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Ronald Stoeferle

Ronald Stoeferle

Ronald is a metals analyst at Erste Group. Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4…

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A Detailed Look at the Increasing Demand for Gold

For the first time in many years investor demand might exceed jewellery demand in 2010. In 2000, investment demand accounted for only about 4.8% of total demand, in 2009 for as much as 37%. We think that this marks a clear bullish trend reversal, setting a new phase of the bull market. In our opinion investors will be dominating the demand side from now on.

Jewellery demand

Jewellery demand continued to fall in 2009, with consumers showing an elevated degree of price sensitivity. Thailand and Turkey recorded the most significant decreases, whereas China actually posted a small increase. The Indian jewellery demand plummeted by almost 20% in 2009 to 340 tonnes. This was due to the high price and the extreme drought, which destroyed a large part of the crop. The Indian farmers were having a hard time compensating for the low income, as illustrated by the low purchases made during the Diwali festival. In the fourth quarter demand picked up substantially again and exceeded 100 tonnes. This improving trend has so far continued in 2010. In the first four months of 2010 jewellery demand was significantly up on the figure of the referential period in 2009. The Bombay Bullion Association reported an increase in demand of 74% to 126 tonnes in the first four months of the year. This is particularly remarkable given that the import tax on gold was raised by 50% to INR 300 (ca. USD 18/ounce). The tax had been raised already in July 2009, which led to an increase in the supply of recycled gold and a decrease in imports.

Inflation rate China vs. India

Inflation rate China vs. India
Sources: Datastream, Erste Group Research

Investment demand

The demand for gold by investors is still on the rise, soaring to 1,270 tonnes in 2009. ETFs especially increased by a substantial amount (594 tonnes). Gold seems to be making it into the asset allocation slowly but steadily, given that it comes with many features that help optimise the portfolio. Because of their negative correlation to numerous other asset classes, the relatively low volatility, and the optimisation of the so-called efficient frontier , precious metals are going through a renaissance of their investment class (please also see the chapter “Gold is the optimal portfolio insurance”). On top of that, investors are realising that gold’s value is not contingent on any promise by a government, institution, or person.

A trend that we described two years ago has now gained more ground: famous hedge fund managers have been gradually discovering their fondness for gold. John Paulson, one of the best-known hedge fund managers in the world, has recently launched a gold fund. Paulson holds large investments in AngloGold Ashanti, Gold Fields, Kinross Gold, Gabriel Resources, and Centamin. On top of that he holds close to 8% in the SPDR Gold Trust, the largest gold ETF worldwide. George Soros, who in Davos had announced that gold was currently the “ultimate asset bubble” with “excessive” valuations , doubled his investment in SPDR Gold last year. The negative public statement thus seems to have been fuelled by self-interest. And Thomas Kaplan , CEO of Tigris Financial, has funnelled all of his assets into gold – both physical gold and companies such as NovaGold and Gabriel Resources. The fact that junior explorers seem to attract a higher volume of investment these days suggests the confidence in the duration of the bull market.

I have never been a gold bug, it is just an asset that, like everything else in life, has its time and place. And now is that time!” Paul Tudor Jones 

Screenshot: Largest shareholders SPDR Gold Trust

Screenshot: Largest shareholders SPDR Gold Trust
Source: Bloomberg Screenshot, 14 May 2010

But not only the hedge funds have discovered the attractiveness of the yellow precious metal. Most recently numerous US pension funds (e.g. Teachers Retirement Scheme Texas and New Jersey Division of Investment) have reported investments in gold ETFs and mining shares.

Generally the investment demand from Asia should continue to pick up speed on the back of the new futures markets, the deregulation of physical trading, and the new ETFs that are currently being promoted massively in Asia. The emerging nations such as China and India, but also Russia, Brazil, and Indonesia show a significantly higher affinity towards gold than the G7 states. That population growth in the emerging markets, which outpaces the growth rates in the developed countries by a sizeable degree, should have positive implications for gold demand in the long run.

For example in Vietnam gold has a higher significance than in the Western world. The Vietnamese per capita demand is more or less on par with the German one, although the German GDP is 40 times as high as the Vietnamese one. According to the World Gold Council (WGC) the Chinese gold consumption should double within the next ten years. If China were to attain the same per capita consumption as Hong Kong or Saudi Arabia, jewellery demand would rise to at least 4,000 tonnes.

Gold demand in grams per capita

Gold demand in grams per capita
Sources: Bloomberg, Datastream, Erste Group Research

Meanwhile the number of counterfeit gold bullions has been on a rapid rise. A number of gold-plated tungsten bullions were discovered in Hong Kong. Moreover, rumours are rife that numerous 16-ounce gold plated tungsten bars had been offered to W.C. Heraeus (the largest private refinery).

A Gold Mine is a Hole in the Ground with a Liar on Top”, Mark Twain

Since the introduction of this financial instrument in 2004, the market capitalisation of all ETFs has increased to currently USD 70bn. We think that the gold mining shares have suffered from this surge and that new gold exposure has been mainly allocated to ETFs. The specific valuation criteria, the operational risk, political uncertainties (nationalisations, legal framework), old scandals (Bre-X), and a lack of experience seem to have led many investors to prefer ETFs over gold shares.


At the end of 2009 the hedged position of gold miners amounted to almost 8mn ounces (i.e. close to 250 tonnes). Barrick Gold reduced its hedge book dramatically. The Canadian market leader has cut its hedged positions by 5.3mn ounces (165 tonnes). In order to fund this strategy, the company increased its capital by USD 4bn and also issued USD 1bn worth of bonds. Barrick’s hedged positions had seen a high of more than 20mn ounces. AngloGold and Ashanti account for the majority (i.e. close to 45%) of the existing positions. We expect de-hedging demand to gradually decrease and believe that in the long run the gold industry may shift towards hedging again so as to ensure that major projects can be planned with a certain level of accuracy.

Central banks

In 2009 we experienced one of the most dramatic trend reversals of the past decades: for the first time since 1988, central banks were net buyers of gold again. On aggregate, almost 400 tonnes were bought. This number includes China’s purchases. Given that central banks are not gold traders but investors with a long-term horizon, this constituted a clear rupture of the former trend. For 2010 and beyond we expect this new trend to continue.

Changes in the officially documented gold reserves of central banks and international organisations 1989-2009

Changes in the officially documented gold reserves of central banks
Sources: Wirtschaftswoche, Bloomberg, Wikipedia

The Central Bank Gold Agreement (CBGA) was renewed in August 2009 for a period of five years. It now stipulates a maximum volume of 400 tonnes of gold (formerly 500 tonnes) to be sold per year. Along with the central banks of the Eurozone, the Swedish and the Swiss central banks also ratified the agreement. We interpret the renewal of the agreement as clearly positive. Generally the agreements tended to stabilise and calm the gold market in the past. After the first agreement had been announced, the gold price increased by 14% in three days.

The CBGA 3 takes into account IMF sales of 403.3 tonnes. 200 tonnes have already been sold to the Indian central bank, 10 tonnes to Sri Lanka, and 2 tonnes to Mauritius. This means that the transactions were settled outside the market. The remaining 191.3 tonnes are supposed to be sold on the market whilst attempting to keep a lid on the impact on prices. Eric Sprott from Sprott Asset Management was interested in buying the 191.3 tonnes but was turned away for paltry reasons. In 2010 the IMF has sold 5.6 tonnes in February and 18.5 tonnes in March on the market. The central banks have only sold 1.3 tonnes since the beginning of the third agreement. We do not expect sales to even get close to the region of 400 tonnes, i.e. the maximum quota, given that the major sales programmes of the European central banks have already come to an end.

The top three holders of gold are Germany, France, and Italy with an aggregate 8,305 tonnes. Germany already announced it would only sell small quantities at best, as did France. Italy may be the biggest question mark. Axel Weber has repeatedly advised against the Bundesbank selling any of its gold, pointing out that “gold sales cannot replace sustainable consolidation strategies in financial politics” . The PIGS countries (Portugal, Italy, Greece, Spain) own more than 3,300 tonnes of gold. There is a chance that these countries may consider selling some of their gold in order to consolidate their budgets in the short run.

Within the framework of CBGA 2, a total of 1,876 tonnes of gold was sold, i.e. 616 tonnes less than the maximum quota.

Volumes of gold sold within the framework of CBGA2

Volumes of gold sold within the framework of CBGA2
Sources: Bloomberg, Erste Group Research, FuW

The Indian central bank bought gold worth USD 6.7bn in December – compared to the Chinese reserves of USD 2.27 trillion, this is a negligible quantity. The Royal Bank of India currently holds close to USD 20bn or 6.5% of its reserves in gold. But the purchase shows a clear paradigm shift: central banks of emerging countries are nowadays prepared to buy gold at market prices in order to diversify their reserves. Venezuela has announced it will continue buying, with 20 tonnes coming from domestic production and the remaining 20 tonnes to be sourced from the world market. Russia has also bought 20 tonnes already in 2010, and Kazakhstan 3.1 tonnes.

Central bank holdings in million ounces vs. gold price

Central bank holdings in million ounces vs. gold price
Source: Bloomberg

China’s official records show holdings of 1,054 tonnes, i.e. some 1.8% of foreign exchange reserves. However, should China actually hold 5% in gold, this would be equal to almost 2,400 tonnes. If China wanted to pass the USA, it would have to buy the entire gold reserves of France, Italy, and Germany. Either way, China will continue to accumulate gold, if only to maintain the current share in terms of total reserves (close to 1.9% at the moment).

Industrial demand

Industrial demand fell by almost 13% from 2008 to 2009. In Q3 and Q4 demand increased noticeably from the electronic sector. The rising gold price tempts some manufacturers into using copper instead, but copper tends to come with suboptimal characteristics in most industrial applications in comparison with gold. On top of that, the input is minimal anyway, and so therefore is the cost factor.

The chemical properties of gold and its relevance for a whole range of technological applications are astounding. For example it is possible to extend an ounce of gold into a thread of 150 kilometres of length. It is highly ductile, which means that one ounce can be transformed into a plate of almost 40 m². Gold is used as light reflector, in the high-wave infrared region (e.g. in aerospace), and as thermal insulator (in windows).

By. Ronald Stoeferle of Erste Group

Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.

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  • Anonymous on March 19 2011 said:
    Barrick Gold lost a butt-load hedging it's Gold at lower prices. Could explain why they don't hedge as much since the price has gone up and will a whole bunch more!

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