Gold Demand Situation: Where we are now, how we got here and where are we going
As many will know, the mandate of the World Gold Council is the enhancement of global demand for gold. Accordingly, the focus of my article is, first and foremost, on gold offtake. Interestingly, gold demand does not depend on how high a country's level of income is, nor on whether or not it is a major gold producer, nor even on where on the globe it is situated. In this respect, gold does differ from other commodities in that it has a demonstrated special appeal, rooted in historic, cultural, religious and emotional motivations, as much as in cold business sense.
For example, as the chart shows: of the two largest offtake markets, India and the United States, one produces virtually no gold; the other ranks number two among the world's gold producers
- one has a per capita income barely above subsistence level, and relatively little financial asset choice; the other has high levels of discretionary spending and a proliferation of savings instruments.
- the number one and number three among gold producers, South Africa and Australia are both near the bottom of the gold consumption league, and although both, unlike the United States, depend for a relatively large part of their economic well-being on the mining industry, one is a developing and the other an industrial country.
All this demonstrates, once again, the broad range of motivations and appeal that gold has worldwide.
When we look at the developments in the gold markets in 1995, we again see this wide variation coming into play. For example, to the chagrin of some market participants, the gold price in US dollars was remarkably stable, with the 1995 average at S384.08 virtually unchanged f om 1994.
- All Markets +12% 2725t
- Developing Countries +10% 1807t
- Developed Counties +13% 918t
- Jewellery Demand +7% 2233t
- Bar/Coin Demand +36% 433t
- Dental +6% 59t
- 1995 was a banner year for gold offtake, with demand outpacing the previous record, set in 1992, by 7.6 %. In fact, based on the markets monitored by the World Gold Council (through 23 offices around the world), it set several records, even one for the number of records that were being posted;
- world gold demand reached a new peak with both developing and developed countries registering record highs;
- the number of markets consuming more than I 00 tonnes annually reached new highs;
- jewellery demand rose by 7 % and investment demand by 36 %, which was record or near record growth for both.
The driving forces that brought offtake to record levels in both developed and developing countries were:
1. Good income growth, particularly in important markets that had experienced cyclical down-turns in 1994, such as the Middle East oil producers and Turkey.
But perhaps more importantly:
2. In 1995, a number of gold's special qualities manifested themselves convincingly yet again:
its indestructibility and security in times of financial uncertainty triggered a 63 % jump, to 160 tonnes, in Japanese investment demand;
its investment value, once the price was considered right, caused a doubling of coin sales in Germany;
its role as a hedge against currency depreciation contributed to the strength of demand in India and Turkey;
its cultural and religious significance continued to underpin demand growth in several Middle Eastern and Asian markets;
and its basic adornment and intrinsic value attributes helped sales in the United States grow faster than total non-auto retail sales for the fourth consecutive year.
Not surprisingly, demand developments varied considerably among markets. As already noted, some, e.g., Turkey and the Middle East, registered strong recoveries f om cyclical lows, while others, especially China, Hong Kong, Taiwan, Mexico and Thailand, experienced cyclical declines, in most cases reflecting anti-inflation, austerity policies.
Consequently, while gold demand in Saudi Arabia and Turkey recorded large increases, in China and Taiwan it consolidated around previous levels of 224 and 160 tonnes respectively, but declined significantly in Hong Kong, Mexico and Thailand. In Mexico and Thailand, the downturn was largely policy induced, with recoveries emerging subsequently; in Hong Kong, the downward trend reflected the earlier asset shake-out and continuing political uncertainty.
The three largest consumer markets, India, the United States and Japan, all registered significant increases. Perhaps most remarkable among these is India, where annual gold consumption jumped 14 %, to 474 tonnes in 1995. This was despite the rather large increases in the local price of gold as the rupee depreciated by 11 % against the US dollar in the second half of the year. The fact that demand held up so well reflected both good income growth - so that people could afford to devote somewhat larger nominal amounts to their traditional purchases of gold - and progress in liberalisation of the gold market, which made gold more accessible at a lessened premium over the international gold price.
It is this combination, of rising income and increased accessibility of gold, that has played an important role also in the large increases in gold demand posted in other important markets. In fact, the latter factor is so important that the World Gold Council is concentrating a large part of its efforts on increasing the efficiency in local gold markets through removal of regulatory and structural impediments to the free flow of gold.
The importance of positioning gold and of generating a 'level playing field' for it was demonstrated forcefully by developments in the Japanese market last year, gold investment sky-rocketed by more than 60 tonnes during 1995, to bring total offtake to 289 tonnes. The Japanese story is particularly interesting because it illustrates how a confluence of circumstances - the fragility of the banking system, the Kobe earthquake and the low price of gold in yen terms - can help enlarge the benefits from earlier efforts to position gold as an important savings and investment vehicle. I am referring to the large growth in gold investment associated with gold accumulation plans. This savings instrument was developed with WGC support over the past several years. It was ready for broad expansion after Japanese savings banks were allowed to promote gold as a savings vehicle and the experience of a number of commercial banks had shown the potential of such savings plans. But actual expansion far outpaced expectations as it rode on the momentum provided by the exceedingly favourable environment. And even the large capital gains - over 30 % - that have been registered since Spring 1995 have triggered only limited profit taking so far.
Similarly, in Germany, the removal of VAT on coin sales in 1993 paved the way for a virtual explosion of demand when the DM price of gold - at DM 17,200 per kilo - reached a two-year low in mid-1995. Concerns regarding the future stability of the local currency, triggered by discussions about the introduction of a European currency, may also have contributed.
All the good demand performance was obviously positive for the gold market, particularly inasmuch as the strength of demand put a firm, and actually rising, floor under the gold price throughout 1995. Yet, at the same time, grumbling was heard from the dealing community, who were looking for a rising ceiling price as well as greater price volatility. As is well known, the firm ceiling on the gold price, and therefore the shrinking volatility, resulted from the unprecedented levels of producer hedging activity in 1995. To re-cap, South African producers, who had been relatively less involved in hedging than their North American and Australian counterparts, elected to use the forward market also as a means for raising project finance in 1995. This, obviously, was not divorced from the strong incentive South, African producers had, in terms of the "real forward premium" (the local premium minus the local inflation rate), to avail tl1emselves of hedging possibilities. By contrast, US and Australian producers saw their real premium effectively disappearing by late 1995. This, together with the first quarter's seasonal lull for hedging activity, may help explain the calmer tone of the hedging market since. Nevertheless, gold leasing rates have stayed well above the 50-75 basis points level that was typical for the early 1990s.
The temporary liquidity squeeze in the forward market that materialised toward the end of 1995 may have helped focus market attention on gold and, together with rather belated recognition of the strength of underlying demand, contributed to the rise in investment and speculative activity that brought excitement to the gold markets in early 1996. These moves also gained from concern over the apparent vulnerability of bond and stock markets, motivating market participants to look for alternative homes for some of their funds. However, with the successful penetration of the $400 per ounce price level, the market quickly set new hurdles, looking to the price to go to $430 and higher and, thereby, setting the stage for virtually certain disappointment. In the event, disappointment was triggered both by profit taking and by the awareness that quick run-ups in the price of gold tend to cut relatively sharply into demand in highly price sensitive, high caratage jewellery markets. And these, in turn, are among the major and most dynamic offtake markets. Thus, the debate in the market about the strength of underlying demand quickly turned negative, despite a fair amount of evidence that showed demand developments to have remained rather more satisfactory than could have been expected under the circumstances.
As a consequence, speculators began to unwind some of their long positions but, with producer forward hedging also at fairly subdued levels, liquidity concerns disappeared. Still, the depth and relative resilience of the market was demonstrated by the fact that the news of a 203 tonnes sale by the National Bank of Belgium in a deal with, another central bank had no immediate impact on prices. If, as some believe, this gold was, at least in part, feel into the market starting late last year, it was even more remarkable that prices did not appear to react visibly.
Higher lease rates are here to stay
It may be interesting to note that the possible addition to gold market liquidity through further mobilisation of gold in official hands is judged to be rather limited. If one takes account of those major holders of gold among central banks who arc either legally, or through publicly declared self-imposed restrictions, presented from engaging in lending activities, the number of holders of sizeable gold stocks, who are not already participating in these markets, appears small. Furthermore, nonparticipants are not likely to hold their gold in money market centres from where it could easily be onlent. This is important, because for a number of countries, especially outside the G7, but not necessarily excluding them, there would be a significant political constraint to being seen to move part of the national gold stock outside national borders. As a consequence, one should not expect large additions to gold market liquidity from potential new Central Bank participants and, therefore, the consensus appears to-be that the higher lease rates are here to stay.
With respect to the possibility of outright sales by official holders of gold, the latest Belgian sale triggered virtually no speculation about similar moves by other central banks, in part, perhaps, because it was, views also as a relative distress sale rather than a 'let's get out of gold" type move. Even the possibility that the International Monetary Fund might sell some gold in its search to find resources to fund its main concessionary loan facility, the Extended Structural Adjustment Facility between 1999 and 2005 (when it is to become self-financing), is now looked upon with relative equanimity. (ln any event, some major shareholders, including Germany, are continuing to oppose such sales.) This does not mean that the large above-ground stocks in both official and private hands might not be activated under some circumstances but, rather, that markets are sufficiently deep, and demand sufficiently strong at recent levels of the gold price, that this is not considered to be a major threat at this time.
In this respect it should be remembered that, while the gold price in 1995 was remarkably stable in US dollar terms, it was not necessarily so in local currency terms.
This was particularly important in India and Turkey, where the local currency price rose sharply. But, in neither case did this local price rise seem to trigger liquidation of gold stocks held in private hands. Unlike in developed countries such as Germany and Japan, where the recent price rise caused profit taking, experience shows that in many developing markets such disposals tend to occur mainly in response to distress situations, such as liquidity squeezes. Profit taking appears to play a lesser role, especially if the price rise reflects local policy problems.
Thus, a distinction needs to be made between consumer reactions to price rises induced by local, political/ policy circumstances and those that stem from externally triggered, global price spikes. The latter, of course, are of interest to traders and producers, but they tend to confuse consumers. The speed with which consumer markets absorb such price rises will depend upon whether consumers are convinced that the rise is there to stay, as well as the strength of income growth. For example, while in India good income growth helped mitigate the effects of the rupee price rise from mid-1995 to year -end, the spike in the international gold price early in 1996 led to a "wait and see" attitude, with consumers returning to the market at the end of the first quarter. Equally important, different markets will react differently to gold price changes. For example, while jewellery demand in most developed countries is relatively insensitive to changes in the gold price, in Turkey the population tends to buy into a rising price trend, and in Hong Kong there tends to be active two-way trading in response to price fluctuations.
Where we are now
- Demand remains within historic highs
How we got here • Cyclical recovery in major markets
- Instability of financial markets, e.g., Japan
- Effects of deregulation
- Steady growth elsewhere
Where are we going?
- Consolidation of gold demands at high level
- Income factors likely to dominate
- Solid base support to gold market
We believe that for gold demand 1996 is likely to be a year of consolidation at levels above those seen in earlier peak years, but not necessarily holding to those achieved in early 1995. To a large measure, whether the record levels reached in 1995 are maintained depends mainly on income growth. There, we see a certain consolidation in those major markets that had experienced demand recoveries in 1995, e.g., Saudi Arabia and Turkey; continued steady growth in India and the United States; and stabilisation in Thailand and Hong Kong. However, growth performance in Europe is likely to be below earlier forecasts, although not as dire as some now believe.
The bottom line is that, in our view, consolidation of gold demand at the levels already reached, or even somewhat below, would continue to provide a strong fundamental base to the gold market.
Mrs Helen B Junz is Director of the Gold Economics Service of the World Gold Council. Mrs Junz joined the World Gold Council in July 1994 from the International Monetary Fund, where she had been employed since 1982, most recently as Special Trade Representative and Director of the IMF's Geneva Office.
Mrs Junz, a US national, was educated in the Netherlands and the United States, receiving her MA in Economics from the New School for Social Research, New York. Before joining the IMF, Mrs Junz held the positions of Economic Advisor, Organisation of Economic Co-operation and Development (OECD); Advisor, Division of International Finance, Board of Governors of the Federal Reserve System; Senior International Economist, US Council of Economic Advisors; Deputy Assistant Secretary for Commodities and Natural Resources, US Department of the Treasury; Vice President, First National Bank of Chicago; and Vice President, Townsend Greenspan and Company Inc, New York.
Mrs Junz, a highly respected economist both in the United States and Europe, has written numerous articles and reports for economic journals and has travelled extensively.