High Gold Prices, High Demand?

Could rising Gold Prices actually boost physical gold demand...?

TRADITIONAL THINKING has a pat answer for this question, says Julian Phillips at the GoldForecaster.com newsletter.

"High prices cut demand!"

Yet this doesn't seem to be working in the gold market. At the turn of this century, in the days when gold was a 'barbarous relic', the Gold Price stood at just under $300 an ounce. Since then there has been an increase in barbarians.

What has happened since then has been a major, revolutionary change in the structure of the gold and silver markets. Jewelry and industrial gold buyers, alongside rural, agricultural Indian demand, used to dominate the Gold Price. In the developed world gold was not bought for itself and its value. It served a more complimentary role in jewelry, often the cheaper part of a piece of jewelry.

The attraction of gold in that role was its beauty and the fact that it didn't tarnish and mark skin. The sheer volume of the cheaper side of the jewelry market gave weight to this demand. In India, the relatively poor agricultural sector demand supplied 70% of India's demand for gold to be used as jewelry/financial security for newly weds. Food prices did not rise that much, so the income available for gold buying remained relatively static. Higher Gold Prices to them did mean that less gold was bought.

These buyers are still there, but buying lower volumes of gold, with the new Indian middle-class buyers coming into the market as non-seasonal but strong buyers!

India began to enjoy strong growth early last decade, and the accompanying urbanization – plus a rapid increase in the size of the middle class – means dependence on the poorer agricultural sector has diminished. The Gold market has thus deepened and widened its demand shape. The Hindu family tradition that favors gold so much does not diminish with this process. Just as life insurance to the developed world stays in place with greater wealth, so gold retains its attractiveness with the Indian community. After all, since the year 2000, who can argue with the performance of gold?

We expect that, as prices find support at higher prices, new and bigger demand will appear in this particular gold market.

In the West, meanwhile, the transition in the gold market from cheap jewelry to investment in Gold Coins and small bars is similar to the process we are seeing in India. But decoration of the body beautiful was replaced by a growing demand for gold as wealth and as a protection from the loss of confidence in the money systems. As we have seen, the quality and quantity of demand dropped initially, as jewelry demand faded, but is now gathering pace and actually increasing on both fronts, especially if we add the small coin and bar demand to it.

As gold moves up the ladder of exclusive and expensive decorative items again, higher quality gold jewelry demand (accepting higher prices) is growing again. At even higher Gold Prices, this trend will continue to grow and jewelry buying will increase, we believe.

Perhaps the most dramatic change in demand as prices rose was seen with the advent of the gold Exchange Traded Funds (Gold ETFs). Many institutions had almost unwillingly climbed aboard the gold train through the shares of the gold mining companies, because they were forbidden from owning actual physical gold. When the Gold ETFs arrived they had an opportunity not only to own indirectly physical gold, but to directly affect the price with their buying.

The demand these securitized trust funds has attracted has been remarkable, relative to the size of the gold market. The tonnage of gold held in such funds has placed their holdings fifth in the table of Gold owners including central banks, so far. China and Switzerland own less then these funds do. These investors are entirely new to the gold market itself. Please note that such buyers hold for the long-term as a protection against other market's falling values. The more unsure they are of the future of various aspects of the global economy and its money, the more gold they will buy. Relative to their buying capacity, they have barely dipped a toe into the market.

As these buyers have shown, when they believe prices will rise, they buy for the long-term!

The story of central banks and gold, in contrast, is a sad one. Both politicians and bankers strove at the start of this century to establish a doctrine that paper currencies, with no gold backing, better serve as money than gold does. By persuading people that central bankers were capable of being a satisfactory "lender of last resort" – and that gold was a barbarous relic that had no place as money – they sanctioned a dual policy of selling and sidelining gold as money, thus accelerating the supply of gold to the point that the easy gold pickings were exhausted.

Then came the bad times starting in 2007, followed by the realization – verbalized by the German finance ministry – that gold was a "useful counter to the swings of the Dollar."

First Germany refrained from joining the broader Eurozone gold sales. Then the European banks stopped selling almost entirely. Once the International Monetary Fund (IMF) has completed its 403 tonnes of sales (half of which went to the Indian central bank in October), it will stop too. But meanwhile, China and Russia have started buying to the extent that central bank – net, worldwide – buying is running at around 400 tonnes a year, so far.

Now central banks have had to revert to their underlying belief (never in fact abandoned?) that gold is a vital reserve asset, particularly when dreams fade and realities take over. And higher Gold Prices in their case have led to a cessation of sales and substantial buying!

As gold and silver prices rise just like a thermometer measuring global financial uncertainty and instability, more and more investors are entering these markets for the first time, not for profit per se, but for protection against such fears and in an attempt to preserve the wealth they have. These investors come from the entire spectrum of investors across the length and breath of our world.

This is the quintessential reason why demand for gold will rise as Gold Prices rise.

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