Mining’s old guard needs strong medicine
A new report details subpar investor returns in the mining industry over the last decade, particularly big cap diversified companies which have not adapted to new realities.
By Julian Murdoch
The World Gold Council released its Gold Demand Trends for the first quarter of 2011 last month. Not surprisingly, gold demand grew 11 percent compared with the first quarter of 2010, as the average gold price for the quarter rose 25 percent year-on-year. It’s an as-expected quarter. But there are definitely some surprises. Let’s take a look at just where that demand growth came from.
Jewelry
The jewelry sector has always been, and remains the big player, accounting for a full 57 percent of global gold demand. Global jewelry demand reached 556.9 tonnes, up 7 percent compared with the first quarter of 2010, despite price increases. (The World Gold Council compares Q1 2011 with Q1 2010 to account for seasonal variance.)
But jewelry demand isn’t equal in all areas of the world. In the big gold countries — China and India, which account for 63 percent of jewelry demand between them — demand increased, especially during the first part of the quarter, when gold prices experienced a bit of a price correction. We saw a situation where not only were consumers buying, but retailers were also replenishing their stocks with gold at lower prices.
India alone bought 206.2 tonnes of gold, up 12 percent compared with the first quarter of last year. In fact, Q1 ’11 showed the strongest demand for gold jewelry since the third quarter of 2008, when gold prices dropped precipitously. The World Gold Council is expecting the second quarter of this year to remain strong in India as the country heads into both its wedding season and the Akshaya Tritiya festival — both traditional occasions for gold gift giving.
Demand for gold jewelry in China reached 142.9 tonnes, up 21 percent from the first quarter of 2010. Forces behind this increase included strong jewelry buying for the Chinese New Year holiday and ongoing inflationary forces in China. (The People’s Bank of China raised interest rates twice during the quarter, fueling inflation fears.) Among consumers, there was also a widely held belief that gold prices would continue to rise, so many bought gold when prices dipped.
Gold jewelry demand was so strong in China that the Demand Trends report noted that some domestic platinum group metal producers were shifting to gold production to cash in on the demand interest.
But not everyone is buying jewelry, or if they are, they’re buying lighter pieces — 14 carat or even 9 carat gold — in deference to the price increases.
Japan was the weakest of all markets in the first quarter, and not just because of the earthquake and tsunami. Prior to those disasters, local gold prices were high and consumers were buying lighter pieces of gold, and due to currency fluctuations, the buying opportunities for yen-gold investors didn’t seem quite as attractive as they did for say, U.S. dollar investors. South Korea and Thailand were also feeling the effects of higher gold prices.
In the Middle East, the high gold prices combined with political unrest resulted in a weak quarter for jewelry demand. In Egypt, gold jewelry demand dropped 39 percent as events unfolded, with many selling, instead of buying gold. One exception in the Middle East was the UAE, which saw an increase in demand for gold jewelry of 5 percent.
Investment
Jewelry may be the largest sector responsible for gold demand, but within the investment sector, demand grew 26 percent compared with Q1 of 2010. Bars and coins was the area with the fastest growth. Physical bar demand increased a whopping 62 percent in Q1 compared with Q1 of 2010.
The January price dip allowed investors to enter the gold market or increase their holdings, and many chose to do so with the purchase of physical gold bars and official gold coins.
The strength in physical gold demand is in sharp contrast to demand for ETFs and similar products, which experienced net outflows to the tune of 56 tonnes. Here’s the chart we always include in these analyses, and for the first time since we’ve been covering the gold demand report, the X-axis has a negative:
Profit-taking and portfolio rebalancing in January are cited as explanations in the report. It is worth noting that the majority of the outflows occurred in the U.S. and U.K. markets with other markets reporting net inflows into ETFs. In the U.S. alone, through the end of May, gold ETFs had net outflows of $1.8 billion.
But this profit-taking (or plain old disillusionment with gold) seems to be a contagion of the Western world, not the Eastern. China had the strongest level of investment for the quarter, with demand reaching 90.9 tonnes — almost double the 40.7 tonnes seen in the first quarter last year. It is becoming increasingly easier for Chinese investors to access physical gold bars, especially with the February launch of the “Only Gold Gift Bar” by the ICBC and the WGC. By the end of the quarter, 1.8 tonnes worth of the 10 to 1000 gram bars had been purchased.
Supply
Total gold supply decreased 4 percent compared with Q1 2010 to 872.2 tonnes. But it wasn’t the mine supply that decreased. In fact, total mine supply increased 9 percent to 653.9 tonnes, with less producer hedging and more actual ore coming out of the ground. The decrease came from central bank purchases. As we discussed in February, central banks are no longer selling down their assets, removing that source of supply from the market. In fact, many countries continue to increase their gold reserves in order to stabilize their economies. Central banks around the world purchased a total of 129 tonnes of gold during the first quarter of 2011, which is more than was bought during the first three quarters of 2010. Mexico alone bought 93.3 tonnes of gold, increasing its reserves to over 100 tonnes.
Moving forward, the World Gold Council expects central banks to continue to be net buyers of gold.
The central banks of emerging countries remain underweight in their holdings of gold, notwithstanding the recent purchases reported here. These central banks are likely to continue to increase their holdings of gold as a means of preserving national wealth and promoting greater financial market stability.
The last source of gold — recycling — actually decreased 6 percent below first-quarter levels last year even though gold prices were 25 percent higher. It seems that consumers across the board are waiting for even higher prices before pulling out grandma’s gold necklace to sell.
Conclusion: The End Of The ETF Run?
So what are we to make of the first-quarter numbers? ETF investors are not, it turns out, a bottomless pit of demand. ETFs, with their easy tradability, are the tool of choice for gold speculators, not just investors. That speculative money is much more likely to head to the door when prices get out of line, or when momentum turns, and that’s precisely what we’ve seen so far this year. Whether this trend continues, particularly in Europe, likely depends on Western perceptions of the global economy.
