From the May 01, 2010 issue of Futures Magazine • Subscribe!

Gold highs near an end?

Cash for gold
Gold scrap supplies showed a hefty 27% rise last year, one that was clearly engendered by record-high gold prices. Consider that 1,674 tons of recycled gold flowed into the market during 2009, an all-time high and a 68% jump above 2007’s inflows. Turkey and India led the parade of secondary supplies of gold, but new records for scrap intake also were noted in Europe and North America as high gold prices and the need for cash drew old bullion hoards out of people’s hands.

Also noteworthy is that producer de-hedging, a major contributor to the rise in gold prices over recent years, has slowed immensely, falling by 90% in the first half of 2009, to the point where it only represented 31 tonnes over the course of the first half of the year. Currently only 236 tonnes of gold are left in the global hedge book.

World gold jewelry fabrication fell by a remarkable 19.8% in 2009, to a 21-year low of 1,759 tons. Jewelry fabrication normally comprises nearly 70% of the market. The culprits for the sharp decline were once again the very high price of gold and the economic crisis spilling over into the luxury buyer segment (see “Too valuable to wear”). Industrial fabrication demand for gold fell by 26% in the first half of 2009 as weak global economic conditions drove electronics demand down accordingly. U.S. and Japanese electronics-oriented gold demand fell by 39% and 32%, respectively.

The first half of 2009 also marked a significant episode in the history of Indian gold bar hoarding, as it fell by 75% and turned to dishoarding for the first time since 1980. The main driver of this phenomenon has been the perception of limited upside potential in the price of gold bullion. The gold industry could traditionally count on India to absorb anywhere from 600 to 900 tons of the yellow metal annually. Bar and coin retail investment also experienced a hefty global decline of 32% in 2009 relative to 2008.

To sum up, total gold supply for 2009 was up by 11% at 3,890 tonnes, while total demand was down by 11% at 3,386 tonnes. This leaves us with a 504 ton surplus, which can be inferred as having been absorbed by the category of “investment.” Most of the off take from investment can be attributed to ETF demand — a niche that, for example, consumed 465 tonnes in the first quarter of 2009 during what appeared to be the most intense phase of the global financial crisis.

The bright spot in the 2009 total supply/demand equation was that global net central bank sales amounted to only 44 tonnes in 2009 (compared with 236 tonnes in 2008) and were the lowest sales level in 12 years. In fact, a handful of central banks actually bought gold last year. The most heavily publicized such purchase was the one made by the Reserve Bank of India (RBI).

However, the buying of the IMF’s gold by the RBI simply reflects the fact that India’s gold reserves, at 4% of total reserves, had fallen in comparison to the past (gold had made up 8.2% of total reserves at the beginning of 2000 and nearly 20% of them back in 1985) due to the rapid accumulation of dollar reserves and compared with other countries in the top-20 global economic powers list.

The picture we describe above leaves us with a gold market that has become highly addicted to and dependent almost entirely upon continued inflows into gold-oriented ETFs and various speculative hedge funds. Yet, the very same and much-vaunted gold-backed ETFs could come to play a critical role in determining the gold price in coming years, especially if holders of these vehicles sell, unleashing a large amount of physical metal onto a market in which demand is relatively weak.

One of the most prominent and blunt warnings came from Paul Walker, CEO of precious metal consultancy GFMS, back in April 2009 when he noted that investment in gold “may dry up over the next five years following a long period of strong interest from global investors.”

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