World Gold Council’s Q3 demand report has generally been received favorably by analysts and the investing community. Total gold demand was reported at 922 tonnes in Q3 2010 (12% yoy) (43% to US$36.4 billion in dollar terms) but -10% qoq. Of the reported demand segments, Jewelry demand at 529 tons was 8% higher ((yoy)), industrial demand at 110 tons (13% yoy from a very low base in Q3 2009) and investment demand at 282 tons (19% yoy) with net retail investment at 243 tons (25% yoy) (bar holding demand at 132 tons, 44% yoy) and ETF demand at 38 tons (-7% yoy). The report projected a rosy demand outlook picture based on the rise in jewelry demand increase in India and China.
I also came across some analysts comments suggesting that Q3 2010 demand trends have restored market’s balance to five years average balance of 65% jewelry, 23% investment and 12% industrial demand (Q3 2010: Jewelry demand at 57%, investment demand at 31% and industrial demand at 12%) . This healthy demand balance has been deemed as a key to keeping gold prices stable. 2009 Tonnage is estimated to climb from last year by 5-6% despite a significant rise in the price of the metal itself. My observations on this report are as follows:
1. The key question which emerges from Q3 2010 gold demand is about potential increase in Jewelry demand being able to take up any slack in investment demand. Another question is about gold investors make up, which should make gold price stable / unstable to any short term headwinds. The answer to both these questions is “NO”.
2. Jewelry buyers, the longer term investors, may not stick to their buying habits and suppliers like miners and recyclers may increasingly feed the market with ever greater quantities as the price is rising.
3. Higher restocking in India in Q3 2010 may mean a decline in Q4 2010 Indian Jewelry demand. In total, the non-investment market for gold is weak and getting weaker as the price of gold rises. Jewelry demand continues to decline while supply is rising from both higher mine output and higher recycling activity.
4. Trailing 12-month gold jewelry demand at end of Q2 2010 was 1882 tonnes which was 24% less than the yearly average for 2002-2008, and 41% less than the 2000 level.
5. Meanwhile, supply keeps rising. It was 3605 tonnes in 2008, 4024 tonnes in 2009 and it is up nearly 11% in the first half of 2010. Another interesting aspect is that of 169,000 tons of gold mined till today, 64% is unaccounted for, and with rise in gold prices - scrap supply is gaining velocity.
6. Investment demand may rise in Q4 2010 / Q1 2011 as portfolios position themselves for 2011. Momentum of investment demand may slow down by mid 2011 because of overall improvement in risk aversion and decrease in risk premium related to competitive devaluation and death of fiat currencies.
7. Inflation does not have any coincident or shorter time period effect on gold price. However, deflation / stagflation may be supportive of gold price in 2011 and beyond.
8. Going forward gold price will be determined by central banks, institutional portfolio demand (SWF, Insurance companies, pension funds, and private wealth etc – total managed money of US$200 trillion) and retail ETF buyers and not Jewelry demand.
9. When the price of gold turns down and sentiment reverses, many investors will find that the exit door has gotten pretty narrow. Gold price will still find support from institutional investors and central banks because of diversifying portfolios and US$ based forex reserves.
Global / Indian Jewelry Demand
Global jewelry demand increase in Q3 2010 was followed by a -5% in Q2 2010 (-14% totaled 408.7 tonnes during the second quarter, a decline of 14% from Q1 levels and 5% from year-earlier levels. Jewelry off-take was lower across most markets, with just a handful of countries bucking the declining demand trend.
Jewelry demand increase in India in Q3 2010 can not be read as start of a trend as India’s Q2 2010 demand of 123 tonnes was very depressed when compared with average second quarter demand over the five year period Q2 2003 – Q2 2007 of 182.1 tonnes. The second quarter is historically the most important period for jewelry demand in India. This demand deficit of 62 tons compared to five years average was likely shifted to Q3 2010 Indian Jewelry demand (+40 tons higher than Q3 2010 five years average demand of 140 tons) as mentioned later in the report that re-stocking has helped shore up Indian gold demand in Q3 2010 (estimated at around 38 tons). If we strip that out to reach a sustainable level, demand is flat to negative in line with the Q2 2010 trend. Indian Jewelry demand has been steadily declining since 2000 as gold price started its long upward ascent. Jewelry now accounts for only 57% of total demand (43% in Q2). That compares with 80% between 2002 and 2008. Stating that Indian Jewelry demand is defensive to higher gold prices is incorrect. Indian consumers may remain cautious given record gold prices. Silver and gold plated items have taken an increasing share of demand at the lower end of the market, where affordability of gold jewelry has been most affected by its price. Also, many previously exclusively gold high-end designers have included silver lines to try and build entry-level ranges for consumers at more affordable prices to offset overall sales declines.
Healthy Market Makeup
It is too early to say that we are returning to the natural balance on the demand side—the relative balance between jewelry, industrial and investment. Besides the running demand, holding gold as an investment has increased considerably over the course of last year, which does not support the healthy demand and supply argument to keep the gold price stable as investors may try to exit at first sign of trouble. Also jewelry purchases by investors are increasing. This view of jewelry as an investment may not be as stable as genuine jewelry demand.
Investment Demand
Another factor behind the increase in total Q3 2010 demand was identifiable investment, (19% yoy) at 281.8 metric tons. The bulk of this came from investors who increased their demand for retail gold products by 25% to 243.1 metric tons. New investment into ETF and similar products at 38 tons was down 7% yoy. Bar hoarding was particularly strong at 132 tons-- up 44% yoy -- driven by a demand among Asian & ME investors. This is the second wave of investment related demand (after ETFs), which may be somewhat more stable compared to ETF demand but may not be as sticky as jewelry and industrial demand. These retail consumers having adjusted their price expectations upwards and anticipating yet higher prices is a bubble symptom and may not be good for gold prices in the medium to long term.
Industrial Demand
Industrial use accounted for 12% of demand in Q3 2010 and was in line with its five-year average (110.2 metric tons, including an 18% climb for electronics products). We expect this demand segment to increase at a decreasing pace.
Recycling / Scrap Supply
I expect that with a higher gold price environment, recycling will further accelerate. Recycling supply activity during the Q2 2010 reached 496 tonnes, 35% yoy and the second highest quarterly number for recycled gold. Most of this price induced recycling activity may come from western, ME and East Asian consumers (gradually rising trend). Recycling activity among Indian consumers is still low and may ensue in the case of a significant price downtick against alternative opinion of a higher price profit point.
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