Panic=Gold

It's axiomatic that gold has a role as safe haven for many investors. That this is largely a matter of collective psychology is irrelevant - it has worked for centuries, and it's unlikely to stop working tomorrow.

But lately, gold been more than a mere market hedge; it's been a panic hedge.

Current Gold

Gold briefly nudged over the $1,000 mark to $1006.43 on Friday, February 20, before settling back down to close at $993.25. It was the first time since last March that gold crossed the insignificant but satisfyingly round $1k level. Technical geeks would point out that it's still below the high of $1012.55 hit March 18^th, but that's splitting hairs.

Of course, gold didn't stay above $1,000/ounce for long last March; it quickly reversed course and traded down all year, before bottoming at $712.41 on November 20^th. Since then, gold has risen 39.4%; it was up 13.4% in January alone.

The last time I wrote about gold (Demanding Gold) was just before that November bottom. Back then I discussed the underlying demand for gold - because one of the great things about commodities is that ultimately, they're always about supply and demand. And with the gold-bug's most important supply and demand report out for 2008, it's the perfect time to revisit the subject. (The full link to the World Gold Council's Supply and Demand Statistics for Q4 and Full Year 2008 report is here.)

Looking At Demand

Gold demand can be broken into three main areas of interest - jewellery, which accounted for roughly 58% of identifiable demand in 2008, industrial and dentistry demand, and finally identifiable investment demand.

On the whole, gold saw demand grow 4% from 2007 to 2008, but the picture is a bit more complex than just that.

Not everything was rosy for gold in 2008. As we predicted, jewellery demand was down significantly. In 2007 around 68% of gold demand was attributed to jewellery consumption. In 2008, that number dropped to 58%.

At the end of December, The World Gold Council released a report entitled "What Women Want: Global Discretionary Spending Report 2008". In it, the WGC details the values and significance different countries attribute to gold jewellery and why people buy it. One new thing the study uncovered is that gold jewellery is now competing with items such as cell phones and other everyday items for discretionary spending.

The report also states that "confidence that gold will hold its value has waned," reflecting in part the volatility gold prices have experienced in the past year. With gold rising and falling by 30% in a single year, it's no wonder people are feeling less comfortable with it as a store of value.

Demand on the jewelry front appears to be price elastic. In India, the largest consumer of gold jewellery, demand in the fourth quarter more than doubled compared to Q4 of 2007. While this would seem to buck the year-long numbers, it's likely due to the fact that lower gold prices occurred precisely at the time of the Diwali festival - a peak gold-buying time in India. In 2007, gold prices were high during the festival, which depressed demand. For the full year of 2008, jewellery demand in India dropped 15%.

China was one of the only countries that posted an increase in demand for jewellery, up 8% from 2007. Much of this demand was for 24-karat jewelry, which commonly implies jewellery purchases that are doubling as investments.

The Big Stick: Gold Bugs

According to the World Gold Council report, gold demand for investment rose from 663.7 tonnes in 2007 to 1090.7 tonnes in 2008 - a somewhat staggering year-on-year increase of 64.3%. Retail investment - things like bar hoarding, official coins, medals/imitation coins and other kinds of retail investment - almost doubled, going from 410.3 tonnes in 2007 to 769.3 tonnes in 2008. That gives some credence to the wide scale anecdotal evidence throughout the year that gold coins were virtually impossible to obtain in many countries.

Exchange-traded funds and similar products also showed a large increase, from 253.3 tonnes to 321.4 tonnes (a 26.9% increase). This trend has continued into 2009. The SPDR Gold ETF (NYSE: GLD) - the largest physical gold trust - now has 1,028.98 tonnes in its vaults. This is a trust that started 2009 with 780.23 tonnes, meaning its gold horde has risen 31.9% in less than two months. To put that in perspective, 249 tonnes is over 10% of the total amount of gold mined in all of 2008. This acceleration happened almost entirely in a dramatic surge mid-February.

Net-net, however, if you offset the huge rush in gold investments with the significant drop in jewelry demand, the net gain in tonnage terms was just 4%.

There is, however, another way to look at things. When viewed through the (occasionally depressing) lens of the dollar, gold demand seems endless:

Gold Supply in Flux

With the demand part of the picture in hand, it's time to turn to supply. The third quarter of 2008 saw a huge supply deficit with demand far outreaching supply. In the fourth quarter, supply rose 19%, almost entirely due to an increase in gold scrap. Yes, that's right: Those late night commercials offering to buy your old tangled gold necklaces were on to something, and people were selling.

Scrap sales for 2008 ended up 17% higher than 2007, and that along with slightly higher total mine supply just about offset lower central banks sales so that in the end, 2008 ended the year with only 1% less total supply than 2007 - practically even.

The moral of the story is simple: supply and demand remain incontrovertible laws. The unbelievable demand vs. the stagnant (mine) and dwindling (central bank) supply created a vacuum, and a new source came on line to fill the need. Thus, at least indirectly, gold went from the scrap heap into brand new shiny gold coins, just when the market needed them the most.

Which brings up the question: how long can consumers fill their own demand through scrap? And what price level is needed to support the tremendous scrap levels already in place?

Comments

[Sakata:]

On Feb 25 08:09 AM The Mad Hedge Fund Trader wrote:

> >...

Don't you have anything original to say? That is the third or fourth time I have read the same word-for-word comment from you. Why not just provide a link to the original to save some time?

Feb 25 12:05 PM

[scotty1560:]

looks to me like countries are wisely using gold has a hedge, why not?

collapsing banks, trillions in spending, monetizing, who knows what is really
going on? Gold is rising form the ashes in it's oldest form and that is
safe haven. $1500-$2000+ should work given the fact that the old dow/gold
ratio is on a a steady march to 2/1. Two more years should finish the race.

Feb 25 07:42 PM

[know nothing:]

Based on the current price of gold, with so many forms of demand falling, it seems that if the economy picks up other forms of demand for gold would also pick up. So we may have achieved a new price range for Gold? Now lets throw in inflation, as a by product of a recession, along with the other forms of demand mentioned above and where do you see the price of Gold then? The down side seems to be very limited.

Feb 26 09:43 AM

[5142152-337:]

sakata...you are swiftly becoming a favorite poster here!

Feb 26 01:31 PM

[Gold Barron:]

Fiat currency and corrupt governments = Buy gold and silver

Feb 26 05:03 PM

[Bundee:]

Gold "reversed course and traded down all year, before bottoming at $712.41 on November 20th. Since then, gold has risen 39.4%; it was up 13.4% in January alone."

How many non ETF stocks can say the same?

We should also keep in mind part of the reason gold fell along with the stock markets-
hedge funds and traders needed to raise cash to cover their losing positions, so they sold gold for cash.
More sellers than buyers=lower gold prices.

Gold bounced back in price, the markets have not.
What does this tell us concerning market psyche, investors fears for the future (short, mid and long term) and the threat of recession or inflation?

Feb 26 08:42 PM

[auto44:]

The fact is that gold is a very rare and very noble metal and that is not psycology. To appreciate what gold is, is a civilized thought that has permeated the world greatest civilizations. Based on the worlds population the amount of gold per person is infintesmal. What it is worth this week or next I cannot tell,but I suspect it will retain it's purchasing power over the long run and therefore belive that a 10% position is prudent at this time with a large cash position of about 70%.

Feb 26 09:55 PM

[craigdude:]

WHAT EVENTS- SCENARIOS ETC. COULD CAUSE GOLD TO RETREAT TO THE $700'S? -----------I HAVE HEARD ALOT OF THEORIES ON WHY GOLD WILL CONTINUE TO RISE- AND i BELIEEEEEEVE THEM- BUT IT IS A COMMODITY- AND COULD RISE AND FALL JUST LIKE ALL OTHER COMMODITIES- TO QUOTE JIM ROGERS---- THE FUNDAMENTALS SEEM TO SUPPORT HIGHER PRICES BUT----- AS I BELIEVE GOLD CAN BE MANIPULATED BY GOVERNMENTS GOLD LEASING AND SELLING- WHAT COULD BE THE SIGNS GOLD WILL GO WAY DOWN? I CERTAINLY WANT TO GET OUT IN TIME- ( SO I CAN BUY BACK IN AT A LOWER PRICE)

Feb 27 09:40 AM