Gold: Recycling Threatens Demand-Supply Equation

More than 25% of gold’s annual supply flows originate in the recycling of scrap. The global recession has now generated another recycling process altogether: the purchase and sale of jewelery items and gold bars entering the marketplace due to declining household wealth.

Gold bugs should take cognizance of the alarming pre-weekend announcement by the Bombay Bullion Association that gold imports into India, the world’s biggest gold consumer, fell 81% year-on-year in December 2008, as purchase orders through the complex gold chain (village-to-city) came to a virtual standstill. Indian gold imports for 2008 as a whole are estimated to have fallen by 47%.

Israel’s offensive in Gaza has caused a spike in gold prices over the weekend. But, unless there is conclusive evidence that the Gaza crisis will spread to Lebanon, any moves beyond $910 per ounce should be used to short gold via Exchange-traded notes (DGZ, DZZ) or, depending upon liquidity and market-sensitivity considerations, via Exchange-traded funds (e.g. UBG and SBUL.LSE). Thus far, Dubai gold shops confirm that aggressive statements from Tel Aviv have not resulted in panic buying; moreover, major gold traders in the Mumbai (Bombay) bullion market are ready to unload excess inventories around $910-935, given that nobody there believes that Hamas has the ability to extend the Gaza ground war beyond a few days.

Of course, the more fundamental argument in favor of higher gold prices (with some calling for $2,000-plus) is rooted in the safe-haven dogma. “With assets being devalued across the globe, central banks, money managers and even individuals will increase the gold allocation in their portfolios throughout the new year,” a spokesperson for the Bombay Bullion Association emphasized yesterday. “Demand will pick up in the second half of January since it is not considered auspicious to buy gold until the 14^th.”

But small-scale gold outlets in the Indian interior are pointing out that, as opposed to any inferences derived from a reading of the stars (i.e. numerology), what is really inauspicious about the Indian gold matrix is the increasing poverty levels in the countryside, and in the dramatic erosion in the wealth of lower-middle-class families in towns and small cities. The last marriage and festival seasons saw an unprecedented trend towards minimal and selective purchases of jewelery; in fact, a record number of households are actually pawning or selling gold and silver possessions merely to survive. Almost two-thirds of physical gold purchases in India originate outside the regional centers of Mumbai, New Delhi, Chennai and Kolkata.

East Asia, the Indian sub-continent and the Middle East account for roughly 72% of world demand; 55% of world demand is attributable to just five countries: India, China, the US, Turkey and Italy. While Chinese demand rose by 24% in 2007, late-2008 statistics are expected to show a sharp decline. How many jobless workers returning to their villages from the once-booming industrial zones have pawned or sold their gold-denominated savings is still the subject of speculation in the Hong Kong media; but the manager of a gold dealing window in Guangzhau (formerly Canton) confirmed in a television show that sales of gold bars had slowed down to a trickle despite the Christmas shopping season. “The Chinese New Year may bring better news,” she hoped.

Gold’s reputation as an alternative store of value is only sustainable if the early-2008 demand-supply equation can be sustained; that demand-supply equation is now completely reliant on the equilibrium shift between those fleeing financial assets to invest in physical gold (not in futures and options) and those actually selling (or pledging) gold assets in order to survive. As far as gold production is concerned, there are enough mines and enough proven reserves (in South America, Africa, Central Asia and Russia) which evidence a solid base of supply. Furthermore, despite regional variations, production costs continue to justify maximum mining-capacity utilization even with gold in the $550-600 range.

Disclosure: no positions

Comments

[mauijeff:]

The percentage of gold used in jewelry is low. I don't think that physical demand for jewelry will have much effect on the price of investments in gold. However, jewelry shops around the world will probably not do well when people need to put food on the table.

Jan 05 05:31 AM

[Apple:]

i was at the beijing gold market on January 1. both levels of the building were packed standing room only with people lined 7 deep around counters. The morning turnover was a record and featured on the Beijing TV news. there were many more people buying than jan 1 last year. double according to the lady handling the pama ingot sales.

Jan 05 05:39 AM

[Apple:]

the cash receipts passing across the display counters of the beijing phyiscal gold market from 9.00 am to noon on Jan 1 was RMB 30,000,000 (US$4.4M).

Jan 05 05:49 AM

[Alan Skoreyko:]

gold is a tiny market entirely manipulated by the government neither jewellery demand or investment demand can actually control the price.

Jan 05 06:23 AM

[NOWHEREMAN:]

MauiJeff: MauiDivers has Clearance Sales. In the month of December, the number of items in this category averaged around 120. The latest January offering is now up to 280.

The offers usually included items up to $5,000. Now they have many above $10,000...$11,500 reduced to $8,200.

This is a high end retailer of quality goods.

Jan 05 07:23 AM

[NOWHEREMAN:]

A two year subscription to a $159 newsletter now gets me a free1 oz. .9999 Silver Panda coin. Same subscription, last November was $159 without the coin.

Silver coins are really hard to find?

Yeah, Right

Jan 05 07:34 AM

[swygert@law...:]

Gold primarily has psychological when value looking at long intervals, clearly goes through periodic manic and depressive phases: either mass worry about the future (creating buying spurts) and mass euphoria sbout the current and future economy (creating hold or sell behavior).

Having said that, this article by Mr. Saxena is an excellent analysis of short term supply and demand factors which clearly affect short term cycles. His point that the downfall in demand in India is not a positive sign for gold bugs seems logically based. In any event, those who play short term cycles may profit or lose, but for long-term investors, gold is one poor investment, one that history has well-established is a lost economic opportunity.

For those in difficult economic times who believe that gold is a safe haven for a feared econmic implosion, perhaps they do not understand that a total golbal economic collapse would destroy the value of all investment assets, including gold. Faith in the future is what life and investing comes down to.

Jan 05 09:49 AM

[Smarty_Pants:]

"the alarming pre-weekend announcement by the Bombay Bullion Association that gold imports into India, the world’s biggest gold consumer, fell 81% year-on-year in December 2008, as purchase orders through the complex gold chain (village-to-city) came to a virtual standstill. Indian gold imports for 2008 as a whole are estimated to have fallen by 47%."

Are those statistics showing a decline in ounces purchased or in money spent? One would assume ounces purchased.

Given that the price of gold stayed below $700/oz for 2/3 of CY2007 you might expect that a large number of people with modest incomes would be able to afford more ounces than they could in CY2008 when the price remained above $850/oz for 2/3 of the year.

If your income can only support a modest level of savings then one would expect fewer ounces of gold purchases at higher prices. Add in the effects of an economic slowdown and the reduction it might bring in the level of savings, plus higher gold prices, then even fewer ounces of gold would sell. That doesn't mean they have stopped buying what they can afford, only that what they can afford is fewer ounces at today's prices.

As far as pawning or selling of dowrys, that is a common practice in India as I understand it. Harder times would expect to increase the practice, but it happens just as much here in the US.

I am friends with a mom & pop jewelery store owner here in the US. He is seeing a very large increase in people selling their jewelry for the same reasons, to make ends meet. Not surprisingly, the amount he buys is directly proportional to the price. Lower prices restrict his buying to a trickle, even with today's near record price levels.

While such selling may provide a temporary surge in supply, there is a limit. People only have so much gold to sell and those who still have it will be more likely to wait for higher prices before they are tempted to sell.

What impact all that selling or pawning will have on the long term price level of gold remains to be seen. However, absent any clarification as to what 'falling imports' of gold mean (ounces or value?), the claim is slightly misleading. Higher prices would require lower volumes if the amount of money available to spend is relatively fixed.

Jan 05 10:54 AM

[Rakesh Saxena:]

Dear Smary_Pants: FYI only, the declines are in terms of ounces imported. Many thanks - Rakesh


On Jan 05 10:54 AM Smarty_Pants wrote:

> "the alarming pre-weekend announcement by the Bombay Bullion Association
> that gold imports into India, the world’s biggest gold consumer,
> fell 81% year-on-year in December 2008, as purchase orders through
> the complex gold chain (village-to-city) came to a virtual standstill.
> Indian gold imports for 2008 as a whole are estimated to have fallen
> by 47%."
>
> Are those statistics showing a decline in ounces purchased or in
> money spent? One would assume ounces purchased.
>
> Given that the price of gold stayed below $700/oz for 2/3 of CY2007
> you might expect that a large number of people with modest incomes
> would be able to afford more ounces than they could in CY2008 when
> the price remained above $850/oz for 2/3 of the year.
>
> If your income can only support a modest level of savings then one
> would expect fewer ounces of gold purchases at higher prices. Add
> in the effects of an economic slowdown and the reduction it might
> bring in the level of savings, plus higher gold prices, then even
> fewer ounces of gold would sell. That doesn't mean they have stopped
> buying what they can afford, only that what they can afford is fewer
> ounces at today's prices.
>
> As far as pawning or selling of dowrys, that is a common practice
> in India as I understand it. Harder times would expect to increase
> the practice, but it happens just as much here in the US.
>
> I am friends with a mom & pop jewelery store owner here in the
> US. He is seeing a very large increase in people selling their jewelry
> for the same reasons, to make ends meet. Not surprisingly, the amount
> he buys is directly proportional to the price. Lower prices restrict
> his buying to a trickle, even with today's near record price levels.
>
>
> While such selling may provide a temporary surge in supply, there
> is a limit. People only have so much gold to sell and those who still
> have it will be more likely to wait for higher prices before they
> are tempted to sell.
>
> What impact all that selling or pawning will have on the long term
> price level of gold remains to be seen. However, absent any clarification
> as to what 'falling imports' of gold mean (ounces or value?), the
> claim is slightly misleading. Higher prices would require lower volumes
> if the amount of money available to spend is relatively fixed.

Jan 05 12:00 PM

[mv1001:]

bocaj21 says: "For long-term investors, gold is one poor investment, one that history has well-established is a lost economic opportunity."

Price data show otherwise. If you had simply bought gold in 2000 and held, your average rate of return (in USD) as of the end of 2008 is 16.8% per annum. This beats most other investment vehicles. See James Turk's commentary at: goldmoney.com/en/comme...

Markets move in cycles. Capital rotates through stocks, real estate, and precious metals in sequence. When investing for the long term, you need to be aware of which cycle is in the bull phase. Gold and the precious metals are rising now. When they have topped out, sell and move to stocks or real estate.

Jan 05 12:54 PM

[Clavis:]

A good article, but we now live in extreme times so that history is not as relevent as previous, accepting the fact that the price of gold has been seriously manipulated and that the COMEX will be unable to meet 90% of it's commitments, as well as the vast derivative bill yet to come home to roost, let alone the true value of the US$ being 30 cents at best, we will see interesting times ahead for gold,

Jan 05 12:55 PM

[NOWHEREMAN:]

Clavis:

Will a default by the COMEX drive gold prices up or will the perception be that "even Gold cannot be trusted"?

Jan 05 02:16 PM

[Scared Stiff:]

Nowhereman-- I think you're confusing gold with gold-themed paper instruments. The great thing about ACTUAL gold is that there is no counter-party risk... a further reduction in the trust in financial institutions can only benefit the value of such an investment.

Jan 05 02:40 PM

[Roger Knights:]

I recall reading that most pawned gold in India is eventually reclaimed by the owner rather than going into the scrap / recycling bin. If so, this limits the impact of pawning on gold's price. (Were any statistics provided on the percentage sold vs. pawned?)

Jan 05 07:33 PM

[Rakesh Saxena:]

Dear Roger Knights: Good point on statistics. Informally, our research shows a 30-70 ratio (used to be 15-85 in earlier agricultural and festival cycles) but, as more numbers are gathered, my estimate is that amount of gold actually sold will rise quite dramatically. More on this issue later. Many thanks - Rakesh


On Jan 05 07:33 PM Roger Knights wrote:

> I recall reading that most pawned gold in India is eventually reclaimed
> by the owner rather than going into the scrap / recycling bin. If
> so, this limits the impact of pawning on gold's price. (Were any
> statistics provided on the percentage sold vs. pawned?)

Jan 05 11:59 PM

[anarchist:]

Gold is a great investment or a vehicle to lose more money than you ever dreamed, bulls and bears can show either cased depending on the time period. To make money speculating in gold, and let's face it-it is speculation) Ones timing has to be very very good.
The whole damn world is caving in financially and gold hit $1000/oz for a nanosecond and then collapsed-explain that to me? Some try and explain golds gyrations with strength or weakness of the dollar. If one compares uup (PowerShares DB US Dollar Index Bullish) against GLD there is a loose correlation but it's still a pretty thin argument.

Jan 06 12:45 PM