Gold prices have been subdued in recent years, following the heady race to $1,924 per troy ounce in September 2012, when growing consumption in India coupled with speculative demand from gold investors pushed up prices to spectacular highs.

The price decline, however, halted at $1,045 in December 2015, which many believe will be the base for gold for some years to come. While gold prices have delivered almost 30 per cent gains since that 2015 low, there are today many influences exerting competing pressures on gold prices—some propelling them further and others dampening them.

Consumption demand for gold is in a structural decline in China and India, which are the largest consumers of gold jewellery. Consumption demand is, therefore, expected to stay flat at best in the coming years. But investment demand for gold is likely to support prices. This will be spurred by safe-haven demand caused by heightened geopolitical concerns, rising inflation across the globe and, finally, the unceasing rally in stock prices, especially in the US and India, which makes gold an attractive diversifier.

Coupled with the fact that gold output is likely to plateau and decline over the long term, this makes a steady trend in gold prices likely in the years to come.

No lustre in jewellery Gold jewellery still accounts for about 50 per cent of gold consumption. Gold investors consume around a quarter of the gold produced, including gold bars and coins. Central bank purchases for adding to their reserves account for an additional 10 per cent of the demand, with industrial use accounting for the remaining demand.

Demand for gold jewellery has been stagnating in recent years, according to World Gold Council data. While 2,043 tonnes of gold was consumed by jewellery makers in 2010, that declined to 1,988 tonnes by 2016. Gold jewellery demand peaked in 2013 as consumers used the fall in gold prices to buy in. But all the major gold-consuming countries, including China, India, West Asian countries and the Americas, have seen gold jewellery consumption decline after peaking in 2013. While regulatory clampdown dampened demand in India, demand in West Asia was hurt by declining crude oil prices, and in China, an economic slowdown pushed down demand.

In 2017, jewellery consumption in India was moderate, averaging 116 tonnes in the first three quarters. Smaller jewellery makers in India were impacted by the introduction of the Goods and Services Tax (GST) in July, which depressed demand and increased the compliance burden. The government had also brought gold jewellery purchases under the Prevention of Money Laundering Act (PMLA) in August, which too impacted sales, especially in rural India. These requirements were, however, relaxed in October, just ahead of the festive season. The sharp increase in gold imports in October 2017 suggest that the last quarter might be good for jewellery demand in India.

Overall, jewellery demand in India, especially from the marriage market, is inelastic. While the impact of GST is expected to be transient, and the relaxation of PMLA regulations will help gold demand recover, the uneven spread of the monsoon this year could impact rural demand going forward. These factors could peg jewellery demand in India at the current levels.

China, the largest consumer of gold for jewellery, is seeing a structural decline in that market as the current generation prefers lighter and innovatively designed pieces as against heavy traditional pieces. Jewellery demand in Greater China declined from the peak of 1,031 tonnes in 2013 to 678 tonnes in 2016. Also travel, entertainment and dining are edging out discretionary spending on gold.

Similarly, jewellery demand in West Asia is down almost 30 per cent from 2013 to 193 tonnes in 2016. The US was the bright spot, with robust demand, thanks to improving economic conditions.

Central bank buying to bolster their reserves has seen an increase since 2011 led by Russia, which has been increasing the proportion of gold in its forex reserves. The central banks of Turkey, Kazakhastan and Mongolia, too, have also been stocking up on gold. But these purchases may not be sustained as these decisions are driven by geopolitical considerations.

Investment demand perks up Demand from gold Exchange Traded Funds fell out of favour following the crash in gold prices in 2013. But it revived in 2016, with 544 tonnes added by gold ETFs after three consecutive years of contraction. The assets under management of gold ETFs, however, remained stagnant at around 2,340 tonnes between the third quarters of 2016 and 2017. ETFs in North America, the largest market, witnessed a sharp 83 per cent year-on-year decline in the September 2017 quarter as a recovery in the global economy and the stellar returns from the equity market diminished its allure as an asset class.

Similarly, demand for gold bars and coins fell from 1,715 tonnes in 2013 to 1,042 tonnes in 2016. Demand remained subdued in the first three quarters of 2017 as well, as higher regulatory scrutiny and the introduction of GST in India dampened sentiment. However, Chinese demand for gold bars and coins was up 57 per cent in the September 2017 quarter as fears of a further depreciation of the yuan and rising inflation drove investors to gold.

Other factors driving demand While jewellery demand is expected to be stagnant at best, investment demand is expected to increase in the coming quarters owing to various factors. First, if geopolitical tension rises, safe-haven demand will cause investors to stampede into gold investments. Second, the sustained rise in global equity markets over the past two years increases the prospects of an imminent correction. Falling equity prices will trigger reallocation of funds into gold. Third, a rise in inflation as stability returns to global growth is also a positive for gold, given its perceived utility as a hedge against inflation. While many feared that gold prices would fall in step with global central banks’ rate hikes, the risks on that front appear to have diminished. A BusinessLine analysis shows that gold prices moved higher in 1994, 1999 and 2004, when the Fed hiked rates. Such a trend is playing out this time too.

Tighter supply Another factor that could drive up gold prices is the outlook on supply. While mine output in 2017 has been at the same level as in 2016, there is expectation of a drop in supply beyond 2019. Due to the sharp fall in gold prices in 2013 and the volatility in prices since then, investment in gold production has dropped. The number of new mines has fallen in recent years as compared to the 2010-2013 period, when there was a boom in output.

Most gold research analyses point to gold production remaining at the current level up to 2019, after which there is expected to be a secular decline in output.

With the surplus in gold production expected to shrink in the coming years, gold prices will receive support. This will make gold a good diversifier for any portfolio.

An allocation of around 5 per cent of the portfolio in gold is recommended, preferably in the form of sovereign gold bonds.