Gold was out of favor throughout this year, but in the last few days it has become the most punished commodity. The shining metal lost more than 12% in two trading days. The gold ETF (NYSEARCA:GLD) performed even worse, losing more than 14%. A sell off turned into panic when China GDP numbers were released. The GDP of the world's most populated country grew 7.7% on a year-to-year basis in comparison with a median forecast of 8%. It seems like that was the kind of news to trigger lots of sell orders from different people - the ones who lost confidence in gold and the ones who wanted to benefit from the decline of its price. When panic happens, and investors rush for their exits, it is important to preserve one's cool head. As the market clearly reacted on the China news, let's find out whether a 0.3% miss in GDP justifies such a drop in gold prices.
Most of the demand for gold comes from jewelry and investment (industry data according to Word Gold Council). Two other sources of demand are technology needs and central bank purchases. As for central bank purchases, China's officials stated that the country was not planning a significant increase in its gold reserves, so slower growth would not influence its gold reserve policy. We would concentrate on how slower economic growth in China could influence two major demand drivers - jewelry and investment.
Consumer demand for jewelry was 510.6 tons in 2012, down 1% from 2011 figures. The drop in demand is the result of higher gold prices in 2012. A similar trend showed itself in India, where there was a 10% drop. Indian consumers turned to be more price sensitive than Chinese consumers. Demand for jewelry in China is driven by urbanization and growth in disposable income. China is an under-urbanized country, and I do not see the process of urbanization losing momentum because of weaker than expected growth. The drop in gold prices could mean that a little more people would be able to afford jewelry. All in all, I do not see a potential threat from the jewelry side.
Let's proceed to the investment part of equation. In 2012, China's demand totaled 265.5 tons, up insignificantly from 2011 figures. What would happen to investment demand because of the slower economic growth? I think that lower prices could actually spur demand, and not diminish it. However, it could take time. In the last years, people saw gold either rising or trading in a range. Seeing gold falling, and falling fast, can put some fear into them and thus hurt demand for gold.
I think that news from China just came at the wrong time. Gold was trading below a multi-month support and everyone was ready to act on the bad news. But the news was not so bad at all. While the world is stagnating, such a big economy is rising 7.7%. This is a very good result. As China grows bigger, such speed of development would be harder to sustain. The miss gave life to fears that the speed of China's growth could decrease in the near term.
It is worth noticing that quantitative easing is somehow behind the scenes in the current environment. Governments are printing money. Currencies are fluctuating back and forth against each other because everyone does the easing. The role of gold as a traditional protection against inflation cannot be destroyed by bad economic news. It is true that no one has seen major inflation problems so far. In my opinion, this is because there is little to no growth in big parts of the world.
In my view, the recent news was not so disruptive to justify such a drop in the price of gold. As the market is in the state of panic now, I would not recommend buying gold or GLD immediately. Panic is irrational by nature, and it's hard to predict where the price would bottom. I think that the recent drop presents an opportunity to invest in the metal which has been loved by mankind for centuries. The actual entry price would depend on the price action, because short-term movements rarely rely on fundamentals.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.