In the context of global economic turmoil, gold has enjoyed a spectacular renewal of interest from investors looking to preserve their wealth and hedge against inflation or dollar weakness, as well as those wishing to capitalise on the positive price outlook: the gold price has risen every year since 2001 from its low of $250 to around $1400 since November 2010. Simultaneously, demand in growth markets such as China and India has soared with the increase in purchasing power.
We wanted to go beyond the hype and understand what really drives this special commodity: the World Gold Council, market development organisation of the gold industry, was the perfect place to start.
The WIM Seminar of 19 January 2011 focused on the demand for gold and the role of the World Gold Council in stimulating and sustaining this demand. Click here to see the presentation slides.
Since the seminar, the World Gold Council has published its Full Year 2010 Gold Demand Trends Report: this publication sets out the key factors that drove gold demand in 2010, together with an outlook for 2011, and includes a focus on the structural shift in central bank policy towards gold which lead central banks to become net buyers of gold in 2010.
Gold Demand Overview
Gold demand has traditionally come from three sources: jewellery, industry/technology and investment. The official sector, including central banks and supranational organisations, has previously been seen as a source of supply. However, after 21 years as net sellers, collectively central banks are now effectively net buyers, causing not only a significant decrease in supply but a corresponding, simultaneous increase in demand.
These factors converge to create a mix that is different from the drivers of other commodities: in general, gold has lower levels of industrial/technological demand than other metals, and higher levels of discretionary and investment demand. It also enjoys lower levels of consumption and a higher degree of recoverability. This unique combination has resulted in low correlation of the gold price with the prices of other commodities even in times of financial stress. Because changes in the price of gold do not correlate with changes in the price of other mainstream financial assets either, gold can play a key role in portfolio diversification.
In creating supply, gold mining companies operate on every continent of the globe – except Antartica where mining is not allowed. This broad geographical dispersal means that issues, political or otherwise, in any single region are unlikely to impact the supply of gold. Beyond mine production, recycling accounts for around a third of all current supply: it is worth noting however that recycling levels were lower in 2010 than in 2009, despite an increasing gold price. In addition, central banks can also contribute to supply should they sell part of their gold reserves.
Around 60% of today’s gold becomes jewellery, where India and China with their expanding economic power are at the forefront of consumption. In East Asia, India and the Middle East, gold has powerful cultural meaning, accounting for approximately 70% of the world’s gold jewellery in 2009.
Many of gold’s key jewellery-buying markets have experienced rapid GDP growth over the past decade, India and China being the best examples. This lead to a sharp increase in households’ disposable income levels: as retail sectors in these countries were revolutionised, gold was one of the many luxury consumer goods to benefit. In effect, rising income levels have put a higher floor underneath the gold price than in the past.
In 2008 and 2009, the gold price reached record highs in key jewellery buying markets, largely due to weakness in their currency: although a rising gold price is not always negative for jewellery demand, as jewellery is often bought with the dual purpose of adornment and investment, in this instance the combination of high and volatile gold prices with a sharp slowdown in growth contributed to a notable downturn in the jewellery market. Chinese consumers however behaved differently, due to the country’s history of price and import controls in the gold market, which has meant that Chinese consumers do not own large stocks of gold. As they are currently still in the accumulation process, Chinese consumers were less willing to sell back their holdings while the global recession was affecting other parts of the market.
There are now positive signs that jewellery demand has started to recuperate as the global economy continues to recover: jewellery demand grew by almost 45% from Q1 2009 to Q1 2010.
Industry and Technology
Over half of the gold used in technical applications goes into electronic components thanks to gold’s high thermal and electrical conductivity and its outstanding resistance to corrosion. The main consumers of this gold are the big manufacturing countries, in North America, Western Europe and East Asia: following a downturn in 2009, in link with the global downturn and turmoil in the electronics industry, 2010 saw a recovery of gold demand for electronic components.
Gold also has a long history of medical use: its bio-compatibility, resistance to bacterial colonisation and to corrosion, as well as its malleability mean that it can be used successfully inside the human body. It’s best-known and most widespread biomedical use is in dentistry, though this share of gold demand is declining.
It should also be noted that research over the last decade has also uncovered a number of practical new uses for gold, including as a catalyst in fuel cells, chemical processing and controlling pollution. This could lead to important new demand for gold in industries that currently consume large quantities of other precious metals (like platinum in the automotive industry).
Investment in gold is made up of
Retail investment in official coins, bars and medals/imitation coins, as well as exchange-traded funds (ETFs) and related products; and
Inferred investment, which is the balancing item between the supply and demand figures: while this category is partly a residual or error term, its more important role is to capture the less visible part of investment demand, such as investor flows in the over-the-counter (OTC) market – transactions that typically occur via the major bullion banks.
Since the beginning of the decade, investment demand has soared from 4% of overall gold demand in 2000 to a record 38% in 2009, due initially to increased demand for ETFs and related products, then after 2008 to investors reaction as global financial markets went into meltdown and growing distrust of governments and financial institutions. Recognition of the commodities super-cycle has also been a key factor. Figures for gold investment in 2010 remained to be confirmed on 19 January when this seminar took place, but were widely expected to at least match those of 2009.
Retail investment demand has been dominated by India, China, Western Europe and the US since 2007. The strength of investors’ interest in gold in these regions has been linked to the release of pent-up demand by the appearance of new products matching investors’ focus on longer-term holdings and inflation hedging. This picture is clear in tonnage terms, but a view of gold investment expenditure growth in 2009 and 2010 shows strong increases in other countries including Thailand, Vietnam and Turkey. Japan is a particular case, with negative demand growth in 2009 and 2010: this was tied to continuing support by Japanese investors for Japanese government bonds combined with the strength of the yen, which entailed that the gold price did not rise as much as it did in dollar terms.
Although some of the flight-to-quality inflows may diminish as the global economy recovers and investors’ risk appetite continues to improve, the World Gold Council sees good reasons to expect investment demand to remain strong. First, one consequence of the recent financial crisis is a greater understanding of risk and diversification on the part of investors. This is likely to support the case for gold as a means of protection against future “event” risks. More broadly, investors increasingly recognise the importance of gold as a diversifying asset, regardless of the state of the financial sector or wider economy. Gold has been one of the few assets to deliver on its “diversification” promise, in contrast with many other assets where the correlations with equities through the crisis period tended towards “1”. Secondly, gold has a long history as a store of value against inflation and dollar depreciation; many investors are of the view that both are on the cards. Finally, the demand and supply dynamics in the gold industry remain positive, supporting tactical allocations: the strength of investment demand should continue to offset much of the weakness in the jewellery and industrial sectors, where demand should improve as the global economy recovers. On the supply side, mine production remains relatively flat and central banks have turned from being large net sellers of gold to small net buyers.
Central banks and supranational organisations have been major holders of gold for more than a hundred years. Central banks started building up their stocks of gold from the 1880’s, during the period of the classic gold standard when the amount of money in circulation was linked to the country’s gold stock and paper money was convertible to gold at a fixed price. At their peak in the 1960’s, official gold reserves were around 38,000 tonnes and probably accounted for about half of above ground stocks at that time. Gradually, as central banks created more money than was consistent with stable prices and after several years of moderate but persistent inflation, the maintenance of the official price of gold became unrealistic and the United States, which was central to the system, was faced with the choice of deflating, devaluing or abandoning the gold standard. In August 1971, it abandoned the system with President Nixon “closing the gold window”. In the 1980’s and 1990’s, some central banks decided to reduce their gold holdings, and the total of official stocks declined by about 10% over those decades.
In September 1999, a group of European Central Banks entered into the first Central Bank Gold Agreement (CBGA) which limited disposal to 400 tonnes a year for five years and reaffirmed confidence in the future of gold as a reserve asset. The agreement was renewed for a second five-year term in 2004, increasing the annual ceiling to 500 tonnes. During that term, sales by signatories decreased regularly and the third five-year CBGA of 2009 saw a return to a 400 tonne annual cap on disposals, in a clear acknowledgement that central banks’ appetite for gold sales had diminished. Since 2009, the International Monetary Fund has conducted sales of gold both on the market via CBGA3 and off-market directly to interested central banks.
While France, Italy, Germany and the United States continue to hold the majority of their reserves in gold, many other central banks around the World hold either no gold or a very small percentage of their total reserves in gold. However, this is starting to change: the central banks of of India, Sri Lanka and Mauritius purchased gold from the IMF in off-market transactions, and in 2009 China announced that its official reserves in gold had increased from 600 tonnes to over 1,000 tonnes. This increase made China the sixth largest official holder of gold, yet gold still amounts for less than 2% of the country’s huge reserves. This indicates that there is ample scope for further growth, as is the case in the rest of Asia.
World Gold Council
The World Gold Council is the market development organisation of the gold industry. Working within the investment, jewellery and technology sectors, as well as engaging in government affairs, its purpose is to provide industry leadership, whilst stimulating and sustaining demand for gold.
The World Gold Council develops gold-backed solutions, services and markets, based on true market insight. As a result, it creates structural shifts in demand for gold across key market sectors. The World Gold Council also provides insights into the international gold markets, helping people to better understand the wealth preservation qualities of gold and its role in meeting the social and environmental needs of society. In the investment sector it seeks to make gold fundamental to investment decision making, and acts as trusted advisor to policy makers and reserve asset managers on all matters related to the gold market. As the global advocate for gold, the World Gold Council is committed to playing a key role in the development of a responsible gold mining industry.
Its 21 members are the leading gold mining companies, accounting for approximately 60% of corporate gold production: their collective market capitalisation is in excess of US$210 billion and their revenues total approximately US$40 billion annually. These companies regard the management of the local environment and relationships with local communities as paramount considerations during the lifetime of any mine project. Together, they work to ensure the industry as a whole is striving to develop and integrate best practice.
The World Gold Council has a strong track record of delivering value for its members, its partners and broader society as a whole, with a number of successful programmes and developments:
- It was instrumental in creating a new investment market for professionals to buy gold through the Stock Exchange in the form of ETFs. Today, ETFs are traded across the world’s major capital markets and represent over $85bn of assets under management. SPDR Gold Shares (GLD) is the market leader; the second largest ETF in the world across all fund categories, accounting for $65bn of assets under management.
- The World Gold Council also focused on widening access to gold throughout India: it is now possible to purchase gold through the Indian Post Office network, thanks to a partnership with the Indian Post Office and Reliance Capital. Currently over 630 branches give access to the benefits of gold investment – across the breadth of India and Indian society.
- In partnership with ICBC, the biggest commercial bank in China, the World Gold Council is also creating gold-based savings products to meet the investment needs of Chinese consumers who want to hold gold in their investment portfolios. Over one million customers opened gold based savings accounts in 2010.
- The World Gold Council also works to place gold at the heart of technological advancement, and it is the authority on innovative uses of gold in industry and society. The World Gold Council accelerated the time to market for a technology that reduces noxious emissions in the automotive industry, and its investment in the company Nanostellar has resulted in the world’s first gold based catalytic converter in a bid to reduce platinum dependency in this sector.