The Hindu Business Line : Despite weak demand, funds push up gold

DESPITE lower supplies (down 9.2 per cent) and higher demand (up 11.2 per cent), the global physical gold market returned to a surplus in 2005. With supply aggregating 3,997 tonnes and demand estimated at 3,770 tonnes, the market had a surplus of 227 tonnes compared with a 78- tonne deficit in 2004, states a GFMS (Gold Fields Mineral Services) report.

Among the highlights of the report were a 40.8 per cent year-on-year increase in official sector sales (663 tonnes versus 471 tonnes) and a deceleration in jewellery demand growth — down to 4.4 per cent in 2005 from 11 per cent the previous year.

A major part of the official sector sales originated from European central banks that signed up to the second Central Bank Gold Agreement (CBGA), under which institutions were entitled to dispose of a total of 500 tonnes of gold per year. In addition, there was also some selling from central banks outside the CBGA.

Experts said deceleration in demand growth from the jewellery sector was not a big surprise, as this segment had arguably the most price-elastic consumers. In countries with a huge appetite for the yellow metal such as India, demand for gold is clearly price-elastic and income-elastic.

In addition to rising prices, consumers' uncertainties eventually impacted demand.

A quarterly breakdown of consumption figures showed that gold buying fell sharply as prices resumed their upward march in the second quarter of 2005. By the last quarter of the year, demand dropped 13 per cent year-on-year as the metal averaged $517 an ounce.

No wonder the sharp fall in jewellery demand was driven by India, traditionally the biggest consumer of gold jewellery. Demand that had grown 67 per cent or by 156 tonnes in the first half, fell by 39 per cent (91 tonnes) in the second half of the year.

The weakening rupee vis-à-vis the dollar added to domestic price strength.

However, what is becoming increasingly clear is that the world gold market is no more driven by the physical market conditions.

Rather, financial markets and macro-economic fundamentals, including inflation concerns, and geo-political factorsimpact gold prices.

A significant part of the gold price rise in the second half of 2005 was driven by Japanese investors as evidenced by a strong rise in open interest at the Tokyo Commodity Exchange.

In recent years, global liquidity has been the most crucial price driver.

There are also reports, unconfirmed though, that China's central bank has been active in buying gold as part of its asset diversification plan.

Given that among the big three economies (the Euro zone, Japan and the US), only the US has a significantly tightened monetary policy, there is upside potential for gold prices, according to Macquarie Research Commodities.