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This is the second part of this series on "What really drives the Gold Price?", in which we highlight the way Indian Scrap gold sales may prove to be a silent, but major force in the market, in the third quarter of this year. How, by its reduced presence! It has not been properly appreciated as a major component of the gold market, but now could shove supply and demand right off balance, so that demand could fail to find the supplies it needs to maintain prices below $400.
Investment Demand the main driver right now?
In the developed world, the key to higher gold prices lies in the decay of global economic health, with the prime emphasis on the state of the U.S. economy. The gold price currently reflects the belief that the recovery of the global economy is there, but not fully established as "sustainable". Latest figures from the U.S. on the level of jobless claims reflects that uncertainty. However, it has become clear that the shape of the global economy is changing shape and dramatically, with the entrance of China onto the scene. More than simply a source of growth, this nation, containing a quarter of the world's population is an entirely new economic force with, as is the case in all nations, national self-interest at its focus of achievement. With the structure of the global economy designed to supply a world in China's absence, structural pressures are heavy on all essential commodities primarily but with demand rising into complex consumer goods. The global economy has moved to a new level, one of many which will result in a shift of emphasis away from the U.S. as the prime driver of the global economy to one of a few, including a growing E.U., now with 25 countries and 400 million people within its 'borders'. The first sign of these 'growing pains' have been seen in the oil market, with prices now steady above $30 a barrel and set to stay there. Consequently, inflation is here again, although at early stages and set to grow, for many reasons.
The weight on currencies to function in a diverse globe, in the absence of a genuine world Monetary Authority, is likely to produce strains which will undermine currency stability still further, as national interests swamp the globe, as we see in the burgeoning U.S. Trade deficit flooding the rest of the world. But at this stage the world financial markets have no intention of properly addressing the issue of a 'world currency'. The traditional move away from the U.S. $ to other ones and to gold has not yet begun, although there are significant signs that many nations are discussing the problem behind closed doors. These discussions should become public before the end of the Year.
But investment demand in expectation of a $ decline and worsening condition did prompt massive demand for gold last year and this. However, with the heralding of the U.S. recovery, such doubts about the $ have been overwhelmed, at least in the media. The spectacular absorption of the sell-off of the large scale speculative position of around 450 tonnes, in six weeks took place in April, confirming that large scale Investors do not like the limelight, but are a strong presence in the gold market even now. In these the summer doldrums for gold [with new trade winds not far off] many observers are inclined to say that, that's just about it for gold and not much reason to hold the metal. If these observers are right, which we do not believe, what will drive the gold price upwards from now on if its is not investment demand? One of the sources of heavy demand [there are others too, dealt with in the other two parts to this series] will come from an source uninfluenced by the macro economic scene. The source will be a traditional source, which in itself, is powerful enough to drive the gold price upwards.
Jewellery Demand / Supply - from India and Asia
But of much greater interest is the phenomenon of jewellery demand increasing, particularly from Asian nations. We believe that the second quarter figures that the World Gold Council. If we extrapolate the increase in the first quarter, the year should show a rise to 3,555 tonnes, making demand from this sector of the gold market rise above the entire newly mined gold supply for 2003 according to the figures from G.F.M.S. The demand for gold from the India and the far East is best reflected in the Demand AND SUPPLY of gold jewellery. It is this feature that has shown itself of late, to have a far greater power over the gold price than Western institutional demand. It is this feature that may if continued, join with the Western institutional demand, to send the gold price on its next phase of its multi-year "bull" market. Just how this aspect of the market is exerting such a strong influence on the gold price?
Old Gold Scrap
Newly mined gold and Central Bank selling are constrained by the difficulties of developing new mines, or re-opening old ones [up to 5 years] and gaining agreements [now every 5 years] with other Central Banks before they can add new supplies to the market. If the gold price were to shoot up, these sources are incapable of providing more supplies at short notice. Immediate new supplies are therefore, restricted to dis-hoarding by investors and the appearance of jewellery for re-sale [scrap sales]. Of paramount importance is the fact that a higher price of gold is the trigger for these supplies. In 2003 the scrap gold supplies moved to centre stage, rising sharply, for the second year in a row. Scrap recovery had risen an estimated 18.4% in 2002, from 684.3 tonnes in 2001, to 808.7 tonnes, according to CPM, who attempt to track these supplies, as no other research company does. They estimated that scrap recovery of gold rose another 13.0% to 914.5 tonnes in 2003. The bulk of the increase occurred in India.
Since the numbers above were collated, this peculiar gold market characteristic has come into play. Gold returns to the market in the form of gold scrap, a feature no 'pure' commodity has. With the last year seeing the gold price rise to new levels and display extreme price volatility, owners of gold jewellery, particularly jewellery whose price is very close to the gold price [and sold by weight] returned to the market, when prices spiked or were at levels thought unsustainable, in the market place. Over the year this volume filled the gap in the supply hole. But a critical change in the perception of these sellers occurred in the second quarter of this year. The gold price at just below $400, was deemed by these sellers to be a sustainable price, so the scrap market began to reduce supply to the extent that demand for gold balanced it, or overtook it, with these sellers becoming buyers again. As a result, what was, until now, only a consequence of higher prices, scrap supplies have risen to be, perhaps, the key supply factor in the gold market. In terms of the gold price these supplies have the ability to provide new supplies to the market overnight.
[One tonne of gold equals 32,150 ounces of gold] Secondary supply = scrap.
The function of a rising price becomes all important in this phenomena, as it turns the tap of scrap gold on or off. The key ingredient to the turning of the tap is not the price, per se, but the perception the scrap sellers have of the price. If they believe the price is sustainable, at whatever level, they withdraw, to an extent from the market, and wait for higher prices.
This was clearly a feature of the rising prices of last year, when we saw the speculative funds dominate the gold price, pushing prices just above levels the physical [Indian and Asian] buyers wanted to pay, forcing them out of the market until they believed the prices would hold the new levels. Once satisfied that this was so, they attempted to buy again, only to find themselves, often, forced out of the market by both speculators and Investors in a rising price market, once again.
Recently, they were holding off buying only at prices above $410, seemingly having accepted the $400 level, but no more. Scrap sellers, in turn, also saw $400 as a reasonable and sustainable price level and asked themselves why sell now? Hence, at a gold price of $400 and below, the sales from scrap supplies were clearly inadequate for the investment and jewellery market, who entered the international market to scoop up the sales of 465 tones, from the 'speculators', all in the six weeks from the beginning of April this year to mid May.
This is a stunningly massive amount in historic terms. In the early 1970's this amount would have been enough to send the gold price rising well over $200, but due to the increase in liquidity, caused by the sales of speculative long positions, such supplies were available. Now with summer seeing the bulk of their activity sidelined for seasonal reasons and the large scale speculators out of the market in the main, the market waits for the last portion of the third quarter of the year and the fourth quarter to see new activity. If scrap sellers are out of the market, the current supply of gold will be insufficient to satisfy the market. With speculators out of the market, what is likely to happen next? Scrap sellers need higher prices to reappear. With a shortage in supply remaining, new buying will have to push the gold price up to create immediate supplies from scrap sellers!
The next question of critical importance is, at what price will the balance of demand and supply encourage scrap sellers to fill the demand gap? We would guess that this would be from $420 upwards, but only so long as they believed that this was an unsustainable price. If they perceive that $500 is unsustainable, perhaps the gold price has to rise to that point, before scrap fills all demand needs.
Certainly, if de-hedgers, or Investors from the West, or even the funds wanted to re-enter the market they may well find it necessary to push prices up to that level in order to get their supplies.
With no other flexible, immediate, source of supplies other than de-hoarders and scrap suppliers in the market, we expect this source of supply to remain in the centre of the stage. As the Jewellery Trade enjoys its summer break, Autumn will see their return and the commencement of the seasonal demand, for Jewellery, from the West as the festive season approaches, from India as their gold buying season commences.
This could be a most dramatic period for the gold market, if the scrap trade waits for better gold prices!
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