2010, the industry remains collectively        2000
bullish, and most mining companies continue to           1500

embrace an antihedging philosophy. Consequently,         1000

we expect new hedges to be modest. Dehedging              500

will inevitably be a dwindling source of demand, we         0

believe, simply because at less than 5moz, there is             2001       2003    2005   2007   2009   2011f

little left in the way of hedges outstanding to close    Source: GFMS, WGC, HSBC

out. After contributing c116t of new demand in
2010 and given the small size of the hedges             Chinese jewelry demand increased to c400t in
outstanding, dehedging will contribute just c25t to     2010 from 352t in 2009, supported by gains in
demand this year, we expect.                            inflation-adjusted consumer incomes and more
                                                        retail outlets for gold products. Other emerging-
Fabrication demand recovering
                                                        market nations also increased their demand for
Jewelry consumption historically accounts for the
                                                        gold jewelry. The surge in demand across Asia
bulk of gold fabrication and is therefore the single
                                                        was supported by rising income, commodity
most important determinant of physical demand.
                                                        inflation, and USD weakness. This implies that
Jewelry’s share of total gold demand, however, fell
                                                        emerging-market buyers view jewelry as a form
to c55% in 2010 from c75% in 2005. Jewelry
                                                        of investment in addition to a luxury good.
demand fell sharply in 2009 as the global economic
crisis and higher gold prices cut into consumer         A feature of the gold jewelry market over much of
demand. Led by emerging-market demand, jewelry          the previous decade is the shift in the locus of
consumption recovered last year. Despite the            demand from the less price-sensitive Western
recovery, it will likely be several more years before   markets to the more price-sensitive emerging
demand reaches pre-crisis levels, we believe.           markets. The majority of the world’s gold jewelry is
                                                        purchased in relatively price-sensitive areas of the
According to data collected by GFMS for the
                                                        world, notably India, China, and the Middle East. In
World Gold Council, jewelry demand in 2010
                                                        most years, high prices curb jewelry demand, and
rose to c2,060t from c1,760t in 2009. The increase
                                                        low prices stimulate demand. Last year was a
was due in large part to a strong recovery in
                                                        notable exception to this rule: Jewelry demand rose
emerging-market demand. Indian demand rose to
                                                        in 2010 in the face of a virulent price rally. Rather
746t, an all-time high, from a multiyear low of
                                                        than a change in market dynamic, we believe, this
442t in 2009. The bulk of India’s gold jewelry
                                                        can largely be explained by the comparison with
purchases occur in the northern tribal belt, a
                                                        weak demand in the previous year.
predominantly rural region. A good monsoon and
high grain prices boosted rural income and              Logically, there is a limit to how much gold
supported jewelry consumption. Demand also was          jewelry consumers are willing to buy in the face
supported by Indian consumers’ optimistic               of rising prices. Although emerging-market
outlook regarding future price appreciation.            demand has been strong until now, we sense a
                                                        reluctance to increase purchases of more than

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     10 May 2011

USD1,500/oz. Even accounting for the recent            consumption will continue to make a limited
pullback, current prices still make it difficult for   comeback this year, we believe gold prices above
consumers to increase demand, even if their            USD1,500/oz are a threat to further sales growth.
disposable incomes rise.
                                                       Another spike in gold prices could erode jewelry
While inflation may encourage gold purchases for       demand further, while a drop to closer to
investment, jewelry must compete with necessary        USD1,200/oz could stimulate jewelry demand.
expenditures, including foodstuffs and fuel,           Because prices remain high despite the recent
staples that account for the bulk of consumer          correction, we do not expect jewelry off-take this
budgets in emerging economies. High food and           year to be greater than 2,100t, which would be a
fuel prices, examined earlier in this report, may      c40t increase from 2010. This still would leave
curb discretionary spending on jewelry. Similarly,     gold jewelry consumption well below the peak
the patchy economic recovery in the US and             demand year of 2001, when off-take reached
economic uncertainty in much of the OECD world         c3,200t. Further price rallies have the potential to
also might limit demand for gold jewelry. The          depress jewelry demand to levels below those in
disaster in Japan is already curbing expenditures      2010, especially in the emerging world. Indian
on luxury items, including gold jewelry.               demand could be vulnerable if this year’s
                                                       monsoon season is poor and agricultural incomes
Global demand for gold jewelry will be largely
                                                       decline. See the chart on gold jewelry demand on
determined by consumption patterns in the
                                                       the previous page.
world’s two biggest gold markets: India and
China. Combined, they accounted for c60% of            The decline in gold jewelry consumption during
global demand for gold jewelry in 2010. Demand         the financial crisis freed up significant bullion
in these nations will be a trade-off between rising    supplies, which, instead of being processed into
incomes and inflationary concerns that should          jewelry, went directly into the investment
support gold jewelry off-take, and high gold           segment. Without this shortfall in demand from
prices and rising prices for food and fuel, which      the jewelry segment, we believe the pace of
could reduce consumers’ discretionary spending         investor demand would have driven gold prices
on jewelry. Continued liberalization of the retail     even higher than current record levels. Were
gold segment in China should support jewelry           investment to drop and gold prices to fall to levels
consumption. In the Middle East, high oil prices       near USD1,200/oz, we would expect a
should increase consumer incomes and bolster           commensurate increase in jewelry demand. If
jewelry demand in this important gold market.          prices stay above USD1,500/oz, demand may be
                                                       constrained. However, if demand is more resistant
Growth in demand for jewelry appears slightly
                                                       to high prices than we believe, then the
positive so far this year. Sales reports from
                                                       combination of persistently strong investment
jewelry retailers in the US, Britain, Italy, Russia,
                                                       demand and a resilient jewelry market has the
Japan, and Germany indicate that demand grew in
                                                       potential to drive gold prices higher.
the early part of this year. Our views are based on
HSBC’s macroeconomic forecasts of global
economic indicators that are likely to impact
jewelry sales, including GDP growth,
unemployment, retail sales, and consumer
spending. While we believe that jewelry

    Global                                                                                                 abc
    10 May 2011

Gold: Supply/demand balance (tonnes)
                                 2003    2004    2005    2006     2007     2008    2009    2010    2011e
Mine production                  2,593   2,463   2,522    2473    2,478    2,410   2,584   2,659   2,750
Official sector net sales          617     474     659     352      484      232      30     -50    -300
Old gold scrap                     939     829     888   1,104      937    1,316   1,673   1,653   1,650
Producer hedging                  -279    -427     -86    -373     -400     -352    -254    -116     -25
Total supply                     3,870   3,339   3,986   3,557    3,469    3,605   4,024   4,146   4,075

Jewelry                          2,481   2,610   2,709   2,279    2,402    2,193   1,759   2,060   2,100
   Electronics                     235     261     281     304      316      293     246     287     300
   Dentistry                        67      68      62      61       59       56      53      50      50
   Other industrial uses            80      83      85      86       87       91      74      83      85
Other fabrication                  382     412     428     451      462      440     373     420     435
Total fabrications               2,863   3,022   3,137   2,730    2,864    2,633   2,132   2,480   2,535

Bar hoarding                      178     245     262     226      257       386     216     380     340
Official coins                    105     114     112     129      124       187     231     205     190
Metals                             27      29     337      59       73        70      57      77      70
Other retail                       15     -39     -24     -24      -32       215     227     333     270
Exchange-traded funds              32     119     208     250      211       321     617     302     230
Total investment demand           357     477     595     659      633     1,179   1,348   1,297   1,100

Total demand                     3,220   3,399   3,732   3,380   3,3533   3,5811   3,480   3,777   3,635

Balance = net investment          650     -180    251     149       -28     -207    544     369     440

Gold price (USD/oz)               364     410     445     604      695      872     972    1,225   1,525

     Global                                                                                                                                                                     abc
     10 May 2011

 We expect the silver surplus to narrow this year; physical market
     should be characterized by surging mine output and rebounding
     industrial demand
 Investor demand for silver should recover from recent steep price
     declines based on investor concerns about accommodative
     monetary policies and heavy deficit spending
 We are raising our average silver price forecasts and introducing
     an estimate for 2013

Lifting our silver price forecasts                                                                           For 2013, we are introducing an average price
                                                                                                             forecast of USD24/oz.
Our supply/demand model indicates that the silver
market will be in surplus by 43moz this year;                                                                Back to earth
narrowing from 178moz in 2010. We are raising
                                                                                                             Based purely on the underlying physical
our average silver price forecasts for:
                                                                                                             fundamentals alone, the silver story did not merit
 2011 to USD34/oz from USD26/oz.                                                                            prices in the vicinity of USD50/oz reached in late
                                                                                                             April, in our view. The subsequent steep
 2012 to USD29/oz from USD20/oz.
                                                                                                             retracement to USD34/oz by the end of the first
 The long term (five years) to USD20/oz                                                                     week of May is a more accurate reflection of
  from USD15/oz.                                                                                             underlying fundamentals, we believe. According

 Silver price (USD/oz)                                                                                        Silver trades directionally with gold (USD/oz)

  60                                                                                                          50                                                         1600
                                                                                                                   USD/o                                         USD/o
                                                                                                              45                                                         1400
  50                                                                                                          40
                                                                                                              30                                                         1000
  30                                                                                                          25                                                         800
                                                                                                              20                                                         600
  10                                                                                                          10
                                                                                                               5                                                         200
                                                                                                               0                                                         0































                             Silver            100 dMA                  200 dMA                                                   Gold (RHS)      Silver (LHS)

 Source: Reuters                                                                                              Source: Reuters

   Global                                                                                                      abc
   10 May 2011

to our supply/demand model, the market is in            above cUSD40/oz or even higher in the near term,
surplus. Silver mine supply will grow, based on         but that such levels cannot be sustained over the
production schedules and the increase in base           course of this year. Therefore, we believe prices
metals from which silver is derived as a                may ease further in the second half.
byproduct. Other sources of silver supply, notably
                                                        Recovery phase
scrap, will react to high prices and contribute to
supply. A revival in hedging policies by some           Propelled by robust investor demand, silver prices
mines will contribute further to supply.                almost doubled since touching a year-to-date low
                                                        of USD26/oz on 28 January. By the end of April,
Industrial demand for silver will continue to
                                                        prices had moved within striking distance of the
strengthen, we believe, based on HSBC
                                                        record high of USD50/oz set in January 1980.
macroeconomic forecasts of global industrial
production. This will be offset by increased mine       The market had been on an almost unbroken
output and scrap supplies. Jewelry demand might         upward trajectory since August 2010, when prices
not be able to rise much, due to high prices.           broke above USD18/oz. The surge in prices was
                                                        accompanied by almost unprecedented investor
The driver of silver prices, we believe, will be
                                                        interest and continuing strength in industrial
investor sentiment. Until recently, investor demand
                                                        demand. The rally accelerated in the past couple
was able to absorb the excess physical silver
                                                        of months, as the eruption of popular discontent in
generated by rising mine output and the decline in
                                                        the Middle East and higher oil and other
industrial demand. Investor sentiment changed
                                                        commodity prices drove investors to seek out hard
abruptly in early May, when a drop in exchange-
                                                        assets, including silver. The re-emergence of
traded funds’ (ETF) silver holdings played an
                                                        sovereign risk concerns in the peripheral
important role in driving prices lower. Going
                                                        economies of the European Union and Standard &
forward, the role played by the silver ETFs and
                                                        Poor’s lowering of its long term credit outlook for
Comex will be crucial in determining price. If
                                                        the US spurred even greater buying in silver
investment demand were to falter further,
                                                        throughout March and April. Prices pulled back
substantial amounts of silver would move rapidly
                                                        sharply in early May as the Chicago Mercantile
onto the market, and silver supply/demand balances
                                                        Exchange raised margins for Comex silver
would record a greater surplus than we currently
                                                        investors. Prices fell to USD34/oz in the first
calculate. This leaves silver highly vulnerable to
                                                        week of May, a decline of c33% from the recent
changes in investor sentiment, in our view.
                                                        high near USD50/oz.
We believe investor concerns about the potential
                                                        The silver/gold ratio
inflationary impact of the US Federal Reserve’s
                                                        In the course of its rally, silver outperformed all
quantitative easing (QE) program, fiscal profligacy,
                                                        other major asset classes and most other
and geopolitical tensions will keep investors
                                                        commodities, including its sister metal, gold. This
interested in silver. The recent correction in prices
                                                        is evidenced by the fall in the silver/gold ratio to
also may boost what has heretofore been a
                                                        multiyear lows near 30:1 at the end of April 2011.
mainstay of the rally, strong demand for bars and
                                                        For most of the past 20 years, it has tended to
coins. Also, price-sensitive emerging-market
                                                        revolve at around 70:1. At the end of April 2010,
demand may increase, now that prices are back in
                                                        it stood at 68:1. The ratio had not been that low
the mid-USD30s/oz area. We believe that the
                                                        since the early 1980s, when it was rising after
market has enough momentum to push prices back
                                                        hitting its post-Bretton Woods low of 17:1 in

     Global                                                                                                                 abc
     10 May 2011

January 1980. The Bretton Woods system for                Silver ETF demand (moz)

monetary and exchange rate management was                 140
created in 1944, when gold became freely traded.          120
From this perspective, silver arguably became             100
expensive relative to gold. The recent correction          80
in silver prices has lifted the ratio to 42:1. This is     60
closer to its long-term historical norm. Over the          40
rest of this year, the ratio may move back to 50:1,        20
we believe.                                                    0
                                                                    2006         2007    2008    2009      2010     2011f
We find it interesting that even at its high this
year, silver remained far below its all-time high,        Source: Reuters

set in 1980, of USD50/oz in real terms. In
inflation-adjusted terms the 1980 high was               status, prices have climbed c300% in almost three
equivalent to cUSD125/oz. From a historical              years. Price corrections, when they occurred, have
perspective, therefore, there is precedent for silver    tended to be brief but sharp.
to trade considerably higher now.                        A restoration of normal economic growth patterns
The surge in silver prices earlier this year was due     would likely end the silver rally, we believe,
primarily to a sharp increase in investor demand,        especially if it were accompanied by tighter US
rather than a compelling change in the underlying        monetary policies and progress was made on
supply/demand balances, in our view. The                 limiting deficit spending in the member states of
significant rise in silver prices, which began at the    the Organization for Economic Cooperation and
end of August 2010, coincided with the US                Development (OECD). According to HSBC
Federal Reserve’s signal at the time that it was         macroeconomics, there are few indications that the
debating whether to reintroduce quantitative             US economy is about to return to normal growth
easing. Concerns about the inflationary                  patterns. As long as investors in and outside the US
consequences of the second round, QE2, and other         remain uncertain about the US economy and
highly accommodative monetary policies,                  concerned about the possibility of QE-related
combined with increased sovereign risks and              inflation and the implications of deficit spending,
elevated geopolitical risk, triggered renewed            we believe silver is likely to be well-bid.
demand for hard assets, particularly the precious        Investor sentiment will remain the key
metals, including silver. The Fed’s announcement         determinant of prices going forward, we believe.
that QE2 would end in June 2011 did not
                                                          Silver/gold ratio
noticeably dim the silver rally. The nearby chart
shows the silver/gold ratio, with silver gaining on       70
gold until the silver correction in early May.            65
Along with gold and the other precious metals,            55
silver has been one of the few beneficiaries of the       45
recent economic crisis. Silver prices were trading        40
in a USD12-13/oz range in the weeks before the            30
eruption of the subprime mortgage crisis in May            Jan-10       Apr-10      Jul-10   Oct-10     Jan-11    Apr-11
2007. With silver benefiting from its safe-haven
                                                          Source: Bloomberg

   Global                                                                                                    abc
   10 May 2011

Investor demand has absorbed the excess physical      one-week drop since investors liquidated almost
silver generated by rising mine output. The silver    c82moz in the week of 6 March 2007.
ETFs have absorbed sizable amounts of bullion in
                                                      Although some long positions have been
just a couple of years, holding the equivalent of
                                                      migrating from the Comex to the ETFs, should
c60% of annual silver mine output, more than
                                                      Comex liquidation continue at the pace of late
twice annual jewelry and silverware demand, and
                                                      April, further considerable downward price
based on our forecast of industrial and decorative
                                                      pressure may materialize in keeping with other
demand for this year, about c80% of that
                                                      periods of heavy liquidation by investors. We
segment’s annual consumption.
                                                      believe the reduction in price will encourage
The chart at the bottom-left of the following page    further investor demand, and we are doubling our
shows investor positions on the Comex and the         estimate of silver ETF accumulation this year by
silver price. Comex positions appear responsive to    40moz to c80moz, though this still would be less
prices, with long positions generally building on     than the increase of 84moz in 2010.
rallies and contracting on downswings. The chart
                                                      If ETF investors continue to liquidate at the pace
at bottom-right overleaf combines Comex silver
                                                      seen in late April, sizable amounts of silver could
and ETF positions. The red section shows the
                                                      continue to appear on the physical market on short
growth in ETF off-take. Demand for ETF
                                                      notice, with a commensurate impact on prices. It
products has been fairly static, compared to the
                                                      may not even be necessary to liquidate ETF
beginning of the year, while long positions on the
                                                      holdings to have a negative impact on prices. The
Comex have been more volatile. The combined
                                                      market has become accustomed to substantial
holdings of all three silver ETFs – the Barclays
                                                      ETF demand, and should ETF demand merely
iShares and the smaller ETF Securities and the
                                                      flatten, the market would move into a more
Zurich Kantonalbank Bank (ZKB) – decreased by
                                                      substantial surplus, according to our
c7.5moz this year to 451t from 458.6t at the
                                                      supply/demand model. So far, however, silver
beginning of the year.
                                                      ETF investors have shown only a modest
Net long speculative positions on the Comex,          inclination to liquidate, and most remain steadfast
while relatively high, are below record levels. Net   even in the face of substantial price volatility.
long positions reached 330moz at the end of
                                                      Silver consumption for industrial and
October 2009, about 49moz below the peak of
                                                      manufacturing applications soared in 2010 and
378.9moz reached in February 2008. Long
                                                      remains robust this year. This is in line with the
liquidation drove net long positions lower in late
                                                      recovery in industrial production in the emerging
2009 and early 2010, bottoming out at 189moz in
                                                      markets followed by the OECD economies. Silver
early February 2010. Positions rebuilt by
                                                      is used in a wide range of industrial processes and
September 2010 to 327mozm just 3moz short of
                                                      applications, many of which are rapidly
the high for 2009, but fell to 251.7moz as of 25
                                                      expanding. These include the electrical and
January 2011. Net long speculative demand
                                                      electronic industries, notably batteries, catalysts,
surged in the following weeks to a high of
                                                      bearings, wiring, brazing, and soldering.
282.3moz as of 5 April. Comex positions have
since been subject to net liquidation, falling to     Nonindustrial demand, specifically jewelry, is up
212moz as of 3 May. This included a 50.7moz           only moderately from last year, we believe, but
drop between 19 April and 26 April, the sharpest      photographic demand remains weak. The surge in

     Global                                                                                                                                                                                                                                                      abc
     10 May 2011

oil prices has led to an increase in demand for                                                                                  With prices far exceeding the cost of production
solar panels, which require silver. New                                                                                          by several multiples, producers have enormous
applications for silver in the biomedical,                                                                                       financial incentives to increase production.
environmental, and chemical industries will buoy                                                                                 Company reports by most primary silver
physical demand this year, in our view.                                                                                          producers put the vast majority of their production
                                                                                                                                 costs at USD5-8/oz. Some higher-cost production
According to our supply/demand model, silver
                                                                                                                                 is closer to USD10/oz, with the highest-cost
mine supply will continue growing at a healthy
                                                                                                                                 projects that we are aware of not much beyond
pace for at least the next two years, due primarily
                                                                                                                                 USD12/oz. Cost pressures may be rising,
to an increase in primary silver mine output and
                                                                                                                                 however. Although prices have been well-
increases in mine byproduct output. Heavy
                                                                                                                                 contained in the past couple of years, recent
investments made earlier in the mining cycle are
                                                                                                                                 increases for essential inputs, notably steel cement
increasing primary silver mine production,
                                                                                                                                 and diesel, as well as power, may pressure overall
notably in Latin America. High prices of silver
                                                                                                                                 costs higher. Despite these increases, we do not
and base metals also provide miners with
                                                                                                                                 anticipate that costs will rise anywhere
incentives to increase output wherever possible.
                                                                                                                                 approaching a level at which they would
Costs of production are very low and are no
                                                                                                                                 discourage production.
deterrent to production.
                                                                                                                                 Furthermore, the majority of the world’s silver is
Supply trends
                                                                                                                                 mined at low or almost no costs. More than two-
New generation of output at low cost                                                                                             thirds of silver production is a byproduct of base
In the 2011 Silver Survey prepared for the Silver                                                                                metals and gold output, which implies that the
Institute, Gold Fields Mineral Services estimated                                                                                marginal cost of production at these facilities is
that silver mine production totaled 736moz in                                                                                    close to zero. Thus, silver production is more a
2010, up more than 17moz from 2009. Silver                                                                                       function of base-metals output than of the silver
mine output has been rising steadily for several                                                                                 price, and it has therefore benefited from
years, supported by heavy investment earlier in                                                                                  increased production of gold and base metals. The
the mining cycle. Also, the rise in prices has made                                                                              high price of base metals also gives base-metals
it easier for silver projects to receive                                                                                         producers considerable financial incentive to
financing and obtain additional funds to                                                                                         increase their output.
accelerate production.

 Silver: Silver price and total speculative positions                                                                             Silver: ETF and speculative interest
500                                                                                                                         50   800                                                                                                          US 50
450            moz                                                                                        USD               45   700      moz
400                                                                                                        /                40   600                                                                                                                        40
350                                                                                                                         35   500                                                                                                                        30
300                                                                                                                         30   400
250                                                                                                                         25   300                                                                                                                        20
200                                                                                                                         20   200                                                                                                                        10
150                                                                                                                         15   100
100                                                                                                                         10     0                                                                                                                        0












 50                                                                                                                         5
  0                                                                                                                         0












                                                                                                                                            Net Spec Position (Moz)                                      Silver in ETF
                                                                                                                                            Silver price
                                           Net Spec Position (Moz)
                                           Sil    i
 Source: HSBC, Reuters, CFTC                                                                                                      Source: HSBC, Reuters, CFTC

   Global                                                                                                                     abc
   10 May 2011

 Silver mine supply (moz)                                             offset by output declines at mature mines, notably
 900                    Silver Mine Production (Moz)
                                                                      in Australia, Chile, and Canada. We anticipate
 800                                                                  gains in output will far outweigh declines. Based
                                                                      on the most recent company data and investments
                                                                      made earlier in the mining cycle, we are raising
 400                                                                  our forecast of silver mine output for this year by
 300                                                                  at least 30moz to c765moz; we previously
 200                                                                  forecast c755moz. Furthermore, we expect
                                                                      production to continue to climb in 2012 by a
        2001          2003          2005   2007        2009   2011f   similar magnitude, based on company projections.
                                                                      The nearby chart shows mine output.
 Source: GFMS, Silver Institute, HSBC

                                                                      Other sources of supply: What’s
Silver production has therefore also benefited                        coming down the line?
from the search for and development of gold and
                                                                      Until last year, government sales of silver were a
base metals deposits. Development of base-metal
                                                                      gradually diminishing source of supply. In 2010
discoveries that contain byproduct silver will
                                                                      government sales jumped to c44moz from
continue to account for a significant share of
                                                                      c15moz in 2009. Russia accounted for almost all
future silver reserves and resources. According to
                                                                      of these sales. We attribute the increase in sales to
outlooks by base-metals consultants, such as the
                                                                      the Russian government’s desire to take
International Copper Study Group and the
                                                                      advantage of high prices. It is possible that high
International Lead-Zinc Association, as well as
                                                                      prices may encourage further government sales
company forecasts, base-metals production is
                                                                      this year, but we believe these will not exceed
likely to grow this year and next year. This will
                                                                      20moz. Sales have also traditionally come from
support increases in silver production, especially
                                                                      India, but we believe that if any government sales
as some of the new polymetallic mines have high
                                                                      from this source appear, they will be quickly
silver byproduct content.
                                                                      absorbed by the domestic market.
Thus, the bulk of mines will continue to produce
                                                                      Scrap’s changing complexion
silver, virtually irrespective of price. Silver also is
                                                                      Recycled silver is the second-largest source of
an exception to the rule that in the long term, the
                                                                      silver supply after mine production. The largest
price of a commodity will tend to move toward
                                                                      contributor to silver scrap recycling is the
the cost of the marginal producer. This explains
                                                                      photographic segment. We have discussed in
why the bulk of silver production has been
                                                                      previous editions of our Precious Metals Outlook
historically insensitive to price changes.
                                                                      the long-running decline in silver scrap due to the
The majority of the world’s silver production                         shift to digital cameras from traditional
comes from Latin America, notably Mexico, Peru,                       photography. This trend shows no signs of
and Bolivia, and we expect this region will                           reversing. Eastman Kodak, Konica Minolta, Sony,
increasingly dominate global silver output.                           and Fuji Film report similar declines in traditional
Several projects in Russia and increased                              film sales due to the increasing popularity of
production at certain mines in North America and                      digital imaging technologies.
Africa also will contribute to strong increases in
output this year. Production gains will be partly

     Global                                                                                                  abc
     10 May 2011

The most recent sales data from large filmmakers      The recycled silver jewelry market has not been a
confirmed that sales of silver nitrate-based film     major source of supply, unlike gold, where it is an
continues to decline. In the Silver Survey, GFMS      important source of supply. This may be because
estimated 2010 photographic demand at 72.7moz,        the silver supply appears to be far less price-
a decline of 6.6moz from 79.3moz in 2009. We          sensitive to recycling than that for gold, possibly
believe that demand in this category will ease to     because of higher sales margins for silver
c70moz this year.                                     products. At current prices, we believe, this metric
                                                      also is changing. Higher prices are encouraging
We anticipate lower silver consumption by the
                                                      the public to hand in more jewelry and other silver
photographic industry and commensurately lower
                                                      items. Based on our conversations with smelters
recycled silver rates for this and next year.
                                                      and refiners, we believe that the public is selling
Other components of the scrap market look set to      greater amounts of old silver items and jewelry
grow. Although the industrial segment is by far the   for recycling, often along with gold items. An
largest consumer of silver, it accounts for a far     element of this may be distressed selling and more
smaller proportion of silver scrap supply. This may   due to high unemployment than the price of silver.
be because silver is generally used only in small     Also, high premiums on coin prices have virtually
quantities in most industrial and manufacturing       wiped out the recycled coin market.
applications. This made it uneconomical to recycle
                                                      According to GFMS, scrap supply rose by a sharp
at prices below USD20/oz. The surge in prices is
                                                      c27moz last year to 215moz. According to our
changing the calculus of the industrial scrap
                                                      supply/demand model, scrap supply contributed
market. At prices above USD30/oz, we believe,
                                                      c9moz more to supply than new mine output. We
industrial users have sufficient reason to seek to
                                                      expect that scrap supply may increase c20moz in
recycle considerably more scrap this year than in
                                                      2011, based on current high prices. Further
previous years.
                                                      increases in scrap supply, along with increased mine
In addition to the price incentive, environmental     output, have the potential to curb the silver rally.
legislation initiated in 2009 now requires
                                                      Hedging: New attitude at higher
recycling of a wide variety of electronic products
with a silver component, such as cell phones and
calculators. This could be a significant              Similar to gold producers, silver producers have
development, as about two-thirds of industrial        tended to close out or buy back hedges in recent
silver demand is for electrical and electronic        years. Because the bulk of silver output is
goods, including PCs, cell phones, and other          obtained as a byproduct of gold and base-metals
telecommunications devices. How much more             production, the marginal cost of producing the
scrap from this segment will materialize is           majority of the world’s silver is low. The
difficult to judge, but even if prices retreat        incentive to hedge is therefore correspondingly
substantially, we believe there will be sufficient    low. Prices well above the marginal costs of
economic incentive to increase recycling rates.       production also reduce the need to hedge.
                                                      Traditionally, mining companies have displayed a
                                                      collective bias against hedging, and the industry
                                                      still embraces an antihedging philosophy.

   Global                                                                                                   abc
   10 May 2011

That said, we detect a small change in attitude by   hard assets, including silver. A prolonged drop in
some producers. The rally earlier in the year may    sales may be an early signal that the price
have reached levels at which even reluctant          correction is not over.
producers were willing at least to reexamine their
                                                     Fabrication: Industrial action
hedging strategies. We detected the initiation of
some new hedges toward the end of 2010.              Industrial and decorative demand for silver soared
According to the Silver Institute’s Survey           in 2010 from depressed levels in 2009, in line
compiled by GFMS, producers hedged c61moz in         with the recession and the global slide in
2010. This marked the first net hedging by the       industrial production. As industrial production
industry since 2005. We anticipate that net          recovered, demand for silver is robust in the
hedging may contribute c40moz to supply this         emerging and developed worlds. We forecast
year. The sudden drop in prices may also             substantial growth in industrial demand for silver
encourage producers to implement hedges. Should      this year, based in part on HSBC economics
silver prices drop further, it is possible that      forecasts of growth in global industrial output of
producer hedging could exceed our forecasts as       6.4%, with 9.0% growth in the emerging markets
producer rush to lock in prices.                     and 4.1% in the developed world. We forecast an
                                                     increase in demand of c65moz to c552moz. In
Demand trends                                        2010, demand grew c84moz to 487moz, following
Investors demand for silver coins and physical       a decline in 2009 of c89moz to 404moz,
silver bars was strong last year and remains         according to data compiled for the Silver Survey
vigorous. Based on our conversations with            by Gold Fields Minerals Services.
merchants and dealers, we believe that coin          The electronic and electrical segments account for
demand will remain robust this year and will rival   roughly two-thirds of industrial silver
but probably not exceed the record-high demand       consumption. Using semiconductor demand as a
year of 2010. According to the US and Royal          rough proxy for electrical and electronic demand,
Canadian mints, silver coin sales remain strong      it appears that industrial silver demand is surging.
this year. In January, 6.42m of the 1 oz Silver      Semiconductor Industry Association (SIA)
Eagle coins were sold. Although these sales eased    President Brian Toohey has said that impressive
in February, March, and April, they remain           growth in a wide range of products reflects strong
historically high. The recent pullback in prices     demand for semiconductors. An important
may stimulate more retail investor appetite for      component of growth was the automotive
silver coins. We forecast sales of coins and         industry, which was increasing its demand for
medals will remain high at c90moz this year but      semiconductors. The world semiconductor market
not exceed 2010 levels.                              grew 31.8% in 2010, according to the SIA’s
Coin and bar demand as a percentage of total         reporting of World Semiconductor Trade
demand is growing but is still modest, compared      Statistics data. The SIA forecasts 9% growth for
to jewelry and industrial uses. Nonetheless, we      2011 and 10% for 2012.
believe that demand for these products accurately    New applications for silver hold the possibility of
reflects widespread retail investor concerns about   increased demand in the medium to longer term. We
inflation and USD weakness, fiscal profligacy,       have outlined the potential for increased silver
European sovereign debt risks, and geopolitical      demand from these areas in previous editions of our
tensions. These concerns are driving demand for      Precious Metals Outlook. Two of the fastest-

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     10 May 2011

growing new uses for silver are biomedical                        Silver: Industrial and decorative demand (moz)

applications and solar panels. The Silver Institute has           600
identified solar panels as holding significant                    500
potential. Other new uses include green
technologies, security issues, food packaging, and
cleaner energy sources. On an individual basis, these
new applications for silver are small in comparison               200

to other sources, but collectively, we believe, they              100
will make a modest contribution to demand this year                  0

and next year.

Jewelry demand                                                    Source: GFMS, Silver Institute, HSBC

Retailers reported a recovery in jewelry demand in
                                                                 GFMS estimates that jewelry demand in 2010
2010 and early 2011 from disappointing sales in
                                                                 totaled 167moz in 2010, up from 158.9moz in 2009.
2009. Based on our conversations with merchants
                                                                 Based on prices, we believe that jewelry demand
and fabricators, we believe that demand for jewelry
                                                                 may edge down to c165moz in 2011. Silver demand
and silverware has increased only moderately so far
                                                                 dropped to 50.3moz in 2010 from 58.2moz in 2009.
this year. Silver also could be gaining some market
                                                                 Based on high prices, we believe that silverware
share at the expense of gold from price-sensitive
                                                                 demand will not exceed c50moz this year.
buyers. Had prices remained in the vicinity of
USD50/oz, we believe that jewelry demand may                     Indian demand, a major driver of jewelry demand,
have contracted this year. Lower prices should help              continues to recover from a near-collapse in
promote jewelry sales. This may be offset by                     imports in 2009. Heavy physical imports were
persistent economic uncertainty in the US and other              recorded in India in late 2010 and earlier this year.
countries and declines in consumer sentiment, which              Some of this may be due to a switch from more-
may discourage consumers from purchasing luxury                  expensive gold to silver by price-sensitive
goods such as jewelry.                                           consumers. Based on our conversations with

Silver: Supply/demand balance (moz)
                                       2003   2004        2005        2006            2007                2008           2009           2010           2011f
Mine production                        597     613        637            641              664             685             718             736            765
Official sector sales                   89      62         66             78               43              28              14              45             20
Old silver scrap                       184     184        186            188              182             176             188             215            235
Hedging                                  0      10         28              0                0               0               0              61             40
Total supply                           870     868        916            907              889             888             889           1,057          1,060

 Industrial and decorative             351     368        407            427              456             443             352            487             552
 Photography                           193     179        160            142              125             105              83             73              70
 Jewelry and silverware                263     242        241            227              222             215             216            217             215
 Official coins                         36      42         40             40               40              65              79            101              90
Total fabrication                      842     831        848            836              843             828             729            879             927
Exchange traded funds                    0       0          0            121               95              95             110             84              80
Hedging                                 21       0          0              7               24              12              22              0               0
Total demand                           869     868        848            964              962             935             862            962           1,007

Market balance                            1      0         68             -57              -73             -47            137              95                  53
Market balance ex-govt stock sales      -88    -62         -2            -135             -116             -75             13              50                  33

Price (USD/oz)                         4.88   6.66        7.31       11.55           11.55            14.99              14.99          20.19          34.00
Source: HSBC, Silver Institute, GFMS

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   10 May 2011

merchants, we expect Indian demand to remain
robust. The price decline from USD50/oz could
stimulate further physical off-take. The bulk of
Indian silver demand is located in rural areas, and
the impact of the monsoon on the harvest and
agricultural incomes will remain a strong factor in
determining Indian silver demand. High food
prices in India have boosted rural incomes and
helped support silver demand.

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     10 May 2011

 Platinum is likely to remain in a modest deficit in 2011, as we
     expect a mixed recovery in global auto production and strong
     industrial demand; investor demand will play a pivotal role
 We estimate producer output will increase modestly this year,
     assuming no major production disruptions in South Africa
 We are increasing our forecasts of average platinum prices and
     introducing a forecast for 2013

Raising our platinum price                         growth rate than in 2010. Auto demand increases,
forecasts                                          the HSBC equity research analysts expect, will
                                                   come principally from North America and the
We are raising our forecasts of average platinum
                                                   emerging world, notably China. Jewelry demand
prices for:
                                                   may be constrained by high prices, we believe.
 2011 to USD1,850/oz from USD1,750/oz.            The decline in Chinese jewelry demand should
                                                   help narrow the supply/demand deficit that we
 2012 to USD1,750/oz from USD1,650/oz.
                                                   forecast for 2011. Should jewelry demand falter,
 The long term (five years) to USD1,625/oz        this could have a noticeable impact on our
      from USD1,600/oz.                            supply/demand balance.

For 2013, we are introducing a forecast of         On the supply side, higher prices are encouraging
USD1,650/oz.                                       platinum production at the margin in South
                                                   Africa, but producers face a variety of challenges,
Heading moderately higher
Based on our supply/demand model, we expect         Platinum price (USD/oz)
the platinum market to move from a surplus of      2,500
290,00oz in 2010 to a deficit of 30,000oz this     2,000
year. Although this deficit would be small, we     1,500
believe that it would be psychologically
significant and support prices.
On the demand side, increases in auto production        0

seem likely for the remainder of this year,
according to automotive analysts on HSBC’s
                                                               Platinum                            100 dMA                             200 dMA
equity research team, but at a more moderate
                                                    Source: Reuters

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   10 May 2011

including a shortage of trained personnel and          recovering from a fierce but short-lived decline to
equipment and the impact of a strong ZAR. Power        USD1,654/oz in mid-March. The decline was
supplies remain tight, and should there be another     triggered by the March earthquake and tsunami in
electricity outage such as the one in 2008, the        Japan, the suspension of a large part of Japanese
resulting decline in output could trigger a steep      auto production, and concerns that automotive
price rally. Much also will depend on the number       demand for platinum would also decline. Prices
of industrial stoppages and accident related           resumed their upward advance in April but fell
shutdowns this year. These occurrences have            back again in early May in line with a decline in
clipped production noticeably in recent years.         gold and silver prices, though they remained well
                                                       above the March lows. Since then, opportunistic
Investor demand for platinum soared in 2010,
                                                       buying by investors halted and then reversed the
particularly for the US-based ETFs. Investment
                                                       slide. Platinum remains considerably below its all-
will play a critical role in determining prices this
                                                       time high of USD2,300/oz set in March 2008.
year, in our view. Demand into hard assets,
including platinum, is channeled by investor           The outlook for platinum prices remains generally
unease about inflation, fiscal profligacy, and         positive, in our view. Platinum mine output
volatility of financial markets. We expect investor    growth is likely to be higher, but limited, and auto
demand to cool in 2011 from the strong gains of        recycling levels may decline from 2010, while
2010 but to remain positive as long as investors       both auto and industrial demand are likely to
remain uneasy about the global economy.                continue to grow.

Driving moderately higher                              We expect weaker platinum jewelry demand in
                                                       response to higher prices will free up additional
Platinum prices have more than doubled since
                                                       supply for the auto and industrial segments. We
bottoming out just below USD800/oz in
                                                       anticipate a wide trading range for platinum of
November 2008. Prices moved steadily higher
                                                       USD1,300-1,950/oz this year.
throughout 2009 in response to lower mine output
and increased demand from the recovery in global       Platinum market deficit in 2011e
auto production. The rally accelerated in 2010,        Based on our supply/demand model, we expect
hitting USD1,752/oz on 2 May, before retracing         that the platinum market will remain in deficit,
to USD1,452/oz on 21 May, as the sovereign debt        narrowing slightly to 30,000oz this year from
crisis triggered fears of a fresh global economic      40,000oz in 2010.
slowdown. After trading in a broad, sideways
range for much of last summer, prices took off         On the demand side, increases in auto production
again in September, as investor demand for hard        are likely for the remainder of the year, HSBC
assets rose in response to the US Federal              equity research analysts believe. US auto demand
Reserve’s announcement of a likely return to           is strong but that market is still recovering from
quantitative easing. Prices climbed above              very low levels in 2008-09, and auto production in
USD1,800/oz in mid-November before correcting          the US remains substantially below 2000-08
to USD1,693/oz by late November.                       averages. Chinese platinum demand for autos will
                                                       be crucial in determining price. Auto production
A positive outlook for industrial demand and           in China is slowing from very strong levels in
strength in other commodities, notably gold,           2010, but remains relatively robust. This holds
buoyed platinum, which reached a year-to-date          true for most emerging-market nations. European
high of USD1,884/oz in early May, after

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     10 May 2011

auto production is also pushing higher at a                Supply trends: Looking flat
moderate pace. Based on automotive production
                                                           Enough supply for decades …
forecasts by HSBC equity research analysts, we
                                                           We expect the platinum mine supply to continue
estimate only a moderate increase in automotive
                                                           to increase as high prices – well above the costs of
demand for platinum in 2011.
                                                           production – provide a considerable financial
Inevitably, high prices are curbing consumer               incentive to producers to increase output, despite
demand for platinum jewelry, despite its                   a host of challenges, including rising costs and
attractiveness, notably to the key bridal market.          infrastructure challenges in South Africa that may
Also, food and fuel prices will crimp consumer             limit increases in output.
incomes and limit Chinese jewelry demand at the
                                                           South Africa occupies a commanding position in
margin. The decline in Chinese platinum jewelry
                                                           world platinum production and reserves, accounting
demand should help narrow our forecast of a
                                                           for 4.6m oz of output in 2010, or about three-fourths
supply/demand deficit in 2011. Should Chinese
                                                           of world mine output, according to Johnson
demand falter further, this could have a noticeable
                                                           Matthey. The enormous deposits of platinum group
impact on our supply/demand balance.
                                                           element (PGE) in the Bushveld Complex in South
Investor demand for platinum soared in 2010,               Africa can be confidently relied upon to provide a
particularly for the US-based ETFs. Investment will        major proportion of global needs for many decades
play a critical role in determining prices this year, in   to come, even if the appetite for platinum accelerates
our view. Demand into hard assets, including               well beyond current assumptions.
platinum, is channeled by investor unease about
                                                           According to a report published at the end of last
inflation, fiscal profligacy, and volatility of the
                                                           year by R. Grant Cawthorne of the School of
financial markets. We expect investor demand to
                                                           Geosciences, University of the Witwatersrand,
cool in 2011 from the strong gains of 2010 but to
                                                           c80% of the world’s PGE are in the Bushveld
remain positive as long as investors remain uneasy
                                                           Complex. The report cited an estimated that
about the global economy.
                                                           Bushveld has sufficient PGE deposits to supply
On the supply side, higher platinum prices are             world demand for many decades, even assuming
encouraging production at the margin in South              no advances in mining and extraction technology.
Africa, but producers face a variety of challenges,        We found it interesting that the scope of the paper
including a shortage of trained personnel and              went beyond the usual time frame of most
equipment and the impact of a strong ZAR. Power            commercial geological studies, suggesting that
supplies remain tight, and another electricity outage      published reserve estimates are often restricted by
occur, such as the one in 2008, the resulting decline      rigorous international reporting codes.
in output could trigger a steep platinum price rally.      Nonetheless, even with the limitation of the
Much also will depend on the number of industrial          regulatory codes, the reserves and resources
stoppages and accident-related shutdowns this year.        reported by the four major mining companies in
These occurrences have clipped production                  South Africa amount to at least 1.2bnoz of PGE,
noticeably in recent years.                                of which more than 50% is platinum, according to
                                                           Mr. Cawthorne.

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   10 May 2011

… but constraints in South Africa                         Supply constraints will not ease substantially until
persist                                                   2017, when additional power stations are slated to
Despite abundant platinum resources and high              come on line.
prices, the platinum industry has been growing            In the near term, Eskom faces the possibility of
well below private and government growth                  labor disruptions as the peak winter demand period
forecasts, expanding just 4% per year since 1990.         approaches. Members of the National Union of
South African producers face a host of challenges         Mineworkers (NUM) employed at Eskom recently
to raising output, including rising costs, notably        reiterated that they would take strike action against
for power, steel, cement, and diesel, high labor          the state power utility in pursuit of a 16% wage
costs, safety issues, a shortage of trained               increase. An NUM spokesman has said that
personnel, long lead times to secure new                  although there was no time frame for the labor
equipment, power shortages, increased                     action, it would likely be before midyear. The
government regulation and supervision, and a              NUM has said it has 16,000 employees at Eskom,
strong ZAR. The following chart shows South               which has a total workforce of 40,000. Given tight
African platinum production.                              underlying supply/demand balances and the
 South Africa: Platinum production (moz)                  paucity of above-ground stocks, we believe that
                                                          any disruption of power generation sufficient to
                                                          halt production, even briefly, could have a
                                                          pronounced impact on prices.
 4.8                                                      Cost pressures due to a strong ZAR are another
 4.6                                                      challenge with which producers have to cope. The
 4.4                                                      bulk of expenses, including power supplies and
 4.2                                                      labor, are priced in ZARs, while platinum is sold
   4                                                      in USDs. Thus, producers are affected by the
        2003            2005     2007      2009   2011f   USD/ZAR exchange rate. Historically, platinum
 Source: Johnson Matthey, HSBC                            producers have often found themselves pressured
                                                          by either a low USD price for platinum or a strong
We regard limited power supplies in South Africa          local currency. Should the ZAR continue to
as one of the biggest threats to raising platinum         strengthen against the USD, producers will come
output in 2011 and beyond. Platinum mining is a           under further cost pressure.
highly power-intensive enterprise, and platinum
                                                          Miners are also faced with escalating costs of steel,
group of metals (PGM) producers are reliant on
                                                          cement, fuel, and other inputs. Since 2009, platinum
Eskom, the South African state-owned energy
                                                          prices have risen faster than input prices, and
utility, for the vast bulk of their power
                                                          producers have been able to cover their costs easily.
requirements. Platinum production – and prices –
                                                          Thus, high prices may have constrained production
are extremely sensitive to even modest reductions
                                                          but they have not triggered cutbacks. Any sudden
in power supplies. Eskom has acknowledged that
                                                          drop in platinum prices to near USD1,250/oz could
power supplies will remain stretched until
                                                          jeopardize some high-cost projects.
September 2012 at the earliest, when the first of
six units of the 4,800MW plants under
development are expected to come on stream.

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     10 May 2011

Zimbabwe won’t make a dent soon                       have important consequences for long-term
Zimbabwe has the world’s second-largest PGM           platinum production.
reserves after South Africa. The Great Dyke could     The president of the Zimbabwe Chamber of Mines,
account for as much as 20% of known platinum          Victor Gapare, said recently that although the
reserves and holds the largest platinum deposits in   mining industry is central to the country’s economic
the world after the Bushveld. The prospects for       recovery, inept government policies threaten its
supply increases outside South Africa are limited.    viability. Mr. Gapare said that although investors
Theoretically, Zimbabwe presents producers with       that are already committed to mining in Zimbabwe
almost ideal mining conditions. The workforce is      would likely stay, the indigenization issue could cut
well-educated and technically proficient, and         off new capital coming into the industry. He said the
platinum reserves are easily accessible, lying in     mining industry needed an additional USD5bn of
scalable formations near the surface. Costs are       investment, with much of that required by the PGM
lower than in South Africa, and working               segment, to meet its potential. Because Zimbabwe’s
conditions are relatively safe. In practice,          domestic financing sources are insufficient, all of
however, realizing Zimbabwe’s potential has been      this funding would have to come from abroad, he
slow going. Development of PGM resources has          said. Most investors are waiting for completion of
been impeded by inadequate infrastructure,            the indigenization and economic empowerment
hyperinflation, poor economic conditions, and         provisions before they invest further in Zimbabwe,
often ineffective government policies, according      according to Mr. Gapare.
to the Zimbabwean Chamber of Mines.                   Despite these impediments, Zimbabwe should
Perhaps the greatest threat to the long-term          produce c1moz of platinum annually in the next 10-
development of Zimbabwe’s PGM segment is              15 years, according to Mr. Gapare. Earlier this
government legislation, particularly the              month, Anglo Platinum announced the opening of its
Indigenization and Economic Empowerment Act,          new USD600m Unki Mine, which the company’s
which requires foreign-owned companies to cede        expects will become Zimbabwe’s second-largest
51% of their equity to indigenous people. We          platinum producer. Anglo Platinum’s Zimplats
discussed the law in more detail in Precious          division announced last year an investment of
Metals Outlook: Golden sovereign (risk), (May         USD450m for its expansion program.
2010). The mining industry in Zimbabwe could          Despite production challenges, we expect South
stop growing if the government presses ahead          African production will grow from 4.585moz in
with forcing companies operating in the country       2010 to 4.75moz this year. Outside South Africa,
to be majority-owned by indigenous investors.         we see moderate increases in output trends.
Earlier this year, Prime Minister Robert Mugabe       Johnson Matthey has estimated that Russian
reiterated his determination to speed up the          platinum production rose to 810,000oz in 2010
process under which ownership is transferred to       from 785,000oz in 2009. We believe it will be
indigenous peoples. Mr. Mugabe’s partners in the      difficult for Russian production to total more than
coalition government, the Movement for                820,000oz in 2011. We also see higher production
Democratic Change, oppose implementing the            in Zimbabwe, despite uncertain economic
law too quickly and are known to have a more          conditions in that country.
pro-mining bias than the Mr. Mugabe’s party.
How the implementation of the law plays out may

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   10 May 2011

Challenges not bad enough, though                     company’s long-range production target of
In response to high prices well above marginal        2.1moz by 2014 is remains intact.
costs of production, producers are increasing         Lonmin, the world’s third-biggest platinum
output wherever possible. They are expanding          producer, reported that for its fiscal first quarter
output and increasing exploration and production      ended 31 December, refined platinum production
budgets. Despite these efforts, we expect mine        fell to 81,982oz from 110,786oz a year earlier.
supply to be constrained by increasingly frequent     The shortfall was due to the rebuilding of its main
industrial stoppages and safety-related shutdowns.    furnace. The rebuild and modification of the No. 1
The world’s largest platinum producer, Anglo          furnace were successfully completed on schedule,
Platinum, announced recently that its 2011            and the furnace was recommissioned in mid-
production target of refining and selling 2.6moz      December 2010.
remains unchanged, despite a 5% fall in               Lonmin is targeting sales of 750,000oz of refined
production in Q1. For the first three months of       platinum in the current fiscal year, up from
this year, Anglo posted output of 560,000oz. The      706,000oz a year earlier. It has a growth profile of
decline was attributed to safety-related stoppages.   700-850,000oz total PGM. This should be
The company said it had initiated plans to make       achieved, according to the company, by ramp-ups
up for lost production. It said it experienced more   at the Saffy, Hossy, K4, and K3 operations over
safety stoppages in Q1 this year than during all      the next five to seven years.
of 2010.
                                                      Aquarius Platinum, the world’s fourth-biggest
Eastern Platinum has announced that production        platinum producer, said it had increased its
at its Crocodile River mine in South Africa in Q1     attributable production 14% in the three months
fell by 7,365oz to 25,387oz from the previous         ended 31 December. Aquarius produced
quarter. An interruption in production due to an      127,579oz of PGMs in the quarter, a 14%
internal safety review carried out in January was     improvement on output from a year earlier and a
responsible for the drop in output, according to      3% increase from September quarter production.
the company.
                                                      Aquarius CEO Stuart Murray said that production
Impala Platinum is South Africa’s second-largest      was up strongly at the main Kroondal mine, and
platinum producer. In February, the company           that both Kroondal and Marikana managed to
announced that its platinum sales for the six         reduce rand cash costs. Mr. Murray said the
months ended 31 December 2010 totaled                 reopened Everest mine remained on schedule and
801,000oz, up 15% from 694,000oz a year earlier.      continued to ramp up output. That mine was
Unit costs were well-contained in the period, at      closed in late 2008, owing to a subsidence event.
ZAR10,271 rising 4% on an annualized basis as a       Aquarius remains on target to meet its production
result of the higher output. Meanwhile, capital       guidance for fiscal 2011.
expenditures increased 11% to ZAR2.4bn. The
company said that a recovery at the giant             Norilsk Nickel, the world’s largest nickel and
Rustenburg mine was on track and that Mimosa          palladium producer, is also the biggest producer
continued to meet operational targets. The            of platinum outside South Africa. Earlier this
company has said its expansion strategy at            year, Norilsk announced preliminary consolidated
Zimplats is making satisfactory progress. The         production results for the fourth quarter and all of
                                                      2010. The company reported production of

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     10 May 2011

161,000oz in Q4 and full-year output of               High platinum prices also are triggering an increase
693,000oz. Production in 2010 rose 5% from            in jewelry recycling rates. According to Johnson
2009, driven by increased output at Norilsk’s         Matthey, platinum from recycled jewelry hit a record
Russian operations.                                   735,000oz in 2010, up 30% from 565,00oz in 2009.
                                                      Of the 2010 total, 450,000oz, or c60%, came from
For 2011, Norilsk plans to produce 665,000-
                                                      China. Based on our conversations with smelters and
675,000oz at its Russian divisions and 40,000-
                                                      refiners, high prices are likely to encourage even
45,000oz at its international operations, a slight
                                                      more recycling this year.
increase from last year. As platinum is refined as
a byproduct, platinum production much will            Demand trends
depend largely on whether Norilsk meets its
                                                      Recovery in auto demand expected
nickel output targets.
                                                      Platinum is a necessary component in the
These figures do not include output from              production of autocatalyst and particulate filters.
Stillwater Mining Co., a subsidiary of Norilsk.       The auto industry generally accounts for more
Alluvial output from smaller Russian producers        than half of global platinum consumption. Thus,
appears to be unchanged or down very slightly.        auto demand is an important if not critical driver
                                                      of physical demand for platinum. The worldwide
Recycling: Less to get per car
                                                      contraction in auto sales in 2H 2008 and 1H 2009
The recycling of catalytic converters and
                                                      greatly reduced the amount of platinum required
particulate filters is a significant source of
                                                      by the auto industry, allowing jewelry temporarily
secondary platinum supply and is the second-
                                                      to reclaim its former position as platinum’s single
largest contributor to supply behind South African
                                                      biggest source of demand. The near implosion in
production. We estimate that recycled platinum
                                                      auto demand also was the principal reason for
from the automotive industry will amount to
                                                      platinum’s slide to a multiyear a low of
c950,000oz in 2011, down from Johnson
                                                      USD732/oz by late October 2008. Platinum
Matthey’s estimate of 1.095m oz in 2010.
                                                      demand from the auto industry plummeted to
Platinum derived from auto recycling topped           2.185moz in 2009 from 3.655moz in 2009,
1moz for the first time in 2010, despite the end of   according to Johnson Matthey estimates, due to a
incentive programs across the OECD countries in       steep slide in auto production.
2009 designed to encourage recycling of older
                                                      The global auto industry has staged a strong
platinum-heavy vehicles. We believe that
                                                      recovery that began in late 2009 and stretched
recycling levels increased in part from the
                                                      through 2010. Demand last year demand bounced
recovery in global auto sales, which continued the
                                                      back to 2.985moz on a continued recovery in auto
recycling trend of older vehicles. We expect
                                                      production. Demand in China, which replaced the
recovered platinum to drop even if the number
                                                      US as the world’s largest auto market in 2008,
recycled autos rises. We expect that many of the
                                                      was especially robust. Sales in other emerging
vehicles being traded in this year will have
                                                      markets, including India, the Middle East, and
lighter platinum loadings due to switching
                                                      Latin America, were strong. Auto purchases in the
and substitution than models made five to
                                                      US recovered notably in 2010. The recovery in
10 years ago.
                                                      auto demand in Europe was less pronounced than
                                                      that in most other OECD markets.

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   10 May 2011

World auto production appeared poised to slow in      expensive. Furthermore, food price inflation is
2011 even before the disaster in Japan, according     forcing consumers in the emerging world to divert
to automotive analysts in HSBC equity research.       spending to necessary staples and may limit
A less-positive global economic climate, rising       auto purchases.
commodity prices, and the re-emergence of
                                                      With the major exception of Japan, where auto
sovereign debt concerns in OECD nations are all
                                                      demand has slumped in the wake of the
contributing to a cooling of auto demand.
                                                      earthquake and tsunami, global auto demand
Emerging-world demand for autos is being hurt
                                                      remains firm, though down from the strong levels
by rising food and fuel prices, which are reducing
                                                      of 2010. On a regional basis, HSBC equity
consumers’ disposable incomes, as well as by the
                                                      research on the automotive industry expects
withdrawal of tax subsidies in China for new car
                                                      Japanese auto production in 2011 to decline
purchases. The effects of the earthquake and
                                                      c10.1% this year from a year earlier. But the team
tsunami in Japan have curtailed domestic auto
                                                      anticipates that output will grow 2.2% in Western
production, but as the year unfolds, other
                                                      Europe, 10.1% in the US, 8.9% in China, and
producers will pick up much of the shortfall in
                                                      4.5% in Asia excluding Japan and China.
production, according to HSBC
automotive research.                                  Substitution continues. It is fair to say that the
                                                      recovery in the auto industry has favored
Light-vehicle production forecasts by HSBC
                                                      palladium over platinum consumption. While auto
equity research analysts Horst Schneider and
                                                      sales for all vehicle types have risen across the
Niels Fehre forecast growth of 3.5% in global
                                                      board since the slump in demand in 2008-09,
auto and light-truck production this year to 76.7m
                                                      demand for gasoline-driven vehicles has
units. This is down from their previous forecast of
                                                      noticeably outstripped demand for diesel-powered
5% growth to 77.4m vehicles, revised in light of
                                                      vehicles by a considerable margin. Gasoline-fired
the Japanese disaster.
                                                      vehicles have a much greater palladium weighting
We forecast a moderate increase in platinum           than diesel vehicles and require relatively little
demand for this year of c4% to 3.11moz. This is       platinum. This largely explains why demand for
based on HSBC equity research estimates of            palladium for the automotive industry has been
global light-truck and auto production, and the       more pronounced than that for platinum.
disruption in output in Japan, continuing
                                                      High prices continue to encourage auto companies
substitution, and thrifting and PGM loadings, as
                                                      to continue to look for ways to substitute higher-
well as demand for heavy diesel vehicles. Auto
                                                      priced platinum for palladium or to reduce
demand reflects the mixed performance of the
                                                      platinum loadings outright. Auto makers’ funds
global economy. Following a sharp rebound in
                                                      devoted to research on substitution and thrifting
2009-10 in most of the OECD world and robust
                                                      were cut in 2008-09 but have since been restored.
gains in the emerging world, the tempo of global
                                                      Based on our conversations with auto executives,
auto demand began to slow this year.
                                                      we believe there will be little progress on thrifting
The main threat to auto demand is inflation,          for at least the next two years. A modest shift is
according to HSBC equity research analysts. Oil       continuing toward substitution of platinum in
prices rises are discouraging purchases of large      favor of palladium for diesel vehicles and to a
vehicles, and steel, copper, plastics, and other      lesser degree gasoline vehicles. Although we do
input price increases are making autos more           not look for advances in thrifting to alter

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     10 May 2011

underlying supply/demand balances                     production and growth in key platinum-intensive
noticeably, substitution may reduce platinum          industries, we look for a continued rebound in all
demand at the margin.                                 major platinum-consuming segments for the rest
                                                      of this year. We forecast that industrial demand
Gains in thrifting and substitution have also been
                                                      for platinum will total 1.925moz for 2011, an
offset by increasingly stringent emissions
                                                      increase of 205,000oz from 2010 and a
legislation. We discussed the positive impact on
                                                      c155,000oz increase from our previous forecast of
platinum consumption worldwide in previous
                                                      1.77moz for combined industrial demand.
editions of our Precious Metals Outlook.
Automakers continues to work toward the goals of      Notable increases in industrial consumption of
US legislation in 2010, which set emission and        platinum include that by the chemical industry,
mileage standards that would translate to a           which rose to 450,000oz in 2010 from 290,000oz
combined fuel-economy average for new vehicles        in 2009. This was based on increased demand for
of 35.5 miles per gallon by 2016. The rules are       chemicals in a wide range of applications, mostly
aimed at cutting emissions of carbon dioxide and      in North America and the emerging world.
other heat-trapping gases by about 30% from           Johnson Matthey estimates that electronic demand
2012-2016. Chinese emission standards are based       have increased to 225,000oz from 190,000oz due
on European regulations. China continues to seek      to a pick up in demand for hard discs, computers,
to impose emissions standards more rigorously.        and other electronic devices. A strong recovery in
Large metropolitan areas in China, including          glass manufacturing was recorded for 2010 to
Beijing and Shanghai, have adopted more               365,000oz from almost negligible levels in 2009,
stringent regulations on an accelerated schedule,     after demand was boosted by the shift in LDC
ahead of the rest of the country. Beijing and         glass production from the US and Western Europe
Shanghai plan to introduce strict standards from      to China and Japan. Platinum purchases for
2012. The more-stringent carbon-dioxide               petroleum refining in 2010 dropped to 175,000oz
emissions regulation globally requires greater        from 210,000oz in 2009, as little new refining
platinum and palladium loadings.                      capacity was built in 2010.

Industrial production: Still going                    With many of the world’s platinum-consuming
strong                                                industries now located in the emerging world,
The rebound in global industrial production           global industrial consumption of platinum is
noticeably increased demand for platinum in the       likely to be influenced more by industrial output
glass, electrical, and chemical sectors. Consistent   in emerging-markets nations than in the
with HSBC macroeconomic forecasts of                  developed world. HSBC economic research
expanding global industrial activity, we forecast     predicts emerging-market industrial growth will
increases in demand for platinum in a range of        be more than twice that of the developed world
manufacturing and industrial processes in 2011.       this year.

According to HSBC macroeconomics, global              This is especially the case with glass
industrial output could increase 6.4% this year       manufacturing. In recent years, the bulk of the
after rising 9.8% in 2010. This output in             world’s glass manufacturing has shifted to the Far
developed economies is forecast to increase 4.1%      East. A continued rebound in consumer
this year and in emerging markets to rise 9.0%.       electronics and glass demand worldwide would
Based on HSBC’s forecasts of industrial               continue to boost platinum demand well into

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   10 May 2011

2011. Other platinum-intensive industries such as     of aggregate industrial demand, according to our
chemicals should also continue to expand.             supply/demand model. We anticipate that the
                                                      automotive industry will remain the largest
Although demand for platinum for industrial
                                                      market for platinum, followed by industrial
applications should grow this year, we do not
                                                      demand and jewelry remaining in third place, for
expect that the sharp increase in 2010 will be
                                                      the foreseeable future.
repeated. This is mostly because in addition to
meeting immediate demand, many industrial users       However, the jewelry market performs a vital
took advantage of the recovery in 2010 to boost       function as a balancing agent in the platinum
stock and inventory levels. This should lessen the    market. Unlike auto and most industrial
need to make new purchases this year.                 consumption, demand for platinum jewelry is
                                                      highly price-elastic. Platinum jewelry products
Jewelry: A Chinese puzzle
                                                      compete with a range of competitive alternatives,
We forecast net platinum jewelry demand will          including gold and other luxury goods. Platinum
moderate slightly to 1.6moz this year, a decline of   jewelry demand typically declines when prices are
c85,000oz from 2010. A high price environment         high, thus freeing up product for the autocatalyst
and ample inventories and merchant stocks appear      and industrial segments. Conversely, when prices
likely to reduce jewelry demand. High prices also     are low, jewelry demand tends to rise, thus
are likely to encourage greater recycling.            absorbing greater supply. The collapse in prices
Counterbalancing this is continued income growth      below USD800/oz in late 2008 triggered a swift
in China and the success of marketing efforts in      consumer response, and platinum jewelry demand
China and North America in promoting                  rose notably. Conversely, the drop in jewelry
platinum jewelry.                                     demand in 2010 reflected consumer reaction to
China accounts for the bulk of world demand for       the steep rise in prices.
platinum jewelry. Following strong increases in       This degree of price elasticity does not exist
Chinese consumption of platinum jewelry in            anywhere else in the platinum market. Without
2009, demand slumped in 2010 in response to           this demand response from the jewelry market,
higher prices. Chinese demand is likely to soften     price movements during periods of
further this year as high prices curb consumer        significant changes in industrial demand would be
retail demand for platinum jewelry. High prices       likely to prompt much more severe price
also may stimulate increased recycling of jewelry     responses, in our view.
items in and outside China. The disaster in Japan
is likely to depress all forms of luxury goods        Platinum jewelry demand is heavily dependent on
purchases in that country. Heavy imports of           Chinese consumption. China alone accounted for
platinum earlier this year may have left              c1.2moz, or c70%, of total global demand in
merchants and manufacturers well-stocked for the      2010. Meanwhile, net jewelry consumption in
rest of 2011.                                         Japan accounted for just 2% of world demand, in
                                                      part because of a jump in recycling levels.
The recovery in global auto demand and fall in
jewelry consumption allowed the auto industry to      In keeping with platinum’s sensitivity to price
reclaim its position as the world’s largest demand    changes, we believe that Chinese jewelry demand
source for platinum. Jewelry, meanwhile, has          began to ease notably when the market traded
moved into third place behind the No. 2 category      back above USD1,500/oz in the summer of 2010.

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           10 May 2011

This coincided with a drop in Chinese platinum                                                                        ETFs: A continued US success
imports for most of 2H 2010. According to                                                                             Investor demand will play a crucial role in
official trade data, Chinese import demand for                                                                        determining platinum prices. The US PGM ETFs,
platinum rebounded from December 2010 through                                                                         launched in January 2010, have been highly
March 2011. See the chart at the bottom of this                                                                       successful and absorbed considerable amounts of
page on Chinese platinum imports. Recent                                                                              metal. ETF demand, however, may be slowing
imports appear to be well in excess of domestic                                                                       from the very strong levels of 1H 2010. Platinum
auto and industrial demand. This implies some                                                                         investment demand also has benefited from the
pickup in jewelry demand. Demand for platinum                                                                         rally in gold and is consistent with investor
jewelry may also have an investment component,                                                                        demand for hard assets, rising inflation fears,
in keeping with the increase in demand for                                                                            escalating commodity prices, and government
hard assets.                                                                                                          deficit spending across the world. As long as
Chinese consumer demand for many luxury items,                                                                        investors remain sensitive to highly
including platinum jewelry, may slow in the face of                                                                   accommodative monetary policies and deficit
growing inflationary pressures, notably food and                                                                      spending, we believe that investor demand for
fuel price rises, which account for a large                                                                           platinum will remain strong. If investor demand
percentage of consumer incomes. The impact of                                                                         remains at current levels, the market will stay in
higher platinum prices and inflation increases may                                                                    deficit, according to our supply/demand model.
be partly offset by income gains and a stronger                                                                       A feature of the platinum market is investor
CNY. Platinum also is the favored precious metal of                                                                   demand, the locus of which is the ETFs. This
the growing upper middle class, a group with more                                                                     increase in demand is so strong as to alter
discretionary income than most Chinese.                                                                               significantly the underlying market
Platinum continues to gain popularity in the                                                                          supply/demand balances. For 2010, the combined
market for engagement and wedding rings. It                                                                           ETF holdings of the four major ETFs increased by
remains the most desirable wedding ring in Japan                                                                      a sharp 555,000moz to 1.126moz. For calendar
and, more important, in the Chinese market,                                                                           2010, platinum ETF holdings of London-based
where official data list more than 9m                                                                                 ETF Securities dropped by 28,000oz to 384,000oz
weddings per year.                                                                                                    from 412,000oz at the beginning of the year.
                                                                                                                      Holdings of the ZKB ETF fell by 84,000oz to
 China: Platinum imports jump
                                                                                                                      249,000oz from 333,000oz at the beginning of the
               12,000                         Monthly China Platinum Imports                                          year. The UK’s ETF Securities launched a US-
                                                                                                                      registered platinum and palladium trust in the US,
     Imports (Kg)

                    8,000                                                                                             which became active in January this year. To date,
                    6,000                                                                                             it has been highly successful. US-listed platinum
                    4,000                                                                                             ETF holdings totaled 445,000oz for 2010,
                    2,000                                                                                             although the bulk of the gains came in the first
                       0                                                                                              few months after the launch. Julius Baer launched








                                                                                                                      an ETF in March, which to date has a total of
                                               Rolling 12 month average                                               48,000oz.
 Source: Official trade data

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     10 May 2011

Platinum: Supply/demand balance (000oz)
                                          2003    2004    2005    2006     2007      2008      2009    2010e     2011f
South Africa                              4,630   5,010   5,115   5,295    5,035     4,515    4,530     4,585     4.750
Russian production                          880     880     890     920      910       805      785       810       820
Russian stock draw                          170     -30       0       0        0         0        0         0         0
Russian sales                             1,050     850     890     920      910       805      785       810       820
North America                               295     385     365     345      325       325      260       210       270
Others                                      225     250     270     270      290       295      345       405       440
DLA                                           0      17      13      13       13         0        0         0         0
Total supply                              6,200   6,512   6,640   6,830    6,600     5,940    5,920     6,010     6,280

Autocatalyst gross                        3,270   3,490   3,795   3,905    4,145     3,655    2,230     2,985     3.110
Recovery                                   -645    -690    -770    -860     -905    -1,130     -830    -1,095      -950
Net autocatalyst                          2,625   2,800   3,025   3,045    3,240     2,525    1,400     1,890     2,160
Chemical                                    320     325     325     395      410       400      295       450       470
Electrical                                  260     300     360     360      320       225      180       225       390
Glass                                       210     290     360     405      390       315       10       365       335
Jewelry                                   2,510   2,160   1,196   1,640    1,460     1,365    2,445     1,685     1,600
Petroleum                                   120     150     170     180      210       240      205       175       200
Investment                                  150      45      15     -40        0       450      300       200       225
ETF                                           0       0       0       0      195       103      360       555       400
Other                                       470     470     475     495      475       535      440       505       530
Total demand                              6.530   6,540   6,695   6,485    6,680     6,160    5,635     6,050     6,310

Market balance                            -361      -89     -55    355       -80     -220       280       -40       -30

Inventory build by auto cos.               150    -330       -0      -0       0         0        0         0         0

Real market balance                       -327    -275      -89     -55     355      -120       285       -40       -30

Platinum price (USD/oz)                    529     540     846     846      897      1,306    1,565     1,210     1,850
Source: HSBC estimates, Johnson Matthey

This year so far, combined ETF demand is up                        We are raising our 2011 forecast of ETF investor
145,000oz to 1.271moz. Combined platinum ETF                       demand for platinum by 80,000oz to 400,000oz. We
holdings totaled more than 1.27moz as of end-                      also are raising our forecast of other non-ETF
April. This was equivalent to more than the                        investments, which include small bars and coins, to
annual output of Russia and Zimbabwe combined.                     225,000oz from 125,000oz, based on strong investor
Demand for platinum is driven by the same                          demand for hard assets including platinum.
factors that are propelling investor interest in hard
assets in general, namely, concerns about
potential inflation, the USD, government deficit
spending, loose monetary policies, and
geopolitical tensions. These factors are likely to
support ETF demand for the rest of this year.

High prices may begin to deter retail demand for
the ETFs, but we expect institutional demand to
remain steady. High prices also could encourage
some investor liquidation of physical platinum by
retail holders, which could reduce non-ETF
platinum investment.

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     10 May 2011

 After many years of substantial supply/demand surpluses, the
     palladium market is swinging into a structural deficit; this is likely
     to have profound bullish consequences for price
 Dwindling Russian stock concerns, recoveries in global auto and
     industrial output, and investor demand for hard assets should
     offset higher mine output and weaker Chinese jewelry demand
 We are raising our forecasts of palladium prices and introducing a
     forecast for 2013

Increasing our palladium price                         a pronounced psychological impact on the market,
forecasts                                              which would drive prices higher.

We are raising our forecasts of average palladium      Our expectation of a deficit is based on continued
prices for:                                            investment demand in palladium exchange-traded
                                                       funds (ETFs). We anticipate investor demand for
 2011 to USD825/oz from USD750/oz.
                                                       hard assets and the need for an inflation and safe-
 2012 to USD750/oz from USD650/oz.                    haven hedge to keep ETF demand firm, although
                                                       we expect the pace of investor off-take to
 The long term (five years) to USD700/oz
                                                       moderate going forward. That said, should ETF
  from USD600/oz.
                                                       investors turn net sellers and liquidate portions of
For 2013, we are introducing an average price          their holdings, the market could move into a more
forecast of USD725/oz.                                 substantial surplus, with a commensurate
                                                       impact on price.
Already high but may go
higher                                                 Based on forecasts by HSBC economists and
                                                       equity research analysts of continued industrial
After many years of heavy supply/demand
                                                       expansion and increases in global auto production,
surpluses, the palladium market has shifted to a
                                                       we believe that industrial and automotive demand
deficit. Based on our supply/demand model, we
                                                       will absorb considerable amounts of palladium
believe that the market will be in deficit this year
                                                       this year. Electronics demand for palladium
by c310,000oz. Although this would be smaller
                                                       should be especially robust, we anticipate but
than the 2010 deficit, which we estimate at
                                                       demand for auto production should moderate this
455,000oz, we believe that continuation of a
                                                       year from 2010 levels.
deficit after so many years of surplus would have

   Global                                                                                                                                                          abc
   10 May 2011

Despite an array of challenges, we expect the        growth in auto production will boost physical
palladium mine supply to grow this year, with a      demand for palladium. Although we expect the
notable recovery in North American output.           growth in palladium ETF demand in 2011 to slow
Power and accident-related disruptions in mining     from last year’s strong levels, we still expect it to
have the potential to drive prices higher. The       be positive, based investor appetite for hard assets
likelihood that Russian palladium stocks are         stemming from fears about inflation and
dwindling could help support prices. We forecast     fiscal profligacy.
declining Russian palladium sales for this year.
                                                     Meanwhile, the scope for near-term increases in
Just as important, we believe that the widely held
                                                     production in Russia, South Africa, and
perception that Russian palladium stocks are
                                                     Zimbabwe is moderate. We anticipate a
inevitably falling is itself price-supportive.
                                                     substantial recovery in North American
Start and stop                                       production from depressed 2010 levels.

Palladium prices reached multiyear highs of          Palladium prices are high despite a decline in net
USD827/oz on 28 February before easing back to       long speculative positions on the Comex. After
USD684/oz by mid-March. Prices have                  reaching a 2009 low of 515,400oz in early March,
subsequently rallied, hitting USD770/oz as of the    net long speculative positions increased rapidly,
end of April. Palladium prices are almost five       surpassing the record high of 1.36moz reached
times higher than their multiyear low of             during the week of 19 February 2008. Long
USD157/oz, plumbed at the height of the financial    positions continued to grow, reaching an all-time
crisis on 16 October 2008. Prices moved steadily     high of 1.975moz in early November last year.
higher throughout 2010, but have become more         Long positions subsequently fell to 1.656moz by
volatile this year.                                  the beginning of this year. The decline accelerated
                                                     during the peak of the Japanese disaster, hitting a
We believe that the disaster in Japan in the wake
                                                     low of 1.179moz by late March. As of early May,
of the earthquake and tsunami and the temporary
                                                     net long positions stood at 1.346moz.
closure of Japanese auto plants provided the
catalyst for the palladium price decline in March.   Supply trends
Since the March sell-off, palladium has made a
                                                     The total palladium supply rose slightly in 2010 to
less convincing recovery than its sister metal,
                                                     7.14moz from 7.1moz in 2009, according to
platinum, which also fell sharply in conjunction
                                                     Johnson Matthey. For this year, we forecast a
with palladium. After recovering to USD800/oz
by mid-April, prices slumped briefly in early May     Palladium plummets and recovers

to USD700/oz in line with weakness in other           1,000

precocious metals.                                     800

Our supply/demand model forecasts a deficit of         600

310,000oz this year, representing a narrowing          400
from a 445,000oz deficit estimate for 2010. Still,     200
we believe that fundamentals remain compelling.
Based on HSBC economics forecasts of further











expansion in industrial production next year, we
anticipate continued growth in palladium off-take                          Palladium                       100 dMA                     200 dMA
in 2011. Strong industrial demand and continuing      Source: Bloomberg

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     10 May 2011

slight decrease of 25,000oz in the total palladium     be used to repay the country’s debts or to increase
supply to 7.115moz. Despite a host of obstacles        its gold and foreign currency reserves, according
facing producers, we believe that mine production      to the official.
is likely to grow 450,000oz to 6.615moz in 2011.
                                                       Other market participants have also expressed
We anticipate a sharp decline in Russian stockpile
                                                       concerns about Russian stockpiles. In September
sales to 500,000oz this year from c980,000oz
                                                       2010, Anton Berlin, marketing director of Norilsk
in 2010.
                                                       Nickel, said there might not be enough stockpiles
Russian stockpiles: Nyet                               of palladium held by the Russian government to
The Russian palladium supply has exceeded              pursue sales throughout 2011, though it was
domestic production by a wide margin for many          impossible to know exactly how much palladium
years. The shortfall has been made up by sales         is left in government stocks. These comments
from existing above-ground stocks. The level of        reaffirmed his statements stretching back to 2008,
Russian palladium stockpiles is therefore a source     when he said that Russian palladium stocks would
of lively debate in the PGM market. All palladium      be exhausted in one to five years. The five-year
stocks in Russia are held by Gokhran, the State        time frame for stock depletion was first made
Precious Metals and Gemstones Repository under         nearly three years ago, leaving at most room for
the Ministry of Finance. Data on the size of the       possibly two more years more of exports at the
stockpile, as well as the timing and quantity of       rate of c1moz a year.
sales, are designated as state secrets.                If additional Russian exports and sales of
Consequently, there is no reliable data on either      palladium are not forthcoming, this may be an
absolute stock levels or the government’s sales        indication that the stockpile is indeed dwindling,
intentions. The only thing that we can be              compelling the authorities to husband metal. In
reasonably sure of is that for many years, Russia      the event of a decrease in Russian stockpile
has exported considerably more palladium than it       exports and sales and continuing growth in
has produced. Thus, we infer that its stocks must      automotive and industrial demand, the only
be declining. Much of the palladium price rally of     immediately available stocks of any magnitude
2010 was predicated on the likelihood that             may be from the ETFs. Rising prices, however,
Russian stocks were nearing exhaustion.                may encourage investors to add to the ETFs,
In the past few years, Russian stockpile sales have    rather than liquidate, thus intensifying a rally.
been relatively steady, averaging a little less than   The perception that Russian palladium stocks are
1moz a year. In previous years, sales showed           contracting may be more important than the actual
some sensitivity to prices, increasing marginally      size of the stockpile. Based on our conversations
when prices were high and edging down when             with market participants, we believe that the
prices were low.                                       perception that stocks are dwindling and may
On 17 November 2010, the Dow Jones News                soon be exhausted is widely held and is a key
Service reported that an official at Gokhran said      element of the current rally. Even if stockpile
the Russian state’s palladium stock was                sales and exports increase, the belief that stocks
“practically nil,” and that Gokhran was unlikely to    are inevitably shrinking and may soon be spent
continue to sell much more palladium on the            will continue to support prices, in our view.
world market. The finance ministry wanted to sell
palladium to raise liquidity, which in turn could

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   10 May 2011

Heavy sales of palladium stocks by Russia have        South Africa and Russia: Mine production (000oz)

been a feature of the market for many years.          3.5
Without Russian stockpile sales, the palladium         3
market would have run deficits in 2008 and 2009       2.5

instead of surpluses. For last year and this year,     2

the absence of Russian stockpile sales would push     1.5

the market deeper into deficit, according to our       1

supply/demand model. Based on the assumption          0.5
that Russian stocks are falling and that the
                                                            2003            2005           2007       2009   2011f
authorities may wish to husband existing stocks,
we estimate Russian stock sales will be                                            South Africa   Russia
c500,000oz this year. This represents a sales
                                                      Source: Johnson Matthey, HSBC,
decline of almost 50% from the three
previous years.                                      USD700/oz, producers have sufficient reason to
According to Johnson Matthey, Russian platinum       increase palladium output wherever possible.
production increased to 2.73moz in 2010 from         South African palladium producers face the same
2.675moz in 2009. We forecasting a 20,000oz          obstacles and challenges that limit platinum
increase to 2.75moz for this year. We base this on   production, as discussed in the platinum section of
Norilsk statements, which estimate that 2011         this report. These include but are not limited to
domestic output of palladium will total between      rising costs, safety-related stoppages, inadequate
2.700-2.715moz. In 2010, Norilsk’s output of         infrastructure, unreliable power supply, often
palladium in Russia reached c2.7moz and the          difficult labor relations, problems associated with
group’s international operations produced            a strong ZAR, and shortages of trained personnel
c150,000oz of palladium. Better-than-anticipated     and mining equipment. Producers also have
grades in nickel deposits, from which palladium is   complained that government legislation has
derived, helped sustain Norilsk production. In       become more intrusive and regulation more
addition, we expect output from alluvial producers   burdensome. Efforts to improve safety conditions
to add to Russian output.                            may constrain output, as producers, labor unions,
South Africa: Catching up                            and governments work to limit the potential for
                                                     mine accidents. The chart above shows South
South Africa is the world’s second-largest
                                                     African and Russian production.
palladium producer, just behind Russia, according
to our supply/demand model. In the longer term,      South Africa is home to the bulk of the world’s
South Africa appears likely to overtake Russia.      palladium reserves, as well as platinum reserves,
Unlike Russia, South Africa holds vast palladium     as we discussed in the platinum section of this
reserves, in the same deposits as its equally vast   report. We remain positive about the long-term
platinum reserves. All South African palladium       potential for increased South African production
output is derived as a byproduct of platinum         of palladium. In their search for platinum,
production. High platinum prices have spurred        producers will derive more palladium, as platinum
efforts by producers to increase platinum            mined in the huge Bushveld complex is
production, which in turn yields greater palladium   palladium-rich. Despite ample reserves and high
output. With palladium prices still above            prices of palladium, it still will take years to lay

     Global                                                                                                  abc
     10 May 2011

the necessary infrastructure to derive significantly   To capitalize fully on its potential, Zimbabwe’s
more palladium, according to the South African         mining industry needs foreign investment of
Chamber of Mines.                                      USD5bn, according to the Chamber of Mines.
                                                       However, this might be hard to achieve. A major
Despite these impediments, we forecast an
                                                       deterrent to investment in the Zimbabwean
increase of c150,000oz in South African
                                                       mining industry has been indigenization
palladium production to 2.635moz in 2011 from
                                                       legislation. Indigenization aims to put a 51%
2.485moz in 2010. The chart on the previous page
                                                       share of any investment in the country in the
showing South African and Russian mine output
                                                       hands of Zimbabwean nationals. The laws require
is based in part on the latest statements from the
                                                       that foreign-owned mining companies present
major producers, including Anglo Platinum,
                                                       plans on how they will transfer ownership of
Impala Platinum, Lonmin, Aquarius Platinum,
                                                       stock to Zimbabwean nationals by 10 May. The
and Northam.
                                                       deadline for the stock sales is 25 September. This
Zimbabwe: A lot there, too                             deadline has been pushed back several times, due
Zimbabwe has substantial palladium reserves            to difficulties in implementing the legislation.
along with platinum, located mostly in the Great       Prime Minister Robert Mugabe in April stated his
Dyke region. The potential for palladium               intention to see the sales through as soon as
production is significant. According to a report       possible. Concerns about indigenization could
issued in April by the consultants Frost &             stifle foreign investment and jeopardize future
Sullivan, Zimbabwe’s mining output, which              palladium production.
includes palladium, could grow 44% this year,          Political attitudes on the mines may be hardening.
about the same rate of expansion as last year.         In his 2011 budget speech, Finance Minister
Percentage increases may be deceptive, however,        Tendai Biti said that the government had received
as Zimbabwe production is starting from a              only USD20.7m from royalties from the sale of
low base rate.                                         precious metals in the nine months ended
Zimbabwe has a distinct advantage in that its          September 2010, while producers had earned
PGM and other mineral occurrences are shallower        USD593.8m from precious metals sales. We
than those in South Africa and in most other           estimate that mine production – excluding South
countries. This allows for opencast mining, which      Africa, Russia, and North America – will total
is significantly less expensive than deep-level        c500,000oz in 2011, up from 385,000oz in 2010,
mining. However, many of the other drawbacks           and that much of this increase will come
that constrain palladium and other precious-metal      from Zimbabwe.
production in South Africa also afflict Zimbabwe.      On the positive side, the Zimbabwean government
These include a lack of infrastructure, specifically   has supported the mining industry by easing some
transport, power, and access to fresh water. The       of the more-restrictive financial regulations.
shortage of skilled geologists, mining engineers,      Output has been boosted by government
and trained manpower in Zimbabwe is less acute         relaxation of capital control laws, allowing mining
than in neighboring South Africa but is                companies greater access to multiple foreign
nonetheless a constraint on production.                currencies. This has enabled companies to
                                                       purchase much-needed machinery, equipment,
                                                       and consumables.

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   10 May 2011

 Palladium derived from auto recycling                  recyclers in the OECD world, we believe that scrap
 1.4                                                    supplies are running near last year’s levels, with the
 1.2                                                    impact of a slightly greater volume of autos being
   1                                                    sold for scrap offset by slightly lower palladium
 0.8                                                    loadings. An increase in the number of vehicles
 0.6                                                    from the emerging world, which have heavier
 0.4                                                    palladium loadings, will also support recycled
 0.2                                                    palladium supplies. We expect the volume of cars
   0                                                    handed in for scrap from Asia to grow significantly
        2003 2004 2005 2006 2007 2008 2009 2010 2011f   in the next few years, given the strong increase in
                                                        demand for new autos, which began in earnest in
 Source: Johnson Matthey, HSBC
                                                        the mid-2000’s. The nearby chart shows palladium
We expect North American palladium production           derived from auto recycling.
to bounce back up to 730,000oz in 2011 from             Demand trends: Shifting gears
560,000oz in 2010, when levels were depressed
                                                        Demand for palladium, like its sister metal
by labor strikes and other production problems.
                                                        platinum, has been strongly affected by the
Recycling trends                                        recovery in global automobile sales and
The supply of secondary metal coming from spent         production. According to Johnson Matthey, global
autocatalysts has increased sharply in recent years     automotive demand for palladium in 2009
from less than 50,000oz in 2002 to more than            slumped to just 4.05moz, a decline of more than
1.32moz in 2010, Johnson Matthey has estimated.         400,000oz from the previous year. The recovery
The only exception to this steady trend higher was      in automotive production in 2010 pushed
2009, when the global economic crisis resulted in       palladium demand for vehicles to 5.15moz,
a near-collapse in new auto demand and led              exceeding 5moz for the first time.
consumers to hold on to older vehicles that might
                                                        Based on HSBC equity research analysts’
otherwise have been traded in for scrap. In 2009,
                                                        forecasts of auto sales, which we discussed in the
auto scrap recycling fell to 965,000oz from
                                                        platinum section of this report, we expect gross
1.14moz the previous year.
                                                        autocatalyst demand for 2011 to increase by
We forecast a very slight 10,000oz increase in          205,000oz to 5.355moz. The slowdown in the rate
auto scrap recycling this year to 1.33moz. The          of growth of auto production this year, compared
continued recovery in auto demand implies               to 2010, explains our forecast of a moderate
greater levels of scrap supply. This will be offset     increase, compared with last year.
by the types of vehicles traded in, which have
                                                        Palladium off-take for the automotive industry
typically lower palladium loadings than those
                                                        will continue to benefit from growing demand for
models that owners turned in under the “cash for
                                                        autos to the emerging world. In the faster-growing
clunkers” program in the US and similar programs
                                                        markets of China and India, consumers favor
in other countries.
                                                        gasoline-driven vehicles. Gasoline-fueled vehicles
Higher prices of platinum and palladium have also       rely primarily on palladium-heavy autocatalysts
increased throughput of stocks of spent                 and use proportionately more palladium than
autocatalysts. Based on our conversations with          diesel vehicles.

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     10 May 2011

Palladium loadings also are benefiting from            downturn in the auto market. We forecast a
increasingly stringent fuel standards around the       moderate recovery in palladium purchases for the
world, which often require heavier PGM loadings.       jewelry sector to 600,000oz this year from
We discussed this in more detail in the platinum       630,000oz in 2010.
section of this report and in previous editions of
                                                       Palladium jewelry demand remains modest but is
our Precious Metals Outlook. We expect little
                                                       growing, based on our conversations with
near-term change in palladium loadings due to
                                                       manufacturers and merchants. The more vigorous
substitution or thrifting.
                                                       rally in palladium prices has dimmed its price-
The worldwide recovery in industrial production        competitiveness with platinum and gold, despite
in 2010 led a surge in palladium demand for            price increases in all the precious metals. Although
industrial and manufacturing applications. Better-     demand for palladium imports into China has been
than-expected demand for glass and high-end            strong so far this year, we believe this was mostly
electronic goods, such as liquid crystal displays      for the industrial and auto segments. Also, Chinese
(LCDs), lifted palladium consumption. Demand           merchants and manufacturers may have been
also was strong for chemical and petroleum             overstocked with palladium from heavy imports in
applications. According to Johnson Matthey,            the past few years and therefore reluctant to
industrial demand for palladium in 2010 rose to        increase purchases.
1.53moz from 1.388moz in 2009. We believe that
                                                       Our forecasts also are based in part on the lack of
combined industrial demand for palladium could
                                                       major advertising campaigns in China and less
rise to 1.8moz this year, based on the HSBC
                                                       promotion of palladium jewelry in Western
macroeconomic forecast for global industrial
                                                       markets, compared to the mid-2000s. Economic
production growth of 6.4% – with growth of 4.1%
                                                       uncertainty and high unemployment in the West
in the OCED nations and 9.0% in the emerging
                                                       also are likely to limit palladium jewelry demand.
world – and on our conversations with executives
in the electronics industry, the largest single non-   ETFs: Eerily quiet for now
automotive industrial user of palladium. In            Palladium ETFs have proven to be a popular
dentistry, we expect palladium demand to fall to       investment vehicle. The combined holdings of
600,000oz in 2011 from 620,000oz in 2010, as the       ETF Securities and the ZKB palladium ETFs
metal is gradually replaced by other materials.        racked up a huge 1.06moz in off-take in 2010.
Jewelry: The East is moderating                        The new US-listed ETF Securities’ PGM ETF,
                                                       introduced in January 2010, has been very
The bulk of the world’s palladium jewelry is
                                                       successful, accounting for 1.125moz last year. A
consumed in China. Demand is noticeably
                                                       new ETF from Julius Baer introduced in
volatile. As recently as 2002, total global demand
                                                       Switzerland in March increased off-take to
for palladium was less than 250,000oz. Demand
                                                       48,000oz last year. The other two palladium
rose to a high of 1.43moz in 2005. Consumption
                                                       ETFs, the ZKB and the UK ETF Securities,
subsequently eased to 545,000oz in 2009, as
                                                       declined by 58,000oz and 96,000oz, respectively,
estimated by Johnson Matthey. We account for
                                                       to 447,000oz and 533,000oz.
this decline partly from the rise in popularity of
platinum jewelry and its price-competitiveness         The success of these ETFs has clearly tightened
with palladium in 2008 and 2009, when platinum         underlying palladium supply/demand balances. The
prices almost collapsed in the wake of the global      large off-take from the ETFs helped push the

    Global                                                                                                      abc
    10 May 2011

Palladium: Supply/demand balance (000oz)
                                     2003   2004    2005    2006     2007     2008    2009    2010e    2011f
South Africa                        2,320   2,480   2,605   2,775   2,765    2,430    2,370   2,485    2.635
Russian production                  2,700   2,971   3,135   3,220   3,050    2,700    2,675   2.730    2.750
Russian stock draw                    250   1,150   1,485     700   1,490      960      960     980      500
Russian exports                     2,950   4,800   4,620   3,920   4,540    3,660    3,635   3,710    3,250
North America                         935   1.035     910     985     990      910      755     560      730
Others                                245     265     270     270     285      310      340     385      500
DLA                                   141      32       0       0       0        0        0       0        0
Total supply                        6.591   8,612   8,405   7,950   8,580    7,310    7.100   7,140    7,115

Autocatalyst: gross                 3,450   3,790   3,865   4,015    4,545    4,465   4,050    5.150    5,355
 Recovery                            -410    -530    -625    -805   -1,015   -1,140    -965   -1,320   -1,330
net                                 3,040   3,260   3,240   3,210    3,530    3,325   3,085    3,830    4,025
Electrical                            900     920     970   1,205    1,235    1,025     875      965    1,200
Chemical                              265     310     415     440      375      350     325      385      400
Dental                                825     850     815     620      630      625     615      630      600
Jewelry                               260     930   1,430   1,005      715      855     745      545      600
Other                                 140     290     485     135       95      120     188      180      200
ETF                                                                    250      375     507    1,060      400
Total demand                        5,430   6,560   7,355   6,615    6.830    6,675   6,340    7,595    7,425

Movements in stocks                 1,161   2,052   1,050   1,335   1,750      635     760     -455     -310

Inventory build by auto cos.         -400    -100      0       0        0        0       0        0        0

Real movement in stocks             1,561   1,952   1,050   1,335   1,750      635     760     -455     -310

Palladium price (USD/oz)              210    230     201     320      355      347     353      525      825
Source: HSBC, Johnson Matthey

market into deficit last year and we believe it will
do so again this year. Palladium ETF demand has
been flat so far this year far. We expect ETF
demand to pick up later in the year, based on our
expectation of continuing investor appetite for hard
assets, strength in other precious metals, and
concern that Russian stockpiles may be dwindling.
We do not expect to see any significant ETF
liquidation. We anticipate that the ETFs will
contribute 400,000oz to demand this year.

     Global        abc
     10 May 2011


Global        abc
10 May 2011


     Global                                                                                                    abc
     10 May 2011

Disclosure appendix
Analyst Certification
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personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: James Steel

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Additional disclosures
1     This report is dated as at 10 May 2011.
2     All market data included in this report are dated as at close 06 May 2011, unless otherwise indicated in the report.
3     HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
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   Global                                                                                                                       abc
   10 May 2011

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Global Currency Strategy Research Team
Global                                              Technical Analysis
David Bloom                                         Murray Gunn
Global Head of FX Research                          +44 20 7991 6797   murray,
+44 20 7991 5969
                                                    Precious Metals
                                                    James Steel
Perry Kojodjojo                                     +1 212 525 6515
+852 2996 6568
Daniel Hui
+852 2822 4340
Dominic Bunning
+852 2822 1672
United Kingdom
Paul Mackel
+44 20 7991 5968
Stacy Williams
+44 20 7991 5967
Mark McDonald
+44 20 7991 5966
Daniel Fenn
+44 20 7991 5003
Murat Toprak
+44 20 7991 5415
Mark Austin

United States
Robert Lynch
+1 212 525 3159
Clyde Wardle
+1 212 525 3345
Marjorie Hernandez
+1 212 525 4109

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