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How weak gold prices have become a buying opportunity

For some investors, a dip in buyers’ demand has brought prices down to attractive levels

By Marcus Grubb | Published Sep 24, 2012 | comments

In the second quarter of 2012 there was a 7 per cent dip in demand for gold as financial markets remained unsettled and the sovereign debt crisis persisted to threaten stability of the eurozone.

Around the world, economic and political crises dampened expected economic recoveries and the eurozone crisis worsened, sending parts of the monetary bloc into deep recession. With the outlook remaining uncertain, the list of negative scenarios that may rationally materialise this year or next grows longer.

In the euro area, the sovereign debt crisis remains a persistent threat to stability. In the UK, a stagnating economy has not been revived by a third round of quantitative easing, with GDP falling by 0.7 per cent in the second quarter of the year. In India, a weak rupee, poor current account and slowing growth have reduced demand, while a slowing economy in China has forced consumers to consider their discretionary spending and has led to further easing of monetary policy.

These challenges also weighed heavily on the gold market during the second quarter of the year. With India and China remaining dominant forces in global consumer demand, accounting for 45 per cent of the market, trends in the two nations greatly skewed the picture for global gold demand overall. In India, the weakened rupee pushed gold above the key psychological Rs 30,000/10g threshold, forcing a drop in investment and jewellery demand to 181.3 tonnes. As Chinese consumers reined in spending and gold’s price direction faltered, investment and jewellery consumption in the nation fell 7 per cent.

This dip in Indian and Chinese demand was the main driver for decreases in demand overall. Total demand in the second quarter of 2012 measured 990 tonnes, 7 per cent less than levels earlier in the year. Demand for jewellery, technology and investment portfolios was weaker, though demand for investment products remained within the historically higher range established in the third quarter of 2008.

As prices consolidated around the $1,600/oz mark, the lack of a clear trajectory prompted a mixed response among consumers.

Some, seeing it as a pause in prices, added to positions, while others chose to liquidate holdings and realise profits.

Major buyers of gold in the second quarter of 2012 were central and eastern European banks seeking to diversify reserves away from dollar and euro-denominated assets and capitalise on opportune entry points into the asset.

The National Bank of Kazakhstan continued with its programme of bolstering reserves, increasing its 2012 target for gold purchases from 24.5 tonnes to 26 tonnes. The bank has previously stated that it plans to buy the country’s entire domestic production over the next two to three years in order to reduce its reliance on the dollar, targeting an allocation to gold of 15 per cent in foreign exchange reserves.

Russia’s central bank similarly added a further 22.3 tonnes to reserves over the quarter. The country’s gold holdings now stand at around 920 tonnes, or 9 per cent of total reserves. Meanwhile, Ukraine made a relatively small acquisition of 3.6 tonnes in the second quarter, representing 10 per cent of the country’s total gold holdings.

Among investors, a 15 per cent year-on-year increase in European demand for gold bars and coins confirms the strength of conviction in developed markets of gold’s capital preservation properties. Across the region, 77.6 tonnes of gold were bought – 19 per cent up on the five-year quarterly average, with investors’ sentiment boosted by favourable prices and a worsening outlook for the eurozone. Germany registered a 51 per cent growth in volume, while markets elsewhere in the region registered a more moderate 6 per cent increase. Based on the five-year quarterly averages, demand was up 72 per cent overall.

The increased investment demand was not restricted to European markets. Thai demand grew 19 per cent year-on-year in a market dominated by a handful of active, large-scale players, with demand activated by dips in the price during May. In Vietnam, demand grew 30 per cent year-on-year. Gold’s role as a hedge against inflation is a critical attribute for Vietnamese investors, where domestic inflation rates (forecast at roughly 10 per cent for 2012) remain high compared with global averages.

While jewellery is the largest single driver of demand annually at 50 per cent of annual demand, emerging country central banks are now major purchasers of gold as they look to diversify their foreign currency reserves and protect their national wealth.

Marcus Grubb is managing director of investment for the World Gold Council

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