The new gold rush

One question that gold investors are asking now is, will 2017 be as spectacular for the yellow metal as 2016? The short answer to this is no.

The short-term outlook for gold is grim, with the Federal Reserve likely to effect the second rate hike in December, with falling consumption demand for gold in Asian markets and the strength in dollar due to weakness in the British pound. Also, recent presidential poll statistics in the US are not in favour of a Donald Trump win; a negative for gold bulls. Policy uncertainty and slowing growth following a Trump win could stoke the yellow metal’s price.

So gold prices could be under pressure over the next six months, but the long-term story in gold is good. The global economy is still not out of the woods and countries continue with the policy of monetary easing, leading to currency debasement. Interest rates have slipped into the negative region in many developed countries, adding sheen to gold’s investment appeal; it will be some time before they generate positive yields. Also, gold as an investment is back in vogue with surge in demand for gold ETFs, bars and coins. If prices rally, investment demand will only rise further, taking prices higher.

And, significantly, this investor demand comes alongside falling consumer preference for gold jewellery. With demand for gold jewellery going down in the large gold-consuming nations, it will be the gold investors who will call the shots in the gold market.

Here’s a look at some of the key drivers of gold prices.

Mine supply plateaus Global gold mine production increased in 2015 to a record 3,176 tonnes. But, the annual increase was only 1 per cent; the lowest increase since 2008. China, the world’s largest gold producer, saw output drop for the first time in many years (a drop of 20 tonnes or 4 per cent in 2015 over 2014). In Shandong and Fujian, which have a long history of mining, the government reinforced health, safety and environmental protection laws, which also impacted output.

In the first half of 2016, global gold production, in fact, flattened, a WGC (World Gold Council) report indicates. The total mine output in the period was 1520.9 tonnes against 1,519 tonnes last year.

The year 2016 is expected to be the beginning of a sustained drop in gold mine output. New gold deposits are becoming hard to find. A report from Sprott Asset Management, a large Canada-based hedge fund, states that global gold discoveries, which peaked in the mid-1990s, have fallen in recent times. Despite exploration budgets growing manifold between 2009 and 2012, there has hardly been any large gold discovery in the last few years. Even in the few discoveries made, the ore quality has been poor. In the 1950s, ore grades averaged 12 gram per tonne, but in recent years miners get only 3 gram per tonne.

Impact: Supply constraint will cushion gold prices in the event of a sharp fall due to factors such as a rally in dollar or a Fed rate hike

Investment demand mounts Physical bar demand in the 2006-2015 period, in all the countries, big and small, has seen a manifold increase. The world’s total annual physical bar consumption has grown from 429.8 tonnes in 2006 to 1,011.7 tonnes in 2015. In the current year, investment demand has been spurred further. After net outflows in the last three years, gold-backed exchange-traded funds have seen huge inflows this year. SPDR Gold Trust, the largest gold-backed exchange-traded fund, has seen its holdings increase from 642 tonnes in 2015 to 953 tonnes now, a jump of 48 per cent in less than a year. The total known ETF holding in gold today stands at 65.67 million ounces, up from 46.9 million ounces in 2015.

A key factor that drove investment in gold is the negative interest rate in many parts of the world (Europe, Japan, Denmark, Sweden, and Switzerland). Data compiled by WGC in March showed that the sovereign debt of about a third of the developed countries traded with a negative yield and an additional 40 per cent of the countries had yields below 1 per cent.

The gold-ETF and bar/coin market demand has all along been a smaller pie compared to demand from jewellery; half the size of annual demand from jewellery in 2015. But in the first six months this year, with fall in jewellery demand and an increase in demand from investors, both the markets contributed almost equally. In the June quarter, while jewellery demand was 444.1 tonnes (down 14 per cent, over last year), investment demand was a tad more at 448.4 tonnes (up 141 per cent, over last year).

Impact: Going ahead, gold prices may be driven more by its worth as an investment. Gold will then compete with other asset classes such as equity and bonds

Global economy in doldrums This will be one of the key drivers for gold prices in the medium term. The global economy is still struggling to combat recession and push up consumption. Recently, the US reported its second quarter GDP data, which showed a very marginal growth of 1.2 per cent versus analysts’ expectation of 2.6 per cent growth. In a statement made earlier in October, the IMF said that the global economic growth will remain subdued at 3.1 per cent in 2016 following a slowdown in the US and Brexit and improve marginally to 3.4 per cent in 2017. It also warned that, “Persistent stagnation in advanced economies could further fuel anti-trade sentiment, stifling growth…”, and added that the economies should maintain easy monetary policies to be more accommodative.

The IMF has reduced its growth forecast for the US to 1.6 per cent in 2016 from the 2.2 per cent it outlined in July. For the UK, growth is predicted to slow to 1.8 per cent this year and to 1.1 per cent in 2017, down from 2.2 per cent in 2015. Conditions elsewhere are also not good. Japan recently unveiled a new stimulus package to counter the impact of slowing consumption growth and lift inflation, which has fallen below zero. The $45-billion stimulus package, itself, economists say, may not be enough to bring the country back on the growth path.

Impact: Slowing growth may continue to fuel demand for gold as a safe haven.

Consumption stagnates in large markets While there are many factors that can boost gold prices, falling gold jewellery consumption can pose a hurdle. Gold consumption demand has been falling for the last three years, from an annual demand of about 2,673 tonnes in 2013 to 2,480.8 tonnes in 2014 and 2,414.9 tonnes in 2015, according to data from the WGC. In the first half of the current year, too, global jewellery consumption has dropped 17 per cent (or 185 tonnes).

A sharp drop in demand from the two large consumer markets — India and China which account for around 45 per cent of the global demand for the yellow metal — explains this. In the recent June quarter, for instance, India’s gold jewellery demand dropped 20 per cent (to 97.9 tonnes) over the corresponding quarter in 2015 and China’s consumption dropped by 15 per cent (to 143.5 tonnes).

While one may argue that the fall in demand is due to a rally in gold prices and Asian consumers are price-conscious, what would explain the drop in demand in the preceding two years when gold prices were correcting? The answer could lie in a combination of regulatory hurdles and a fundamental shift in the buying behaviour of consumers. In 2013, to curb India’s rising current account deficit, the government imposed many restrictions to import gold. But by the end of 2014, when these restrictions were removed, the demand in the physical market dried up. As gold prices started to decline, consumers kept postponing purchases for a better price.

The Centre’s clamp-down on black money transactions, too, created fear among those stashing away unaccounted money in gold. In December, the Centre made PAN (permanent account number) mandatory for all transactions in gold worth more than ₹2 lakh (earlier it was only for gold purchases above ₹5 lakh) so that there is an audit trail. The sovereign gold bonds launched in 2015, too, took away some gold buyers.

Increased consumer awareness has also resulted in lower consumption demand. In a recent survey conducted among our online readers, we found that many preferred non-physical form of gold such as sovereign gold bonds, over jewellery, as the latter comes with high costs of making charges and wastages. In the last two tranches of the sovereign gold bond, the Centre received about 2 lakh applications, up from about 62,000 applications in the first tranche in November 2015. In the five issues so far, sovereign gold bonds have raised money worth 10.22 tonnes or 10,220 kg of gold.

In China, again, where gold is a part of the culture, there is a shift in the consumer buying behaviour. Given higher gold prices, middle-class consumers in China are considering jewellery made from metals that have a resemblance to precious metals, say analysts. Also, large numbers of consumers who were buying 24-karat jewellery have now moved to the coin and bar market, since the value proposition is better.

Buying gold coins or bars has become very easy in China in recent times. The Shanghai Gold Exchange even has a smart phone app for customers to buy and sell gold. In the first six months of the current year, even as China’s jewellery demand dropped by over 60 tonnes, the investment demand was down only by 2 tonnes. Gold in China is a better investment compared to illiquid real estate and bank deposits that yield very poor returns.

The trend in gold consumption globally, too, appears similar. Numbers from GFMS, Thomson Reuters show that jewellery demand has been stagnating in the large markets such as India and China and is declining in many others such as the US, the UAE, Turkey, Russia, Indonesia and South Korea.

Impact: Dropin consumption demand may mitigate to some extent the impact of slowing mine output and increased investment demand and check price increase.

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