Rebound of Physical Gold Demand in Third Quarter justifies Recovery of Gold Price

Rebound of physical gold demand in third quarter justifies recovery of gold price

In earlier issues of Goldletter International, I warned that the boost in the gold price in the first half of the year from $ 650 mid-year 2007 to a record level of $ 1,030.80 at March 17th, 2008, an increase of 57% was not justified by physical fundamentals.

While investors were mislead by pronouncements of so-called professional gold experts from leading investment houses and major gold companies, preaching to the converted by predicting that the gold price would bounce back to a level of $ 1,000 in the current fourth quarter, they have been punished for their unbridled imagination,
based on the gold price having reached an interim low of $ 692.50 on October 24, representing a fall of 33% since its 2008 high.

What counts is the ability to recognize the difference in impact of fundamental and external factors on the gold price in a right way.

Factual data speak for themselves. Because of its price sensitivity, the booming gold price in the second half of 2007 and the first quarter of 2008 severely affected jewellery and retail investment demand, resulting in a decline of gold demand in the first half of 2008 of 23% to 1,125.4 tonnes from 1,466.3 tonnes, compared with the corresponding period in 2007.

Most notable was the fall in total consumer demand (jewellery and net retail investment) in India, being the main driver in demand in the last few years, from 498.3 tonnes for the first six months of 2007 to 263.5 tonnes in the first half of 2008, a decline of 47%, thereby showing an unexpectedly high price sensitivity enhanced by the country’s economic growth dampening.

A positive note is that over the last couple of years Exchange Traded Funds (ETF’s) have emerged as a meaningful component of gold demand, but accounting for 9% of total demand only.

Having contributed 260 tonnes and 253 tonnes in 2006 and 2007 respectively, also ETF’s have been showing strong price sensitivity due to the dramatic increase of the gold price since September 2007.

With demand for ETF’s fluctuating strongly, the third quarter of 2008 showed record sales of 150 tonnes compared with 139 tonnes in the corresponding period of 2007 and a mere 4 tonnes in the second quarter of 2008. ETF’s set a new record of 1,130 tonnes of gold held at the end of October 2008.

Apart from the fall in overall gold demand in the first half of 2008, gold investors shouldn’t be mislead by overstatements on the impact of net retail investment demand on the gold price as it represents 17% of total demand only, compared with a robust 61% represented by jewellery demand.

Looking at the impact of external factors on the gold price, the sub-prime mortgage crisis having turned into a global financial crisis and having extended to a credibility crisis having a direct impact on the world economy, was supposed to create a perfect storm for gold. This was undoubtedly the main driver for more than 90% of
all gurus to predict an early return of the gold price to a level of $ 1,000.

The negative performance of gold is even more painful for gold bulls, if considering the strong recovery of the dollar against the euro, which touched a low of $ 1.59 in March and June, compared with a current exchange rate of $ 1.26, an increase of 26%.

Also based on a longer term, against both the euro and the US dollar index, weighted 57.6% in euro’s, 13.6% in Japanese yen, 11.9% in Swedish crones and 3.6% in Swiss francs, the dollar has substantially recovered from its negative performance since the introduction of the euro on January 1, 2001, at which time the dollar
was valued above par against the euro.

The current exchange rate of $ 1.26 against the euro equals the level at year end 2003, and had been even higher at $ 1.18 by year end 2005, before it dropped to a low of $ 1.59 in March 2008, followed by the above mentioned recovery.

Related to the US dollar index, since this index went up in 1995 from a long term resistance level of 80 to a high of 120 in 2001, at the time the euro was introduced, it dropped to a low of 72 in March of this year, but followed by an upward correction to 87, well above the historic resistance level.

US Dollar Index from 1986, and 200 day exponential average in red, 200 day rate of change (ROC) green

Since having already observed in the August-issue of Goldletter International that gold was losing its lustre as a safe haven, in the October-issue, I questioned whether the dollar had become a better safe haven in a period of turmoil on financial markets than gold.

Like I already indicated many times earlier, there are no options available to replace the dollar as the world’s key currency. Of all transactions in the global financial markets, commodities markets and also including merger acquisitions, two-third is accounted for in dollars. The dollar’s key role has even been extended by government rescue and stimulus packages for an aggregate amount of up to initially $ 2,000 billion to be effectuated in dollars.

In summary, this means that as long as the financial crisis is not under control, and even more so confidence in the financial markets is not restored, the dollar will be able to benefit from the currently prevailing situation. Also, the dollar is supported by the ongoing accumulation of monetary reserves in Asia and the Arab world, having benefitted from a strong increase in trade balance surpluses in the last five years, led by China.

Since having entered the World Trade Organization by the end of 2001, in less than seven years China has accumulated monetary reserves of $ 1,900 billion (of which only 1% is held in gold), while the size of Sovereign Wealth Funds has expended to $ 3,000 billion.

These data actually show that the initial impact of the financial crisis was still manageable until in the second week of October when it culminated in a confidence crisis threatening the real economy of all countries in the world. This was reflected by world stock markets shedding $ 6,200 billion or 20% of their value in the week of October 3-10, and more than $ 12,000 billion since the beginning of the year.

Gold demand in third quarter reverses negative trend

Comparing half year data with data over the third quarter of 2008, as published by the World Gold Council in their November-2008 issue of “Gold Demand trends” (www.gold.org), based on data from GFMS, gold demand in tonnage terms rebounded strongly in the third quarter after several quarters of weakness.

Identifiable demand totaled 1,133.4 tonnes in the third quarter, up 170.1 tonnes (18%) on the levels of a year earlier. In US$ value terms this represented a 51% rise to $ 3.8 billion, an all-time record high and a 45% leap from the previous record set in the second quarter.

The biggest contributor to the increase in total identifiable demand in the third quarter was net retail investment, up 127.0 tonnes (53%) to 232.1 tonnes relative to year-earlier levels, representing 34% of total identifiable gold demand.

Jewellery demand rose 45.5 tonnes or 8% to 647.6 tonnes of 57% of total identifiable gold demand, while industrial and dental demand declined 6.5 tonnes or 1% to 103.7 tonnes, representing 57% and 9% of total identifiable gold demand, respectively.

Driving the improvement in identifiable investment were bar hoarding, up 41.3 tonnes (69%) to 100.9 tonnes, official coins, up 23.0 tonnes (60%) to 61.2 tonnes. Medals/imitation coins were up 2.7 tonnes (15%) to 21.0 tonnes.

Other identifiable retail investment improved 60.1 tonnes from 11.0 tonnes negative in the third quarter of 2007 to 49.1 tonnes.

ETF’s and similar products were up 10.5 tonnes or 8% to 150.5 tonnes, representing 39% of total identifiable investment.

Gold demand in first nine months 4% lower

Looking at demand in the first nine months of 2008, in spite of the strong recovery in the third quarter, total demand was still 4% lower than in the corresponding period of 2007.

Jewellery consumption declined 12% from 1,829.8 tonnes to 1,603 tonnes, representing 61% of total demand. Industrial and dental demand declined 7% from 350.8 tonnes to 326.8 tonnes, 13% of total demand.

Identifiable investment showed a substantial increase of 30% from 516.8 tonnes to 670.3 tonnes, representing 26% of total demand of which net retail investment showed an increase of 29% from 343.4 to 443.6 tonnes.

Most of the increase of net retail investment cane from identified retail investment other than bar hoarding, official coins, medals/imitation coins, showing an improvement of 80.7 tonnes from minus 41.3 tonnes to 39.4 tonnes.

This category reflects the impact of western institutional investor activity in the secondary retail investment market.

GFMS also publishes data for Inferred investment which is the residual from combining all the other data in the table. It includes institutional investment other than ETF’s & similar, stock movements and other elements, as well as any residual error.

In the third quarter and first nine months of 2008, Inferred investment was 296.8 tonnes negative and 164.2 tonnes negative, respectively, compared with 40.6 tonnes negative and 222.8 tonnes negative in the corresponding period of 2007, respectively.

These data show the big impact of Inferred investment on total demand. This makes the specific data of total investment demand less transparent.

Gold supply in first nine months unchanged

In the first nine months of 2008 total supply at 1,474 tonnes was just 3 tonnes higher than in the corresponding period of 2007. A 52 tonnes (3%) lower mine production at 1,791 tonnes was offset by a decline in net producer dehedging of 56 tonnes.

In the third quarter of 2008, total supply at 858.0 tonnes was down 10% on year-earlier levels. This largely represented a significant reduction in official sector sales from 178 tonnes to 23 tonnes, partly offset by lower levels of producer dehedging (63 tonnes against 82 tonnes) and an increased ion scrap to 244 tonnes from 215 tonnes in the corresponding period of 2007.

Lower gold production reflects a further decline in South Africa’s output, including a 6 months shutdown at the main shaft at Goldfield’s Kloof Mine, and a decline in Indonesia, which was in part attributable to the pit wall failure at Freeport McMoran’s Grasberg Mine.

Gold production in the first nine months of 2008 also reflects a further shift from traditional countries to emerging countries, demonstrated by an increase in production in China and Peru.

According to data published by the “Fortis hedging and financial gold report”, global hedging continues to contract rapidly. The delta-adjusted global gold hedge book fell 2.3 million ounces (72.3 tonnes) in the third quarter of 2003, leaving outstanding hedging at just 16.5 million ounces (512.1 tonnes).

This compares with 29.1 million ounces a year ago, and 41.5 million ounces at the end of the third quarter of 2007.

Barrick Gold was the largest dehedger in the period under review, converting 1.0 million ounces of fixed price contracts into floating price contracts. Next largest was AngloGold Ashanti, who closed out 0.6 million ounces through a combination of delivery of mined gold into maturing contracts and early buybacks.

With global hedging having fallen 10.3 million ounces in the first nine months of 2008, Fortis expects it to be likely that full year dehedging will still be in or slightly above their earlier forecast range of 10-12 million ounces, as fourth quarter dehedging will slow sharply.

A 5% decline in the gold price in the third quarter, and the continuing reduction in the size of the hedge book improved the market-to-market valuation of the global book to negative $ 7.6 billion, $ 1.8 better than arevised negative $ 9.4 billion at the end of the second quarter of 2008.

In 2009, Fortis expects a continuation of modest dehedging, with perhaps 1 million ounces a quarter. However, it is almost impossible to predict turning points, and the possibility of both much higher and much lower dehedging – or even en increase in hedging – can not be discounted.

Looking at the trend in old gold scrap, it should be noticed that this is recycled gold from earlier fabrication demand. As such, it also offers a price sensitivity with supply increasing at higher gold prices and decreasing at lower gold prices.

With the rebound of gold demand in the third quarter, signalling a new buying momentum, and the fall of the gold price being excessive, the last few days the gold price has recovered to my earlier predicted resistance level at $ 810 – 830.

If the upward trend in demand can be maintained in the fourth quarter, I expect a further price increase to $ 850 – 860 within the next few months.

From an external point of view, the question is what the impact will be of the change in fear for inflation, at the time of the energy and food crisis, up to just three months ago, to the current fear for deflation, resulting from the financial crisis.

While the price of gold is supposed to benefit from higher inflation, it more than doubled in price in the period of 2001 – 2006 when inflation was still under control.

Also, with the threat of an energy and food crisis not having just disappeared, and the oil price under $ 50 oversold a recovery as expected by m e, would also be a stimulus for a higher gold price.

With the rebound of gold demand in the third quarter, signalling a new buying momentum, and the fall of the gold price being excessive, the last few days the gold price has recovered to my earlier predicted resistance level at $ 810 – 830.

If the upward trend in demand can be maintained in the fourth quarter, I expect a further price increase to $ 850 – 860 within the next few months.

From an external point of view, the question is what the impact will be of the change in fear for inflation, at the time of the energy and food crisis, up to just three months ago, to the current fear for deflation, resulting from the financial crisis.

While the price of gold is supposed to benefit from higher inflation, it more than doubled in price in the period of 2001 – 2006 when inflation was still under control.

Also, with the threat of an energy and food crisis not having just disappeared, and the oil price under $ 50 oversold a recovery as expected by me, would also be a stimulus for a higher gold price.

CONFERENCE AGENDA

2008

December 2 – 3                                  Mines and Money London 2008 *

2009

January 18 – 20                                  Mena-Ex,  Jeddah, Saudi Arabia *

February 9 – 12                                 INDABA , Capetown, South-Africa

March  1 – 4                                       PDAC Toronto, Canada

March 27 – 29                                    Asia Mining Congress, Singapore *

* with Goldletter International as Media Partner

Marino G. Pieterse,
editor Goldletter International

***

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