Demand for gold was 929.3 tonnes (t) in Q3. Jewellery demand softened by 4% year-on-year, but continued to perform well in a longer term context. Net investment demand increased by 6%, reaching 204.4t. Technology demand dipped to 97.9t as substitution again eroded gold usage. Central banks added a further 92.8t to their coffers. Supply was down 7% in Q3; little changed year-to-date. Read more…

Gold demand by category and the gold price

Source: GFMS, Thomson Reuters; The London Gold Market Fixing Ltd; World Gold Council

Contents

Contributors

Louise Street

louise.street@gold.org

Krishan Gopaul

krishan.gopaul@gold.org

Alistair Hewitt

alistair.hewitt@gold.org

Marcus Grubb

Managing Director,

Investment Strategy

marcus.grubb@gold.org

Diwali shines a light on Indian jewellery

In an otherwise quiet quarter, Indian jewellery was a highlight. Demand jumped 60% to 182.9t (Chart 1). This was the second highest Q3 on record (Q3 2008 pips it to first place, when demand jumped following a steep price decline). True, base effects flatter the year-on-year comparison. The third quarter of 2013 was decidedly weak as the introduction of complicated new measures to restrict gold imports and the subsequent sharp rise in local prices knocked demand. But this quarter, other more positive forces were also at play.

General sentiment among the Indian populace is on the up, aided by confidence in the new government. During a week-long field trip to India in October,² support for Prime Minister Narendra Modi and his economic policies was palpable. Such optimism appeared to be justified by widespread upgrades to Indian growth forecasts. This provided an encouraging backdrop for gold demand. A weakening of the rupee gold price during August and September also supported gold demand to an extent. Although Indian consumers are typically wary of buying gold while the price is still moving, preferring to wait until it settles at a more stable level, the opportunity to buy at cheaper prices proved, for some, hard to resist.

September saw much of the surge in demand, a fact borne out by trade statistics which show a sharp jump in gold imports for that month. This can largely be explained by the onset of the festival season. With Dhanteras heralding the start of Diwali in mid-October, jewellery purchases began to pick up momentum in September. These were magnified as consumers had deferred their gold buying while they waited for the price

to settle at lower levels. The release of this pent up demand during the closing weeks of the quarter accelerated the festival-related buying. Reports so far are that gold sales during Diwali were very strong. Demand for the fourth quarter as a whole is expected to be healthy, but the September surge in imports is unlikely to be replicated.

Ongoing revival of US jewellery market

The desire for Indian jewellery extended beyond the domestic audience as the ripple effects of continued growth in US jewellery demand were felt across the globe. The US sucked in greater volumes of gold jewellery imports from markets as diverse as India, China, Italy, Mexico and Oman (Chart 2).

Third quarter growth in the US market was very much an extension of the trend that has prevailed since early last year. Mounting conviction in the economic recovery has boosted sentiment and whetted consumers’ appetite for discretionary purchases. Gold jewellery has been a clear beneficiary: improving sales of higher carat and non-wedding related items helped demand to the highest Q3 total since 2009.³

Lower gold prices have aided the recovery of US demand as retailers are more easily able to meet key price points without crimping margins. Or, similarly, to increase karatage while maintaining price levels. This has enticed some mass-market retailers back into the gold jewellery sector, which bodes well for the seasonally strong fourth quarter. Recent research from the Shullman Research Center backs this up.⁴ It found that around one-third of high earners intend to buy jewellery during the festive season, with a majority of consumers planning to spend the same as or more than last year on their holiday shopping.

Recycling flows ebb

The economic recovery that heralds good news for US jewellery demand in the months ahead has different implications for recycling. Recycling volumes in industrialised countries have declined as economic prospects have improved and the gold price has probed lower levels. 2008-2011 was an unprecedented period in terms of Western populations selling their gold jewellery to generate funds during times of dire economic need. Of course, the prolonged bull run that took gold to record highs was a key incentive, but ‘distress selling’ was also a driving force.

Since Q3 2011, as confidence about the outlook for the US economy has grown and fears of a euro zone break-up have eased gradually, gold recycling in these markets has fallen back towards pre-crisis levels (Chart 3). But there is still some way to go. Between Q1 2004 and Q4 2007, industrialised countries

recycled on average 91.1t of gold each quarter, and accounted for 37% of total recycling supply. Over the last three years, those figures have been 154.8t and 45% respectively.

This is not just a Western phenomenon. Recycling in developing markets has followed a similar pattern, although the rise and fall have been less pronounced. Developing markets typically tend to be more price-sensitive and recycling patterns often reflect price trends: a significant move higher in prices will flush out a wave of gold jewellery. But the increase is temporary. Once this initial reaction has subsided, recycling settles down and a further price rise is required to stimulate fresh recycling.

The volume of recycled gold supplied to the market year-to- date – 807.2t – is the lowest since 2007 and 35% below the average of 1,250.6t during the peak years 2009-2012. We have highlighted this trend in recent quarters and expect it to continue as we head into 2015.

Jewellery

In the third quarter, 534.2t of gold jewellery was consumed around the globe. On the face of it, the 4% year-on-year decline suggests a weak market. But such comparisons are heavily influenced by the events of last year: Q3 2013 was the strongest third quarter for jewellery demand since 2008, and by a fair margin. Longer term analysis shows a market in good health. Q3 demand was marginally stronger than the 5-year quarterly average of 527.6t, while year-to-date volumes continue to extend the broad uptrend from the low seen in 2009 (Chart 4).

India did much of the heavy-lifting: jewellery demand there jumped to 182.9t, almost matching Q2 2013’s upsurge. India’s market is discussed in detail in the Executive summary.

Demand in China was comparable with 2012. The scale of 2013’s exceptional buying continued to overshadow the market, dictating a 39% year-on-year decline. Demand was, however, broadly in line with both Q3 2012 and the 5-year quarterly average (of 148.2t and 154.9t respectively). As usual, the pattern was strikingly similar in Hong Kong, where consumers from the mainland tend to account for most of demand.

China’s jewellery market continued to normalise following last year’s rapid expansion. The industry consolidated further during Q3, although larger brands have been relatively immune to the crunch. Some have managed to expand. In Wuhan, for example, Chow Tai Fook is building a whopping 436,000 m², multi-billion dollar jewellery park, which will house manufacturing, logistics, sales, training and e-commerce.⁵

Looking at consumer preferences, 18-karat (K-gold) jewellery was relatively more robust than the 24-karat (chuk kam) segment. The government’s anti-corruption drive may have contributed to this trend.

The Golden week holiday in the opening weeks of October lifted demand at the end of the quarter. Reports so far in Q4 suggest that sales during the holiday period were good, but fairly short lived. However, demand should begin to pick up towards the end of the year thanks to the usual boost from Chinese New Year.

Indonesia – largest of the smaller Asian markets – saw Q3 demand dip below 10t. This was partially a response to strength of demand last year. But equally important was the Presidential election in July, which created a degree of political instability and discouraged spending on gold jewellery.

Jewellery demand in Turkey of 19.2t was the lowest Q3 on record. Consumers were unnerved by domestic political turmoil; worrying economic signals; and escalating Syrian violence in close proximity to the Turkish border. The ban on paying for gold jewellery by credit card instalments continued

to hang over the market, although this restriction was partially repealed in October. Consumers buying gold on credit will now be able to pay in instalments for up to four months. This should provide some support to Turkish jewellery demand going forward.

Demand in the Middle East was 36t – 14% weaker year-on-year. Demand for gold jewellery across the region suffered from the comparison with strong demand last year. A trend towards lower-karat and gem-set jewellery encroached on fine gold volumes. However, the long term picture appears to show the market building something of a base, with a series of higher lows from the trough of Q4 2011.

Growth in the US jewellery market – as discussed in the Executive summary – was replicated in the UK. Consumers benefitted from last year’s higher-priced stock having worked its way out of the market. Lower international prices were reflected at the retail level and retailers took the opportunity to start building stocks ahead of the seasonally strong fourth quarter. The 18% increase in Q3 was the fifth consecutive year-on-year rise in UK jewellery demand.

Gold jewellery demand in Russia edged up to 18.6t, marginally above Q3 2013. This was in spite of a rise in the average domestic gold price – in contrast to most other markets – due to a weaker rouble. The market has recovered well since the 2009 collapse, holding above the 10-year quarterly average of 17.5t. However, domestic geopolitical challenges reined in demand growth, the pace of which is slowing.

Investment

As discussed in the Executive summary, subdued investment demand contributed to the relatively stable price environment during the quarter – and vice versa. Net investment of 204.4t in Q3 2014 was 6% higher than in the year-earlier period.

Retail demand for gold subsided as investors continued to digest last year’s price-driven surge in demand for bars and coins. It is important, however, to analyse the bar and coin market over a longer time frame. Third quarter demand of 245.6t was remarkably close to the 10-year quarterly average of 240.6t. Comparing the latest investment numbers with pre-crisis levels shows that demand from this sector is still at multiples of its historic levels: quarterly average demand from 2003-2007 was just 92.2t.

The strength of bar and coin demand compared to pre-crisis levels is particularly noticeable in the European market (Chart 5). It is easy to focus on the rapid escalation of demand in this region during the global financial crisis and draw conclusions as regards recent levels of investment. Yet investment in these markets has undergone a structural

shift: historically demand was virtually non-existent, averaging just 2.6t per quarter during the five years prior to the global meltdown. The fact that Europe now accounts for between 200-300t of demand annually is undeniably constructive for the dynamics of the gold investment market.

ETF outflows were far smaller in scale than those in Q3 last year. As of end-September, ETF holdings have declined by a little under 84t, equivalent to just 12% of the outflows over the same period of 2013. This lends weight to our analysis – as laid out in previous research⁶ – that more tactical investors have largely exited and the remaining base of ETF positions are held as strategic investments.

There was, however, little during the quarter to encourage fresh investment in ETFs as investors kept their gaze locked on the US economic scenario. The prospect of US interest rates remaining low ‘for a considerable time’ and the widely-anticipated end to quantitative easing (QE) by the Federal Reserve eclipsed all other considerations. The soundness of gold’s underlying fundamentals was widely acknowledged, but in itself offered little fresh impetus to drive an increase in investor positions.

Total investment demand was down by 12% at 314.9t. This also captures gold deposit accounts, stock changes that have yet to be allocated at the country level, transactions in the relatively opaque OTC (Over-the-Counter) market as well as any statistical residual. OTC investment and stock flows was estimated at 110.5t in Q3, considerably lower than the 164.2t from Q3 2013.

Much of the year-on-year decline in bar and coin investment can be attributed to the more price-sensitive Asian markets. In particular to China, whose investors were responsible for hoovering up vast quantities of gold bars and coins during the first three quarters of 2013. To give some context, demand from January to September last year was 320.8t. Average like-for-like demand over the preceding five years was 132.5t, just 40% of the 2013 total. Unsurprisingly, Chinese investment demand this year has paused to catch its breath. Something that can be seen in the lack of a price premium in Shanghai. The quiet environment provided China’s notoriously price-savvy investors with a further reason to stay out of the market.

With the exception of the Golden Week holiday in October (when demand briefly picked up as gift-buying was encouraged by a dip in the gold price) fourth quarter bar and coin demand is shaping up to be much the same – steady, but unremarkable. Heading into the all-important Chinese New Year in early 2015 we would expect demand to increase, although the government crackdown on corruption is likely to contain any exuberance.

Investment demand in India did not match the recovery in jewellery demand, weakening by 10%. The soft price environment played a part, as did continued restrictions on the Indian coin market (imports of coins are embargoed). Domestic manufacture of coins was up year-on-year (as indicated by a 53% rise in medals/imitation coins, which is primarily Indian fabrication) but this can largely be attributed to the weakness in the third quarter of last year when the coin ban had only recently been introduced. Year-to-date demand is less than half that of 2013. This in part reflects the anomalous Q2 last year, which was by far the highest quarter on record.

Yet the appetite for investing in gold remains strong in India. Research by Nielsen on behalf of the World Gold Council found that gold products are second only to bank fixed deposits on the list of investment products currently held by Indian investors. Gold ranked equally highly in a poll regarding future investment

plans. And, as you may expect given India’s relatively youthful demographics, the age profile of gold investors is tilted towards those aged between 20 and 40.

Elsewhere in Asia, Indonesia and Thailand together accounted for a 21t year-on-year decline in investment demand. In Thailand, the unstable political climate in the wake of the military coup cast a pall over demand. However, the lack of price volatility was key to the sharp decline in the sector, which has traditionally been dominated by a small number of Bangkok-based speculative players. Indonesian investors were in defensive mood, waiting for the inauguration of the new President and the appointment of the new Cabinet in October, before deciding whether or not to increase their gold holdings. Viewed against the backdrop of very strong demand last year, 2.8t in Q3 seemed particularly weak.

Japanese net investment turned slightly negative for the first time since Q1 2013. Volumes on both sides of the market were very low, reflecting the general global mood. The increase in VAT from 5% to 8% has also curbed demand since its introduction in April.

Investment in Turkey grew marginally, but at 6.6t was very much at the lower end of its historical range. Also, the comparison is with a weak base period. A strike at the Turkish mint during the third quarter of 2013 resulted in a sharp slowdown in coin production during that period.

In the US demand for bars and coins failed to match year-earlier levels. Rangebound prices and continued signs of economic improvement kept investment demand in check. Within the sector, bar demand was considerably more robust than that for coins.

European investment demand was weak in comparison with 2013, as discussed above. The 28% drop in Switzerland was the biggest contributor to the regional decline. This chimes with activity in the ETF space where redemptions were concentrated among the Swiss products. Price stability, the US recovery and investor fatigue towards geopolitical turbulence kept demand under wraps. Conversely, demand in Germany strengthened slightly. Uncertainty over the ECB’s QE measures kept gold on the radar and demand for smaller bars ticked higher on dips in the gold price.

Central banks

With many economic and geopolitical wounds still open, central banks once again sought the protection and diversification of gold. Net purchases of 92.8t in Q3 brought year-to-date net purchases to 335t, in line with 2013 over the same period (324t). Signs are that 2014 will be another solid year of strengthening reserves with gold.

Similar to recent quarters, purchases were mainly from the Commonwealth of Independent States (CIS) (Chart 6). Russia (55t), Kazakhstan (28t), and Azerbaijan (7t) continued to add significantly to their gold reserves. The IMF pruned its growth forecasts in October, recognising that increased downside risks are prevalent: larger gold allocations would provide a buffer in the face of a potential slowdown. While purchases were sizable, the same cannot be said for sales. Gross sales over the quarter amounted to a paltry 4t.

The third Central Bank Gold Agreement (CBGA) drew to a close in September. Only 207t of gold, out of a possible of 2,000t, were sold during the 5-year period; with the majority of these sales (181t) conducted by the IMF as part of its limited sales programme. As the fourth agreement gets underway, the signatories will almost certainly maintain their lack of interest in gold sales.

Chart 6: Central banks continued to strengthen reserves with gold

Source: IMF IFS; World Gold Council

Technology

The tug-of-war between improving economic sentiment and ongoing substitution continued to pressurise gold demand for technological applications. Demand in the third quarter totalled 97.9t, 5% lower than the same period in 2013.

This divergence was no more apparent than in the electronics segment, where demand contracted by 5%. On one hand, the semiconductor market is strengthening as demand for consumer electronics trends higher. This growth is reflective of an improving and more stable global economy, although economic concerns surrounding Europe and China have hampered demand in those regions.

Data released by the Semiconductor Industry Association (SIA) shows that worldwide semiconductor sales reached US$29bn in September (the latest data available). This represents an 8% increase year-on-year, while third quarter sales also rose 8% to US$87bn. Geographically, year-to-date sales were seen to increase across all regions.

Yet losses from substitution to cheaper materials (primarily palladium-coated copper) in bonding wire production continues to impact gold demand in the technology space. This trend is unlikely to diminish in the near term.

Demand for gold for other industrial and decorative uses fell 5% to 22t. A sizable decline in India more than offset modest rises in a number of key markets. Changing fashions, as well as thrifting and substitution, have caused demand for jari thread to stagnate. Conversely, markets in East Asia benefitted from a weaker price environment, with strong export orders for plating salts also boosting demand.

An identical 5% drop in gold usage in dental applications extended the long-term decline in that sector. Cheaper alternatives to gold (such as cobalt: chrome or ceramics) remain a lure for consumers – both for financial and cosmetic reasons.

Supply

In comparison with 2013, third quarter supply was down 7%: year-to-date virtually unchanged at 3,147.4t.

The broad themes surrounding gold supply during the first half of the year continued to play out in Q3. Recycling was well below last year’s levels, languishing around seven-year lows. Mine production edged higher to exceed 800t for only the third time ever (Chart 7). Year-on-year growth from projects that came on stream over the last couple of years had a diminishing impact on aggregate supply. Producers continued to show little appetite for hedging.

The volume of recycled gold flowing into the market continued to shrink. Supply from this source (250.5t) was 25% down year-on-year. The contraction was global: a feature of both developing and industrial markets. This was partly a consequence of gold prices being relatively low and stable, and partly due to ready supplies of old gold being exhausted. Please see the Executive summary for a more in depth discussion of recycling.

The supply of fresh gold from mine production grew marginally: looking ahead we expect this growth to wane. Supply was swelled by growth in output from a small number of relatively new operations that have come on stream over the past couple of years, having been developed during the bull run of the last decade. Yet the additive impact from such projects is now losing momentum. The prospects for further growth are limited. We still anticipate that mine production will level off over the course of the next year or so.

The list of names registering an increase in mine production is familiar, having been the primary contributors for the last few quarters. Canadian Malartic and Detour Lake were prominent among them, resulting in a likely increase in Canadian production at the country level of around 4t. Similarly, Pueblo Viejo in the Dominican Republic made further gains, contributing to country-level gains of up to 2t. Production increased again in China and Indonesia.

Conversely, small-scale declines in mine supply were seen at a broad base of operations across a number of countries. At the country level, mine supply contracted year-on-year in Peru, the US, Australia and Russia.

Hedging activity subsided back to trifling levels in Q3. Deliveries into existing positions outweighed fresh hedging by a mere 15t. New positions were few in number, small in scale and project-related. We see no significant change in this trend as we head into 2015. The relatively large position taken out by Polyus Gold last quarter has been the recent exception, but we expect this to be run down over the course of the next year.

The global hedge book stood at around 146t at the end of September. As we have said before, while new hedging remains scarce, so does the opportunity for existing hedge positions to be closed out. Activity from this sector is unlikely to move the dial on supply over the coming quarters.