After the Gold Crash

Spring 2014 marks several anniversaries for the bullion market – 60 years since the resumption after World War II of London’s daily fixings for instance, or three years since silver touched $50 per ounce for the second time ever, and ever so briefly again. Gordon Brown’s ham-fisted announcement of UK gold sales in May 1999 still captivates public memory in the UK. But perhaps our market’s biggest anniversary this spring should also be a first. Because it marks one year since the historic crash in gold and other precious metals prices starting in mid-April 2013.

Goldman Sachs had advised clients to short gold early that week. Cyprus was told to sell gold on Thursday by the EU and IMF. Gold prices fell into London trade on Friday 12 April, dropping as the market closed for the weekend through $1,530 per ounce – the previous 18 months’ low – only to slump another 3.5% by the time New York trade ended. Then on Monday the real trouble showed up. Fellow members need no reminding (and most will want it still less). But the way last year’s crash unfolded, and how it altered demand worldwide, deserves study. Because whether those changes now prove permanent looks critical to our market. The crash also highlighted unique features, most plainly in gold, which may prove more lasting.

Across last year as a whole, gold prices fell some 30% – the same amount US equities returned to investors in total. Yet gold squeezed almost all of 2013’s drop into the second quarter alone, down 25.4% in dollar terms, and half of that was achieved in just those two days in April. A second slump to $1,180 per ounce then marked gold’s low of the year, hit on the last trading day of June and again on New Year’s Eve. Prices have essentially been flat for 12 months now, closing between $1,200 and $1,400 on a monthly basis. Viewed as a market reset, therefore, gold’s drop was swift and successful. Because while the slump was in fact finished by midsummer, the wrenching loss in Q2 forced Western sellers, whenever they then sold, to accept the discount prices needed to unleash bargain buying from Asia in particular. The surge in consumer demand for gold jewellery, bars and coins very nearly matched the outflows from exchange-traded trusts and other investment vehicles. But this extra demand wasn’t for the securitised form those investments took. Nor was it local to where their underlying bullion was held.

Unique amongst major asset classes, physical gold enjoys a diverse set of buyers worldwide, with very different motives. Industrial use accounts for around 10% of annual demand, proving highly inelastic in tonnage terms over the last decade based on Thomson Reuters GFMS data, despite the 300% swing in annual average prices. All other demand broadly splits between jewellery and investment, but within those categories lie many different markets with very different behaviours, some of which were extended by spring 2013’s price crash, while others briefly reversed. To supplement supply and demand tonnages, Figure 1 below shows interest in buying gold amongst internet users in the USA and India. Google Trends shares search volume data as a proportion of all queries on the search engine, rebasing peak interest to 100. Measuring searches for ‘buy gold’ in English shows that both Indian and US consumers usually have much more pressing concerns, whether ‘Miley Cyrus’ or ‘Shilpa Shetty’. But mapped against the gold price, spikes in that query confirm that, for public interest in buying gold to become most urgent, the US needs rising prices, while India prefers a discount. Added urgency came in spring 2013 because the Indian government was accelerating its moves to the current de facto ban on legal imports. Levels of interest in the US also spiked, and full-year household demand for gold bars and coins did rise by weight from 2012 according to Thomson Reuters GFMS data (see Figure 2). But as a proportion of all Google searches, ‘buy gold’ in the US reached only three-quarters of its summer 2011 peak, and full-year demand lagged the 2008-2011 average by almost one-third in tonnage terms, despite the price drop.

India’s world-leading private consumption, in contrast, hit record levels in 2013, leaping so fast on April’s crash that the government finally brought down the shutters, hiking import duty to 10% and then imposing the ‘80/20 rule’, which forces dealers to re-export 20% of any new shipment before taking delivery. Smuggling has clearly solved that riddle, but as the grey market doesn’t hit the official Current Account Deficit, the ban has helped the rupee to recover on the FX market at the cost of hurting India’s legal gold industry. China’s gold demand meantime rose faster still, finally taking over from India as the world no.1 and swallowing well over 1,160 tonnes of imports based on official data, even while continuing to top the league table of gold- mining nations with a further 440 tonnes of supply. Looking at retail bar and coin purchases (see Figure 2), China accounted for 30% of the 2013 jump in global demand, pushing it to new highs both in tonnes and compared against full-year supply. China also accounted for almost half the growth in world jewellery consumption, another new record. But for all that additional Asian consumer demand, it failed first to stem or then reverse last spring’s crash.

Much has been written about Western investment funds exiting gold in 2013. Their changed view as the year began clearly prepared the ground for Q2’s drop – a mix of boredom, greater allocations to equities, and not wanting to be last out the door, even as Western households regained their strongest interest in gold since 2011, briefly aping a more ‘Asian’ response to the drop. The thinking of money managers going into and during the financial crisis, however, with its concomitant peak in the gold price, looks hard to split from broader public sentiment, especially amongst higher earners (see Figure 3). Opinion-poll specialists Gallup only added gold to its menu of ‘best long-term investments’ in 2011, and only then in what seems an urgent survey as prices broke through $1,900 per ounce that August. (Previous and subsequent surveys were conducted each April, each again of around 1,000 respondents.)

While gold’s popularity has ebbed since then on Gallup’s surveys, it has ceded first place only to real estate, and that headline rate itself belies gold’s continued top ranking amongst the two lower, much larger income categories that the pollsters apply. This highlights ongoing but untapped (and perhaps merely wishful) demand for investment gold amongst US households, at least as far as opinion polls go.