Commodities | Jul 18 2013
-Jewellery demand supports gold price
-Chinese buying significant
-Shortage of gold scrap
-Will demand push price back up?
By Eva Brocklehurst
Demand for gold jewellery features in the cut and thrust of the world's gold markets, perhaps more than at assumed. Of note, Chinese consumers have bought a lot of gold jewellery in recent months. Were they seeking bargains in the expectation prices might go back up? Macquarie observes demand so far this year has been higher than last year and that has cushioned the significant drop in the gold price. Some of the increased demand may, more or less, be permanent but a slowing Chinese economy won't help.
What is significant to Macquarie is the high level of Chinese yuan expenditure in gold jewellery. This has been underpinned by some factors which could be weakening. They include reduced Chinese GDP growth and, within that, private consumption growth. Macquarie has reduced the Chinese GDP growth forecasts to 7.9% and 7.5% respectively for 2013 and 2014, from 8.8% previously.
An important feature this year has been a rising market share of gold jewellery in Chinese retail sales, which have been up strongly across the economy in nominal yuan terms. The gold and silver jewellery percentage of retail sales rose to a high of 1.7% in April. One reason has been new store openings and other changes at the retail level. Such changes should entrench some of the gains. Where the increase in market share of retail sales has been the result of the falling price of gold, anticipatory buying and bargain hunting may evaporate when the price turns higher. Indeed, Macquarie observes the market share of gold and silver jewellery has eased back to 1.3% of total retail sales in May and June and, although this may be seasonal, it could be indicative.
China's other uses for gold, as investment mainly, have increased even faster than jewellery. This tells us there is an underlying appetite for gold and, without it, gold's price fall may have been more dramatic. Nevertheless, there may come a point where the jewellery market is saturated and the price will hit a point that pushes demand down. Standard Bank suspects US$1,300/oz may be the level. The precious metal is edging back to US$1,300/oz but it could encounter resistance here.
Recent trends indicate to Standard Bank that physical demand from China will ease if the price gets above US$1,300/oz. This trend in demand is runs parallel with the physical premiums on the Shanghai Gold Exchange. The premium for gold on the exchange was generally below US$10/oz until mid April, when gold fell to US$1,400/oz. At that point the premium rose to US$20/oz when demand jumped on lower prices. With gold moving to well below US$1,300/oz in June physical demand increased even more, and the premium rose above US$30/oz.
JP Morgan points out that physical gold prices have now fallen enough for there to be a significant shortage of scrap. This factor has been widely overlooked. Lower prices are reducing scrap availability. Scrap has traditionally accounted for at least a quarter of the global supply that meets annual physical demand. The analysts have canvased a number of refiners which report they are now struggling to acquire sufficient scrap feedstock to meet orders. The supply shock will ease, if gold prices rise enough to push the required metal into the market. This highlights the paradox that is gold. Miners are suffering from cost explosions and reduced cash flow in the wake of the falling price. Of note, JP Morgan has trimmed gold mine production forecasts by 1.7m ozs for 2013.
Meanwhile, on the demand side, Asian retail investors have responded aggressively to the lower prices. Chinese gold imports from Hong Kong from November 2012 through to May 2013 amounted to 26.7 million ozs, 1.8 times larger than the quantity from the same period in the prior year. This quantity is the equivalent of 18.4% of gold physical demand in all of 2012. From this evidence, JP Morgan concludes that the spot price of gold is likely close to a bottom in the current correction. The average spot price is projected to rise from US$1,275/oz in this quarter to US$1,400/oz by the June quarter of 2014 and US$1,450/oz by the end of 2014. Along the way volatility will be substantial.
JP Morgan projects global jewellery sector demand growth of 4.2m ozs in 2013, increasing in 2014 and 2015. Rising incomes in emerging markets and the appreciating yuan relative to the US dollar are underpinning this view. Moreover, developed market jewellery demand is seen stabilising. Countering this, JP Morgan expects overall gold demand will decline in 2014 and 2015 as investors sit on purchases and sophisticated investors return to more liquid investments such as Exchange Traded Funds, for gold exposure.
Fasten your (gold-plated?) seatbelt. It's going to be a bumpy ride.
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