How low can gold go?

Indeed, since mid-February, investors have sold 620 tonnes of gold from ETPs. And, just as prices gained momentum on the upside, they are now experiencing momentum on the downside. Selling by investors is helping to push prices lower, further encouraging other investors to capitulate as well. Meanwhile, ETPs, which accounted for 6% of total demand for gold in 2012, have so far this year added net supply equivalent to 14% of last year’s total supply of gold.

When supply and demand of gold is imbalanced, the market can usually rely on natural stabilizers to help the situation, as mentioned earlier. Jewelry demand is one aspect of this mechanism. As prices rise, customers are priced out of the jewelry market – just as when prices fall, consumers can afford to buy more gold.

Global jewelry demand declined significantly between 2008 and 2012, deterred by higher prices. Yet there has been a noticeable increase in jewelry demand in the recent context – seen by the rise in physical premiums for kilo-bars in a range of locations and the backwardation in London prices, which indicates a near-term scarcity of physical metal in the market.

The second key stabilizer is the supply of gold scrap. This is because lower gold prices lead to a sharp drop in global supply of gold scrap. Usually, when the price of gold goes down, we can rely on both of these automatic stabilizers to balance out the equation. But, because of today’s strong outflow from investor demand, it’s tempting to acknowledge that this won’t be enough.

From net demand of around 1,300 tonnes in 2012 (according to GFMS), investment demand has turned into a source of net supply in 2013. If current trends continue, this net supply could reach as much as 400 tonnes or more, with sales from ETPs far outweighing new investment in gold bars. And even if ETP investors stop selling, it will be difficult to see net demand turning positive for the year as a whole.

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