This article is one reproduced from "Gold - Authentic Money" in its June issue of this year.
In this the second part of this series on "what really drives the Gold Price?", we cover the foundation for the gold price from the global economic scene and highlight the way the Indian Scrap gold sales may prove to be a silent force in the market in the third quarter + of this year. How? - by its absence, to a large extent! Scrap supplies have not been properly appreciated as the major component it is in the gold market. Now it could shove the balance of supply and demand so off balance, that demand could fail to find the supplies it needs. Following this will be the third part and conclusion of the article, which focuses on the synergies of the gold market forces and how they interact.
The "Global economic scene and Gold.
Since publishing the first part of this article we have seen gold behave, as it always has, as a barometer of the state of the global economy, or macro-economic scene, not just of the U.S. $. The state of the global economy is set on a recovery, with growth in China as a focal point [followed by India] of global growth. But an impact of this has been to see a rise in the demand for oil, across a broad front, from the U.S., where new production has been extremely slow due to the risks, particularly on the price side, to China, a country containing nearly a quarter of the world's population. As the total amount of oil required to supply this growth burgeons, prices, in the long term have to rise and substantially. Yes, security threats are producing short term price spikes in the oil price which may well be contained with increase in supplies, but these will not be sufficient to cap the oil price, long term. An underlying consequence of this situation will be the shift in the balance of power from buyer to seller. This will, eventually, be included in the oil price formula. China and the U.S. will not act 'in concert' on this front, as demand from their separate nations competes with the other. This will destabilise many elements of the world economy, as great strain is placed on most nations. This lays one of the foundations on which the gold price will rest.
O.P.E.C.'s power is already increasing substantially, as this body sees a reduction in the overall power of the West over demand, for its oil. As non-O.P.E.C. oil supplies diminish from 2015 onwards, the power in the hands of O.P.E.C. rises, still further. The target price level of $22 - $28 set in O.P.E.C. will rise steadily [Venezuela feels it should rises to $25 - $32 right now and others even higher]. Now there is real competition for the limited oil supplies available, particularly as China's demand will rise considerably from present levels in line with the explosive growth there, with the number of cars alone, rising up to 50% per annum. What does this do to the global economy? It has to introduce global inflation again, reducing each nation from a relative 'control' position over its own economy, to a 'response control' over its own economy, a situation that will permit inflation to rise, alongside a deflationary pressure [the two can impact simultaneously in this situation]. Central Banks will focus on protecting growth and the underlying health of their economies. The resulting "Stagflation" will be extremely difficult to handle, with only national and no global controls over the situation.
We have to emphasise that the short term moves in the oil price will cause gold to react as though the two were linked, as we have seen of late, just as the shadowing of the Euro by gold over this year to date, is a short term phenomena.
The markets insistent search for the easy formula to foretell the gold price just isn't there. In the 1970's and 1980's when the oil price rose, they were not "linked" to each other, directly. Yes, they did follow the same overall direction and for the same overall reasons, but linked they were not, so any relationship remains general and not specific. That is why the gold price is not rising at present, yet, either. Once the inflationary impact of the oil price and other factors are measurably affecting the world economy the gold price will rise as a consequence of that fact too and probably more than the relationship indicates it will, at present.
Jewellery Demand to burgeon.
As you see above, the World Gold Council has reported a rise in jewellery and industrial demand. The reason for the rise in industrial demand has nothing to do with the price, simply the need for gold in electronic applications. The intrinsic qualities of gold have shown them superior to other metals, so demand is rising, as demand for electronic equipment is rising and will continue to do so in line with the demand for these products.
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 W.G.C. releases in three months time will show a startling increase on that front, even compared to this report. We could see demand from this sector of the gold market rise above the entire supply for 2003 according to the G.F.M.S. figures. This is before one factors in the extraordinary demand in the second quarter. So here is evidence that this facet of the gold market, one only partly linked to the global economy, has asserted itself on the market, showing how the respect for gold as a store of wealth, goes beyond medium term, institutional reaction to the world economy. 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, as it reflects the decaying state of the world economy, and send the gold price on its next phase of its multi-year "bull" market.
Just how is 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. 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.
[One million ounces of gold equals 31.10 tonnes of gold]
Secondary supply = scrap.
Whilst it is the custom to sell old gold jewellery as partial payment for new gold jewellery, in India and other parts of south Asia and the Middle East, in many other cases old jewellery was being sold for cash, based on the higher gold prices. CPM stresses that it is difficult to get an accurate estimate on gold refining from scrap around the world, as this segment of the market is even more secretive than other sectors. CPM estimated that 350 tonnes of gold were refined from scrap in India in 2003. This represents almost a doubling from the 180 tonnes estimated to have been refined from scrap in India in 2002. They qualify their estimates by saying that, the amount of gold that was refined from scrap in India in both 2002 and 2003 may have been substantially higher than the figures used here and that some estimates put 2002 scrap refining at closer to 280 tonnes, and 2003 recovery at 500 tonnes.
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, in the same way. 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 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.
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 a large 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 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. 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 physical market, who entered the international market to scoop up +465 tonnes, all since the beginning of April this year.
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 unloading what remains of their long positions, the market waits for the last portion of the third quarter of the year and the fourth quarter to see new activity. With scrap sellers out of the market the supply is 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 such a short supply remaining, new buying may find inadequate gold and the price will have to rise 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 [to cover the 100 tonnes of short positions they have just opened], 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 centre stage from now on. 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, if the scrap trade waits for better prices as bargain hunters buy?
Our conclusions and the realities of the synergies of this market will be in the final part of this series.
The publication date of this article was June of this year. In the middle of September 2004, G.F.M.S. the highly regarded monitors of gold demand & supply issued their third quarter report which said the following: -
The first half saw a sizeable 14% drop in old gold scrap to 424 tonnes, in part illustrating growing acceptance of prices at around the $400 mark. The largest decline by area was in East Asia, with Thailand and Indonesia registering substantial falls. The second half is expected to see a yet sharper decline to almost 350 tonnes.
Implied net (dis)investment underwent a massive swing from major investment in both halves of 2003 to disinvestments of 143 tonnes in the first half of this year. Much of the swing was due to long liquidation by more short term investors, disappointed at the performance of the gold price. Implied net dis-investment is forecast to feature in the second half but at a much lower level.
Jewellery fabrication rose a useful 6% to just over 1,300 tonnes with much of the gains occurring in Turkey, India, China and other East Asian countries. Stronger global economic growth, growing acceptance of higher prices and the absence of disasters such as SARS or the official Iraq war accounted for much of the change. This sector is forecast to show marginally faster growth in the second half. Other areas of fabrication saw a rise of 4% in the first half and a similar gain is expected in the second.
Bar hoarding jumped an impressive 66% to 133 tonnes with most of the gain taking place in Asia.
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