What impact will continued weakness in gold jewelry demand have on prices...?
GOLD IS NOW barely $30 away from its record levels, and the US Fed is going back into Quantitative Easing because the "L" shaped recovery is threatening to turn into a double-dip recession, writes Julian Phillips of the GoldForecaster.
US consumers are saving 6.4% of their income, where before they saved only 1% to 2 %, while money velocity is threatening to slow, money supply is shrinking, and deflation is looming on the horizon.
All of this points to a weak US gold jewelry market. In the rest of the developed world the picture is nearly the same, so it is reasonable to expect world jewelry demand to be weak. With gold jewelry accounting for roughly 60% of total gold demand in the past, can the Gold Price rise if the gold jewelry market is weak?
As defined by most market analysts the word jewelry is a misnomer. It is a broad sweeping title that fails to describe accurately the type of demand it is supposed to describe. In the mind's eye of the Western analyst it describes developed world jewelry, with the insinuation that global jewelry markets are the same. They are not. In Western cultures (through to Italy), buyers of gold jewelry do so not as an expression of investment but simply as decoration. This makes it totally different from gold jewelry markets East of Italy.
Developed world gold jewelry markets use gold to enhance a piece of jewelry. The emphasis and main cost lies in the workmanship of the designer and the stones used, rarely the gold content. Gold content is usually a minor part of the piece.
Where a Western version of gold metalwork represents the entire piece, the gold is often diluted from a pure gold content of 24 carats down to 18 or 9 carats of gold. Consequently the piece of jewelry is bought as decoration and almost never for its gold content. There is almost never any intention of mortgaging, re-selling or melting down for scrap when the piece is bought.
Jewelry markets east of Italy, in contrast, change their nature. Gold jewelry becomes an expression of wealth, of money and of investment by the owner. And when we talk of this attitude to gold jewelry, we are talking here of around three quarters of the globe's population (and getting richer by the day).
India in particular loves gold. India expresses this attitude in the most visible way. The bride's parents give their daughter a gift of pure gold in the form of jewelry with which to provide financial security to the couple. In parts of South India, which has more gold per capita than anywhere else in the world, wealthy families can be expected to send off a bride with at least a kilogram of gold (currently worth $39,000) as part of a marriage arrangement. Along with its key role in weddings, gold is used to flaunt family wealth and signify social status. It has also been a popular source of retirement saving and insurance against calamity.
No one knows exactly how much gold has been passed from generation to generation and is now stashed in safe deposit boxes across India. But we believe Indian families are sitting on about 20,000 tonnes of gold in India alone.
Gold at family level is seen as money, and it's valued far more than the Rupee, which comes with the watchful monitoring eye of government and taxes and regulation, something history has taught Indian citizens to despise.
A basic intention of Buying Gold in India and in Asia in general is that one day it can be sold or mortgaged to save the family from a financial crisis. It is occasionally sold when the owners believe that the local price of gold is too high and will come down. But such a sale is usually done with the intention of buying back the gold at a lower price. A look back 50 years helps us to understand this.
India's disastrous 1962 war with China severely depleted India's foreign reserves and removed credible backing for the Rupee. To prevent a massive flight out of the Rupee, the government established the Gold Control Act in 1962, forbidding private ownership of Gold Bullion and mandating the conversion of all private gold into gold jewelry. In an action similar to the 1933 Gold Confiscation Act of the United States, this was intended to prevent the rise of an alternate currency if the Rupee should flounder.
In 1969, the Indian government under Indira Gandhi nationalized the banks and mandated licenses for almost everything. This was the beginning of the "License Raj" in India, which instituted rampant corruption in all levels of the bureaucracy. Indians had to develop a system, at ground level, to avoid the impact of this new cronyism. Due to the official ban on Gold Trading, the value of gold in relation to other commodities and the Rupee soared.
The high marginal tax rate (then 95%) also gave rise to a huge black market. Citizens needed a way to hide and protect their assets from the taxman, and gold was one of the two asset classes that proved effective for doing so (the other being real estate). These attitudes persist today, because government has not improved its record that much since then.
Add to that another reason why extensive gold holdings are prudent in today's context is the paltry level of insurance provided to bank deposits. A fractional reserve banking system is inherently insolvent and needs government insurance to prevent a run on deposits. In India, the amount covered under deposit insurance is just Rs100,000 – only US$2,170. In contrast, federal deposit insurance in the United States was recently increased from $100,000 to $250,000.
With the need for banks to be close and supportive of government action, there is little incentive for Indians to embrace the banking system fully. So gold is very much a part of an alternative financial system that is not likely to disappear in the foreseeable future.
In India, gold jewelry should be defined, in western parlance, as investment, not jewelry. This applies to Asia in its entirety. And thus re-defining the jewelry market as the developed world jewelry market, we do indeed believe that demand will recover in line with the "L"-shaped recovery and dip, if a recession re-visits the Western markets.
Thanks to the vigorous growth we are seeing in India and the rest of Asia, the demand for (investment) gold will rise alongside their growing wealth, and alongside the development of their middle-classes. The turmoil and poverty experienced by so many will prompt them to accumulate gold as savings for dark days. Some of this gold will be shaped into jewelry, but it will always remain an investment – a form of savings and insurance – rather than primarily for decoration, as in the West.
The Indian experience holds a future significance, too. Because we have no doubt that, in time, the world will move closer to the Indian attitude towards gold and jewelry. As we saw, their attitude stems from government abuse of money and of their citizens' private savings in particular. Pertinently, when the government banned gold ownership in 1962, the Gold Price in India soared – certainly a feature of gold that will be repeated if any government decides to confiscate its citizens gold.
With this in mind we have no doubt that the price of gold will rise as financial crises become par for the course in today's world.
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