For the past few years the production of gold has been flat, while the demand from investors and central banks has been trending upwards. This article looks at the fundamentals of the gold market, and how they have been impacted by the recent drop in price.
According to the CPM gold year book 2012, world annual gold production has been flat for the past four years. This trend is confirmed by data from the World Gold Council who note that during 2012 the supply of gold actually contracted by 1.4% to 4,453.3 tonnes.
The chart below shows quarterly gold supply over the past three years. The chart also denotes the source of the supply, i.e., Mine production, Net producer hedging or Recycled gold.
Quarterly gold supply by category (in tonnes)
Source: World Gold Council. Note: Net producer hedging measures the impact of mining companies’ gold forward sales, loans and options positions. Hedging accelerates the sale of gold, by releasing gold from existing stock piles into the market. Over time however, hedging activity does not generate a net increase in the supply of gold since the process of closing hedged positions reduces the amount of gold available to the market.
Although gold demand was down 4% in 2012 versus 2011, it was still 15% higher than the average level seen during the past five years. Demand totaled 4,405.5 tonnes, which on a value basis was an all-time record of $236.4 billion.
The table below shows annual gold demand over the last 10 years. The chart also indicates the source of the demand, i.e., Jewellery, Technology, Investment or Central bank net purchases.
Gold demand by category (tonnes) + gold price in US$ per ounce
Source: LBMA, Thomson Reuters, World Gold Council.
In 2012 some 43% of gold demand came from the jewellery industry, 29% came from the purchases of bars and coins, 12% came from net purchases by central banks, 10% came from the technology industry (primarily for use in electronics), and 6% came from purchases by ETFs (exchange-traded funds).
Gold demand breakdown 2012 (tonnes)
Source: World Gold Council.
The recent growth in demand for gold has come primarily from the physical bar segment of investment demand as well as from purchases by central banks.
Action at the margin
In the investment world we often hear the phrase “price is set at the margin”. In the case of the gold market the supply and demand at the margin is set by those who are selling their metal and those that are looking to buy it. The price of the entire market is in their hands, and not in the hands of those who are just sitting tight.
This is important because it was the action at the margin that took the price down by 238% in just trading three days beginning back on 12 April. The price dropped sharply as around 1,100 tonnes of gold were sold into the paper market in just the first day. The selling continued on 15 April with a further 2,300 tonnes of paper gold sold into the market.
Clearly the market was unable to absorb gold sales that amounted to more than 77% of annual production in just two days. What’s interesting about the sharp drop in the paper price of gold however, is the reaction of investors. Typically investors are attracted to rising prices and they will tend to enter the gold market when it’s undergoing a sustained rally. On this occasion however, the price decline has triggered unprecedented demand for physical gold (and silver), so much so that it has led to shortages.
Last week the US Mint, which is on target to record its best month since December 2009, ran out of its smallest gold coin. The UK Mint also reported a tripling of bullion purchases. Meanwhile gold inventories monitored by the Comex tumbled to the lowest level since July 2008.
According to the Bombay Bullion Association Jewelers in India are paying premiums of as much as $10 an ounce, up from $2 just 10 days ago. The volume for the benchmark contract on the Shanghai Gold Exchange also surged to a record last week. There has also been a surge in gold demand in Turkey which is causing delays in coin deliveries.
The recent surge in demand has not just been limited to retail investors; central banks have also been buyers. Bloomberg reports that Russia and Kazakhstan have boosted official reserves for a sixth month, and according to the World Gold Council, central banks will buy as much as 550 tons this year, the most since 1964.
The record buying in the physical market has triggered a swift reversal in the gold price which has risen from a low of $1,321.50 on 16 April to $1,472 per ounce today.
The bottom line
Gold is an asset that tends to be held by those that see the economic and monetary “big picture”. And it’s because they see the link between record debt, rising deficits, high unemployment, weak economic growth and the destruction of paper currencies that they are happy to step in and buy gold when the paper price is brought down by an orchestrated attack.