Not all Gold Investment demand is the same...
The GOLD MARKET changed dramatically in 2009, writes Julian Phillips of GoldForecaster, and thanks to the latest data from the GFMS consultancy, we now have evidence of these changes.
The main features of these 2009 changes?
- Mine production was up by 6% in 2009;
- Supply of gold scrap was up by 27%;
- Jewelry demand was down by 23%;
- New Gold Investment jumped from 885 tonnes in 2008 to 1820 tonnes, a year-on-year gain of 105%.
These are the cold facts, but what of the spirit in the market of gold and silver? It is this that counts because this gives us direction for the future of the Gold Price.
The rise in Gold Mining production in 2009 will likely turn to a fall in production in 2010. GFMS forecasts a continuation of the last decade's underlying trend in its latest outlook. Because as the major reserves of the world are depleted (can you believe that South Africa once produced 1,000 tonnes a year and is now down to 220 tonnes?), replacement ore bodies are proving very rare.
Even with China's production on the rise, unless there are major discoveries, there will be no rise in the global production totals. And bear in mind that it can take 5 years before a new mine delivers gold to the market.
With this in mind any rise in Gold Investment demand (which is happening at the institutional level with vigor) has to find new supplies from scrap sales. A rise of 27% in scrap gold sales worldwide last year was due to the run of record prices. By its very nature, this change of ownership sees gold move from existing holders, more used to lower prices who believe that current prices cannot hold, to new owners who believe that prices will hold and rise in the future.
When you find that these new owners are also the world's most important money institutions, plus traditional investors who hold Gold Bullion itself as well as new entrants to the gold market in the Far East, then you know that this shift in ownership, far from being a danger to the Gold Price, is a very healthy change in the fundamental structure of the market. Even now, major investors are poised to enter the gold market. We suspect they're looking to Buy Gold on any sizeable dips in the price.
There is no doubt that if supplies from the scrap sellers were to fall, then prices would rise to bring other scrap sellers to the market at higher prices. Otherwise, where else can gold supplies come from? Falling scrap sales would necessarily mean higher Gold Prices, which may then fail to elicit a similar level of scrap flow as 2009.
Right now, for instance, we are receiving reports from India – formerly the world's heaviest private buyers, and by far the largest private holders – that scrap sales will fall by half this year if the Gold Price stays around the current levels.
In contrast to India and new world No.1 China, jewelry in the Western world is not typically bought for its gold content. The artistic and design input is the key component. Even the relatively simple wedding ring, while needing the title of a 'gold' wedding ring, is not bought for its gold content, but for its ability to retain its looks and design throughout the marriage.
This implies an 18 carat ring (meaning 75% gold) with other metals hardening the ring and giving it durability. Because of these factors, price is important. After all, this type of jewelry is not bought with a future sale in mind. So with Gold Prices rising, demand for this type of jewelry was bound to drop significantly as hard times hit. Should the US economy really recover, however, you can be sure that this type of demand for gold will too. It is actually remarkable that the fall was so small.
Indian jewelry demand, on the other hand, is for 24-carat gold. In reality, it doubles as investment demand, rather than for adornment. And this element of the gold market has changed remarkably in its nature over the last year. The cold fact is that global gold demand overall rose 105%.
In the financial markets of the developed world there is a mindset which believes that the purpose of investment is to make a profit. Western markets in particular have this attitude towards the gold market. But the gold market offers far more than the opportunity to grow capital value. That has been the case since gold was first considered valuable.
With that in mind, let's take a look at the nature of Gold Investment demand:
Type 1: Anticipating a Gain
Whether Buying Gold for a future profit or as an anti-inflation/deflation play, this typifies the developed-world investor. He or she buys with a sale in view, perhaps with a time horizon in mind. The buyer continues to trust the financial system as part of the foundation of his world, but believes that if he buys gold it will rise in price and so justify its place in his portfolio.
It will take hard times to broaden this perspective. Even the largest pension-fund manager factors in that his average contributor works from around age 20 to 60, and then wants to take his savings and spend them in his remaining years, hoping his last check won't bounce. If there is an inheritance left over, so be it, but often that is not the motive. So, after Buying Gold, a sale must eventually take place. Call it a cultural thing if you will.
Type 2: Seeking Protection
Holding gold as a protection against feared financial reverses, this "safe haven" demand see gold as the ultimate in financial safety. This investor has seen hard times and believes they will come again, so steps must be taken to minimize their impact.
As to profits or the rising value of the Gold Investment, this serves only to protect the value of wealth, its purchasing power. Buying Gold for the family, the buyer harbors it against unforeseen events. The gold is not for sale, therefore, not unless it is sold to resolve one emergency or another.
You will find this investor east of the Eurozone, from the Middle East through to China and Japan. In the Eurozone, particularly Germany, you will find many large instances of this type of investor as well as the Type 1 investor too, but he is typically from "old money". These family fortunes were made during the last turbulent century in nations that saw wars and frequent currency collapse. These investors buy unobtrusively and in large amounts. They know that gold is money when skies blacken – and they are buyers right now!
Type 3: Holding Gold in Reserve
To hold gold in quantity, and retain it with no view to a sale, is to hold it as a reserve asset, i.e. a form of money. These investors are the central banks of the world. They hold gold as a reserve asset to back-up their paper currencies, despite the fact that the printed notes offer no gold as collateral for the obligations of government which these bills represent.
When push comes to shove, and a nation's paper loses international confidence completely, their gold can be mobilized to solve the worst of financial woes, as it has in the past.
Gold sales, since the Seventies, by central banks in the developed world were made in support of our zero-backed, paper currency world. Discrediting gold, so paper money would be trusted completely, these sales relied on the inherent confidence people have in the overall system under which they live. That was all very well and good, provided the money makers kept money – and consequently prices – stable. The last two-and-a-half years, however, have given us anything but a stable money system.
Confidence in the system fell alongside growing instability, with the US Dollar – the pivot of the paper system – proving most unstable itself. And how have central banks expressed their opinion of their own paper money system? In 2009, says GFMS, official gold sales ground to a near-halt worldwide.
The European Central Bank's gold agreement signatories – who first agreed in 1999 to cap their annual sales, right at the end of gold's 20-year bear market – set up another Agreement on 27th September 2009, largely to accommodate the International Monetary Fund's sale of 403.3 tonnes. (The IMF is not a signatory, but its sales were explicitly included in the new 400-tonne per year limit, itself cut from 500 tonnes in the 2004 agreement.) Since signing in late September, the member banks have sold almost no gold themselves. And on the other hand, non-developed world central banks bought more than 300 tonnes of gold in 2009.
Alex Weber, president of Germany's Bundesbank, coined the phrase which most aptly describes this new appetite for gold. Speaking in defense of Germany's retention of its gold reserves – second largest after the United States – "Gold acts as a useful counter to the swings of the Dollar," he told reporters.
So this central bank sector, potentially the greatest and influential source of demand for gold, has swung vigorously from seller to buyer overall, and at a time when the supply of gold is not sufficient to satisfy their net purchases. You can be sure that they will Buy Gold as and when they can, favoring large purchases in particular, in the days to come. In so doing they are telling us something and telling us loudly.
Central banks fully realize the need for the current monetary system to have solid support from Gold Bullion. So is it any wonder then that world investment demand exceeds jewelry demand for first time in 30 years? We expect that to continue.
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