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March25,2009Commodities:FrameworksGoldmanSachsGlobalEconomics,CommoditiesandStrategyResearch1March25,2009Commodities:FrameworksForecastinggoldasacommodityGoldasacommodityThisreportintroducesanewframeworkforanalyzingtheinfluenceofmonetarydemandandgoldsupplyonthepriceofgold.Basedonthisframework,wepresentanewapproachforforecastingthepriceofgoldbasedonthemonetarydemandforgold(specifically,thebuyingbygold-ETFsandthesellingbycentralbanks)andonthecrucialroleoftherealinterestrateindeterminingtheopportunitycostofmining.LowrealinterestratesexpectedtosupportgoldpricesabovecurrentlevelsThis“goldasacommodity”frameworksuggeststhatgoldpriceshavestrongsupportatandabovecurrentlevels,shouldthecurrentlowrealinterestrateenvironmentpersist.Specifically,assumingrealinterestratesstaynearcurrentlevelsandthebuyingbygold-ETFsslowstolastyear’space,wewouldexpecttoseegoldpricesnear$930/tozoverthenextsixmonths,risingto$962/tozona12-monthhorizon.Shouldrealinterestratesmovelowerorbuyingbygold-ETFscontinueatitscurrenttorridpace,however,theupsiderisktopriceswouldbesignificant.DavidGreely(212)902-2850|david.greely@gs.comGoldman,Sachs&Co.JeffreyCurrie+44(20)7774-6112|jeffrey.currie@gs.comGoldmanSachsInternationalTheGoldmanSachsGroup,Inc.doesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Asaresult,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.Forimportantdisclosures,seethetextprecedingthedisclosuresorgoto:FrameworksGoldmanSachsGlobalEconomics,CommoditiesandStrategyResearch2TableofcontentsForecastinggoldasacommodity3Thehistoricalbehaviorofsupply,demandandphysicalinventories,andtheeconomicsofthegoldmarket5Forecastinggoldprices13Realinterestratesandthepricingofgoldasacurrency21Disclosures23March25,2009Commodities:FrameworksGoldmanSachsGlobalEconomics,CommoditiesandStrategyResearch3ForecastinggoldasacommodityThemonetarydemandforgoldhasplayedasignificantpartinthelargeswingsingoldpricesofthepastdecade,withthesellingofgoldfromgovernmentcentralbankreservesinthelate1990sdepressinggoldpricesandthebuyingofgoldforprivateinvestment—includingthenewgoldexchangetradedfunds(gold-ETFs)—sendinggoldpricesthrough$1,000/toztwiceduringthecurrentfinancialcrisis(Exhibit1).Becausethemonetarydemandforgoldhashadsuchasignificantinfluenceongoldpricesoverthepastdecade,itistemptingtoviewgoldpricesasdrivensimplybythevagariesofgovernmentpolicyandtheinvestor’sviewoffinancialdistress;however,whenviewedwithinthelargerhistoricalcontext,thepastdecade’sriseingoldpricesfallswithinalongercycleingoldprices,drivenmorebytheeconomicsofgoldsupply.Thisreportintroducesaframeworkforunderstandingtheinfluenceofbothmonetarydemandandtheeconomicsofgoldsupplyonthepriceofgold.Basedonthisframework,wepresentanewapproachforforecastingthepriceofgoldbasedonthemonetarydemandforgold(specifically,thebuyingbygold-ETFsandthesellingbycentralbanks)andonthecrucialroleoftherealinterestrateindeterminingtheopportunitycostofmining.Exhibit1:Goldpriceshaveincreasedfour-foldoverthepastdecade,andhavebecomesubstantiallymorevolatileoverthepastyearUSD/toz0.00200.00400.00600.00800.001000.001200.00Mar-99Mar-00Mar-01Mar-02Mar-03Mar-04Mar-05Mar-06Mar-07Mar-08GoldPriceSource:CommoditiesExchange(COMEX).This“goldasacommodity”frameworksuggeststhatgoldpriceshavestrongsupportatandabovecurrentpricelevelsshouldthecurrentlowrealinterestrateenvironmentpersist.Specifically,assumingrealinterestratesstaynearcurrentlevelsandthebuyingfromgold-ETFsslowstolastyear’space,wewouldexpecttoseegoldpricesstaynear$930/tozoverthenextsixmonths,risingto$962/tozona12-monthhorizon.However,shouldrealinterestratesmovelowerorgold-ETFbuyingcontinueatitscurrenttorridpace,theupsiderisktogoldpriceswouldlikelybesignificant.ThisreportisthefirstinournewFrameworksseries.Thisseriesofoccasionalreportsisintendedtoexploreingreaterdetailtheframeworksnecessaryfordevelopingviewsandforecastsforcommoditymarketfundamentalsandprices.InthisfirstFrameworksreport,weoutlineanapproachtoforecastinggoldpricesandfundamentalsfromtheframeworkof“goldasacommodity”—basedontheeconomicandfinancialdeterminantsofgoldsupply,demand,andinventories.Historically,wehaveviewedgoldmoreasacurrencythanacommodity(seeourFebruary4,2009report“Gold:Thecurrencyoflastresort”),March25,2009Commodities:FrameworksGoldmanSachsGlobalEconomics,CommoditiesandStrategyResearch4valuinggold(inUSdollars)inrelationtotheUSdollarprice(orexchangerate)ofabasketofcurrencies.Weviewtheapproachinthisreportascomplementing,notreplacing,thecurrencyapproach,witheachframeworkprovidingavaluableperspectiveongoldpricing.Intermsoftheapproachtogoldpricing,theseframeworkscanbedescribedasfollows:•Currencyframework:Goldpricedinrelationtothepriceofpotentialsubstitutesforuseasastoreofvalueandmediumofexchange.Keypricedrivers:Exchangerates,financialriskasmeasuredby