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Clyde Russell

CONTRIBUTOR > Two of gold price’s three legs look wobbly

Clyde Russell

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If you want to know why the gold price has stagnated in the past few months, look no further than the World Gold Council’s latest report that shows demand is at its lowest in more than two years.
In fact, so rapid has been the decline in gold demand since last year’s record price in September that if there is a surprise, it’s that the price has held up as well as it has.

Since the start of the second quarter, gold hasn’t been above $1,680 an ounce, but it also hasn’t dropped any lower than $1,527 and the current price around $1,603 is around the mid-point of its recent range.

This price stability happened despite a slump in second quarter demand to 990 tones, the first time it’s dipped below the 1,000-tonne mark since the first quarter of 2010.

Demand is down 10 percent from the first quarter and 7.1 percent from the same quarter last year, according to the council’s quarterly report released on Thursday.

If the pattern of the first half of 2012 is repeated in the second half, demand would total about 4,180 tonnes, down a significant 8.6 percent on the 2011 figure.

However, gold demand has now weakened for four consecutive quarters, so assuming that it will hold steady in the second half may be a touch optimistic.

For gold to resume its upward trend, a few things will have to happen, and while these are possible, they are perhaps less likely now than they were a few months ago.

The first is for the European sovereign debt crisis to ramp up again, causing a flight to the safety of gold.

The next is for major central banks, and the U.S. Federal Reserve in particular, to launch further quantitative easing, thereby debasing the value of paper currencies.
And the third, and to my mind most important, is that physical demand in India and China will have to increase.

Demand in the two top gold buyers is largely linked to wealth levels, with people buying more gold if they feel household finances are in strong shape.

This is particularly true in India, but even in China gold is commonly bought as an investment only when inflation is seen as a concern, something that is definitely not now the case.

India’s gold demand dropped to 181.3 tones in the second quarter, down a massive 38 percent from a year earlier and 13 percent from the first quarter.

The imposition of a new tax, the weakening rupee and slower economic growth combined to slug Indian demand, and while it’s possible these factors may reverse in the second half, it’s unlikely.
Even assuming India’s gold demand remains steady in the second half with the first, the annual total would be about 778 tones, 19 percent below last year’s 961.4 tones.

That’s a loss of about 184 tones in gold demand, which can’t be offset by China’s likely increase in consumption.

China’s demand was 144.9 tones in the second quarter, down a huge 43 percent from the first quarter and a stake through the heart of gold bulls who believe China will ride to rescue of the yellow metal.

If China’s second-half demand matches the first, it will total about 800 tones for the full year, only 29 tones more than it did in 2011.

With inflation down at an annualized 1.8 percent, the gold price marooned and slower growth in the economy, it’s hard to see why Chinese demand should rise dramatically in the second half.

Without these two major buyers underpinning the physical market, gold will find the going tough.
With the benefit of hindsight, it seems the rally to last year’s record high was built on three factors combining at the same time.

These were widespread fears of a collapse in the eurozone coupled with quantitative easing hopes, significant central bank buying and the economic situation in India and China being strong enough to support solid jewellery demand as well as investment demand from inflation fears.

Inflation has gone from the agenda in India and China and both are suffering from slower growth.

While a collapse in Europe is still possible, it’s definitely less likely now than it was toward the end of last year and in the first half of 2012.

Quantitative easing by the U.S. Fed and other major Western central banks is also still a possibility, but again is looking less likely.

That leaves only central bank buying as the major pillar holding up gold, and indeed it has remained strong, rising to 157.5 tones in the second quarter from the 96.7 tones in the first.

If this continues apace in the second half, official sector purchases could reach more than 500 tones, exceeding the 457.9 tones of 2011.

But is this enough to provide support to the gold price, especially if Indian demand drops by about 180 tones?

I would think not. Therefore the risks to the gold price have to biased to the downside until Chinese and Indian demand regains momentum and/or Europe’s debt crisis reignites

August/18/2012

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