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Executive Summary

The gold market is undergoing radical change with investments in Europe and US taking a lead over the traditional market – Jewelry in India. While Indian Jewelry is still the world’s biggest consumer, the market seems more diverse now. The Gold ETF (NYSEARCA:GLD) has become the biggest market mover and there has been heavy demand for coins and bars. If this fundamental change in consumer/investor choices continues, Gold could see a significant upward movement in price in the short to medium term, and even a $1200/ounce is likely. It remains to be seen how this change in behavior would continue after the end of this crisis (in 3-5 years). If it is a permanent change, it is good for the gold industry as it gives a far wider/diverse base and removes the quirkiness associated with Indian marriage seasons and domestic economy.

Indian consumption is the only bright aspect in the Jewelry scene, as Jewelry consumption of rest of the world has gone down the toilet. This is most likely due to the fact that the world recession has not come to India so far. However, Jewelry consumption could significantly tank once the reality sinks in and Indian market goes faces economic winds.

In October 2008, when gold was below 700, I claimed that the metal will significantly go up. And go up it has. But, I am moving to a neutral territory now. My personal opinion is that $1000 is a good price for gold in the current scenario, but if there are new surprises from financial markets, then we should cross $1200. Once the crisis is over and when people start getting out of gold to stocks and homes, gold could fall to the sub-700 range. In short, it is still a good investment for short to medium investors, and long term investors might want to book profits now at around $950-1000.

Investment

  1. One of the biggest Individual gainer is the Gold ETF – GLD (Figure 2). It has more than 1000 tonnes of gold in its management and has become a great market mover of the underlying (it is now the tail wagging the dog).
    • Since the start of Jan 2008, GLD has had a more substantial lead in gold holdings than similar ETFs (Figure 3).
    • Gold Investment in Europe has skyrocketed (by over 10 times) in the 2008. Europe is now the biggest net retail investor in gold, while Vietnam and US were leading this space till 2006 (Figure 5).
    • In the US, gold investments declined in 2007 from 2006 and then strongly rebounded in 2008. Now, over 75 tons are consumed for investment purposes in the US (Figure 5).
    • More people are buying gold for investment purposes than for other consumption (Figure 4).
    • Bar and coin sales have grown more than twofold since last year, while sales of Jewelry (biggest consumer) went down 6% (Figure 1).

Consumption

    • While Gold prices were choppy in 2008, measured in Dollars, gold prices were more stable and smooth than measured in Euros (Figure 0).
  1. India is still the world’s biggest consumer at 147 tons in Q4, followed by China, Europe and the US (Figure 6). It had briefly ceded its lead to the US last year and now got it back with a bang. It consumes 21% of world gold.
    • Indian Jewelry consumption more than doubled in Q4 2008 compared to Q4 2007, while for Turkey it went down by 57% (Figure 6).
    • The US exports far more gold than it imports (Figure 8).

Production

  1. The US is the world’s third biggest producer (230 tons) following South Africa and China (Figure 7). Mining employed 9200 in 2008 and the US produced close to 10% of world mine production.
    • US production dropped nearly 10% since 2006 (Figure 8).
    • Official sector sales dropped over 27% – maybe the Central banks are hoarding gold now (Figure 1).

Analysis

Gold has been pretty choppy in 2008 with an uncharacteristic volatility. The main reason for it has to do with the US Dollar. Gold and the dollar have an inverse relationship, and the USD went for a ride last year. However, if you measure Gold in Euros, 2008 was not volatile at all, and you can see a more smooth curve in there that is growing upward. While 2008 movement was due to a weaker dollar, now gold has started to become a bet against all currencies in anticipation of a major crisis forcing people to shift to Gold and Treasuries. So, in a sense the gold-dollar relationship of last year has reversed.

The market has fundamentally changed from one that is highly dependent on Indian Jewelry demand to a market now dependent on more markets with a renewed interest for bars and coins in Europe and the US. While it is not clear if it is a permanent consumer change of heart or a reflexive reaction from collapsing markets, this is a very bullish market for gold. Now, the gold market need not fluctuate seasonally with the Indian marriage season. This is a very important point.

Figure 0: Price of Gold in different currencies


Supply Characteristics

The central banks have dramatically reduced their sales (-27%) and bar and coin sales have grown by 247%. Mine production is almost unchanged at ~630 tons/year, while there is a significant bump in old gold scrap. It is pretty likely that people are bringing up junk and cashing in on the bullish markets.

Figure 1: World Gold Supply and Demand Statistics

A. Supply and Demand

image

Demand Characteristics

It is interesting to note that electronics and industrial usage has come down. Either they have made significant technological progress to reduce the need for gold in their manufacturing processes, or it is an indicator for a fundamental demand collapse in world markets for those products. It is bad for the global economy, but for gold it is not that much of a problem given that they consume a small portion of annual consumption. World mints are running out of coin supply as consumers and investors are pounding them to get a hand at the most secure thing in the world. Jewelry sales have come down a bit, and are more of an indicator that consumers are tightening their belts in US, and there are some fundamental alterations in consumer trends in India, where many girls prefer platinum these days. It has not impacted gold sales in India that much, but is of concern over the long term.

B. Demand Breakup

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Source: World Gold Council

Gold ETFs

The world’s biggest Gold ETF fund (to keep it simple, assume that it buys gold for its warehouses and sells shares on its store) has been seeing a huge increase in their assets. Holding gold as an ETF is the most cost effective thing, as trading costs are very minimal and you don’t need to worry about assaying and value estimation, security, etc. While the “end of the world” pessimists might be reluctant to use an ETF for their most secure investment, for most practical investors this is the way to go. It might make some sense to have gold in bars and coin for emergency situations. GLD is the most heavily traded ETF and it has been buying gold in gobbles and now hold more than a 1000 tonnes of gold (worth about 30 billion USD).

GLD’s asset increase has coincided exactly with the increase in gold price and thus it is reasonable to assume that Gold is mainly moved by this ETF.

Figure 2: Gold holdings in the ETF - GLD

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Source: The mistake that Greenspan made

GLD has also gained a significant lead on other ETFs over the last 12 months. However, the ratio of GLD to other ETFs has remained closer to 3:1 range it started out in 2005. GLD has a significant advantage that its size offers the ETF a lot of liquidity and it has plenty of options for the traders to play with.

Figure 3: Holdings of GLD vs. Other funds

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Source: World Gold Council

Long-term Demand Trends

Jewelry usage has decreased drastically in the past 10 years by over a third, from about 3000 tonnes to 2000 tonnes now. Industrial usage has remained constant and investment usage has dramatically increasec by over 10 times from 2000 levels. The gold demand in dollar terms has been steadily on an upward slope since 2001.

Figure 4: Trends in gold demand

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Source: World Gold Council

The striking thing about the demand is the one happening in Europe. Europe’s investment usage has gone up from nowhere to the top of the world at 175 tonnes last year. It indicates that the Europeans are more uncomfortable with economic conditions than their counterparts in US, China and other countries. Vietnam’s lead in the investment space has dwindled in the past 2 years, and China is again going on an upswing in investments. US investment demand went up from negative 20 tonnes in 2000 to over 100 tonnes last year. In 2000 when the economy was at its peak and prices of commodities at the bottom, people were essentially bearish about this previous metal.

Figure 5: New markets sprouting for Gold Investments

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Source: World Gold Council

Country-consumption statistics

India, as expected, leads the space. It consumed nearly 21.3% of world gold in Q4 and it has regained back its lead from the US. China, Europe and US for the next 3 big markets. Indian Jewelry shows a significant upswing while Jewelry consumption in many other countries are facing deep downturn – most notably in Turkey, the US and the UK. This is partly due to the fact that the world recession has not come to India in a big way so far. But this could change and Jewelry could be deeply hit.

Figure 6: County-wise consumption

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Source: World Gold Council

Production Trends

China is the production leader followed by South Africa and the US. Australia and Indonesia had a sharp drop in production last year. Overall, there is a slight drop in mine production.

Figure 7: World Mine Production and Reserves (in metric tons)

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Source: US Geological Survey

US mine production has been on a downward trend since 2004. Scrap metal refining is on a upswing and exports have dramatically increased. In the last couple of years, the US has turned from a net importer to net exporter. Its biggest importers include Canada and Peru.

Figure 8: US production and import statistics

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Source: US Geological Survey

Related Articles

1. http://econjournal.com/2008/11/25/historic-gold-silver-oil-prices-and-their-relationships/

2. http://econjournal.com/2008/11/06/whats-happening-with-gold/

Source: How Will Radical Change in Gold Markets Affect Gold Prices?