Commodities | Jul 14 2006
By Greg Peel
According to the World Gold Council, of all the gold the world has produced since 1950 – some 155,500 tonnes – 52% of it has ended up as jewellery. 12% has been put to industrial use, mainly in electronics, 16% is held in investment form and 18% is held by central banks. Only 2% is unaccounted for – gold is rarely "consumed".
The average demand flows for gold over the period 2001-05 broke down into 11% industrial, 12% investment and a massive 77% jewellery.
We can argue all day about whether gold is a currency, a commodity, or an asset in either case, but at the end of that day one conclusion is inevitably reached and that is gold is manly coveted for its prettiness, and for flaunting purposes.
This doesn’t mean that a purchase of gold jewellery cannot be considered an "investment" as well. In fact, between 2001 and 2005, 16% of world gold sales were jewellery resales, compared to 62% of newly mined metal.
A great deal of gold jewellery, however, is produced for cultural reasons. Wedding "seasons" in the likes of India and Turkey are inexorably linked to requisite jewellery purchases, which places a lot of pressure on the average Joe Citizen in Mumbai or Istanbul who might find the obligation a bit of a stretch.
Suffice to say, when the gold price rises, jewellery demand falls. When gold shot up through US$700/oz recently there was a noticeable drop in jewellery demand and hence purchases of gold for jewellery purposes. Given the price, however, the dollar value of purchases still grew slightly. A volatile gold price had an adverse effect as well, with jewellery makers retreating to the sidelines until a clear price trend became visible.
Outside of cultural expectations, jewellery demand in, for example, the US is subject to price-based substitution, such that when the gold price rises other metals such as silver, platinum or palladium might be preferred. Of course all those prices have risen lately, which may well suggest precious metal demand for jewellery purposes will fall collectively in volume terms, if not in dollar terms.
While the advent of gold investment instruments, particularly exchange-traded funds, has been credited with pushing the gold price to recent highs, there must also be a dampening effect as demand for jewellery subsides. The question then becomes: will investment pick up the balance?
GFMS reports that at a recent London Bullion Market conference 65% of delegates considered gold to be an asset class. The three major drivers of the gold price in the next three years were agreed to be the US dollar, inflation (those two are linked) and world tensions. These factors suggest actual jewellery demand will not be critical.
The World Gold Council believes gold exchange traded funds have only seen the beginning of their demand. There are now some 500 tonnes of gold being held through ETFs, and the WGC can only see this figure growing as more and larger public managed funds begin to accept the instrument as investment grade. (Why Gold Will Break All Records, 11/07/06).
GFMS points out that the amount of gold held in commodity indices and non-indices (ie "paper" gold) is US$110bn. This is the short term trading market. It represents 35% of that held in ETFs (considered long term) and only 5% of last year’s fabrication holdings (which includes bar form). By comparison, the capitalisation of Microsoft is US$238bn.
It is this sector of the market that makes the gold price volatile, as we witnessed over May. Nevertheless the bulk of gold investment is there for the long haul, which is why the gold price is usually not that volatile.
Most gold observers are tipping gold to breach its US$850/oz highs within the next couple of years. To do so, the demand for gold as an investment will have to seriously substitute for jewellery demand. However, such a substitution makes sense, as prior to the advent of ETFs and other vehicles, jewellery purchase (and this includes coin and bar) was one of the primary means of gold investment, wedding purchases notwithstanding.
Then there is the supply side to consider. In a report today, JP Morgan analysts declared "Despite jewellery demand sensitivity to higher gold prices we remain more positive on precious metals than we do on base metals. If the momentum of Central Bank selling slows, gold mine supply will not be able to respond quickly enough to even a slow growing jewellery demand that comes from higher gold prices".