Gold demand in Q2 2014 was 964 tonnes, lower compared with Q2 2013 but in line with its 10 year average. Jewellery demand weakened year-on-year, but the broad 5-year uptrend remains intact. Investment demand pulled back from the extremes of last year amid relatively stable price conditions. Central banks continued to buy gold at a steady pace. Read more…

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

Demand in the Technology sector declined by 3%. Economic improvement in a number of consumer countries offset the impact of continued substitution away from gold (in favour of relatively inexpensive alternatives) in electronic applications. Central banks continued to make net additions to gold reserves,

purchasing 117.8t in Q2. Year-to-date net purchases amount to 242.1t. Viewed on a half-yearly basis, demand from this sector has been remarkably consistent since the beginning of 2011.

Gold market steadies in calmer waters

So far this year, the gold market has steadied following the extreme moves that were seen in 2013. The rapid 25% drop in the gold price during the April-June period of 2013 sparked a leap in gold demand that we have heard described as a ‘once in a generation’ event. By contrast, the recent quarter saw the US dollar gold price hold within a relatively narrow sideways range (Chart 1) with the result that price volatility in the second quarter was well below average levels.² This became something of a self-fulfilling cycle as gold investors, lacking strong conviction in their price expectations, held off from buying gold – thereby further contributing to the subdued price environment.

A decline in local price premiums in regional markets – notably India and China – further confirmed a muted appetite for gold, after a great deal of purchasing was effectively brought forward during last year’s rush.

The second quarter saw a continuation of many of the factors that were in play during Q1: the huge stockpiling of gold that took place in Asian markets during 2013 was still, to some extent, being digested; the election and import restrictions forestalled Indian consumers; bar and coin investors continue to sit on the sidelines; while jewellery consumers in the US and UK were further encouraged by improving economic conditions.

A broader perspective

Year-on-year analysis of Q2 demand inevitably brings into focus the exceptional events of the previous year. Looking at the market through a wider lens shows gold demand to be more in line with longer term norms. Taking jewellery as an example, Q2 demand is just 2% below its five-year quarterly average, continuing the general rising trend that began in Q1 2009.

In particular, the larger markets of China, India, Turkey, Russia and the Middle East were notably closer to their

five-year average levels. This seems to verify reports we have heard from market contacts of more measured behaviour among gold consumers, who demonstrated a more ‘needs-based’ approach to jewellery buying in the second quarter.

In a historical context, bar and coin investment is comfortably within the higher range established in the post-financial crisis world (Chart 2). Nonetheless, it is considerably weaker than jewellery relative to the long term picture, down 20% on its five-year quarterly average. China and India account for the bulk of this weakness. Indian investors had their hands tied by a number of factors: the ban on coin imports; uncertainty created by the election; and the restrictions that were imposed on movements of cash and other hard assets³. Chinese investment demand was suppressed by a number of factors, including lack of price direction, uncertainty around future price trends, and the hangover from last year’s buying frenzy.

Supply to slow beyond 2014

Turning to the supply side of the market, 2014 could potentially be a pivotal year. In line with our prediction in the previous issue of Gold Demand Trends, mine production posted another increase in the second quarter. Year-to-date, mine production has delivered an additional 58.2t of gold to the market vs H1 2013.

We expect this rate of growth to slow in coming quarters as the supply pipeline starts to thin and producers face limited opportunities to impose further cost cutting measures. Indeed, mine supply may have peaked and will likely plateau over the course of the next 4-6 quarters as a result.

The impact of mine production on supply has been further magnified over recent quarters by hedging activity, which contributed 50t to total mine supply in the second quarter. The prospects for hedging are discussed in more detail in Supply, but this development is unsurprising in the longer-term context of the virtual eradication of the global hedge book from its peak in 1999. We have argued for some time that new producer hedging is unlikely to contribute significantly to supply – a view we maintain (see Supply).

Year-to-date, recycling activity has generated supply of 578.3t – the lowest first half total since 2007. The environment of stable gold prices has discouraged consumers from selling their gold holdings. Recycling by consumers in industrialised markets contracted modestly, but appears to have reached a floor.

Jewellery

Jewellery demand historically has accounted for over half of global gold demand and Q2 was no different at 53%. The year-on-year decline was predictably dramatic, given the remarkable levels of demand seen in Q2 2013. Jewellery demand on a year-to-date basis was notably weaker than H1 2013, but seems to be extending the broad upward trend from the base established in the depths of the financial crisis in early 2009 (Chart 4).

Almost without exception, Asian and Middle-Eastern countries experienced double digit declines in demand. On the other hand, western markets made year-on-year gains with the exception of Italy, where – although local demand is down – the fabrication sector is benefitting from improved US demand and re-stocking in other key markets.

China was the market most affected by the comparison with Q2 2013, which was the highest quarter ever for jewellery demand in that market due to the intensity with which consumers responded to the price decline. The impact was mirrored in Hong Kong, where mainland consumers account for much of demand.

The second quarter began as the first had ended, with consumers adopting a more cautious, considered and ‘occasion-driven’ approach to gold jewellery buying. This is perhaps best illustrated by comparing 2014 with 2012, arguably a more typical year for Chinese gold demand. Year-to-date, Chinese jewellery demand is 16% above the same period of 2012. Between 2008-2012, H1 demand increased on average by 16% year-on-year (with a minimum increase of 10% and a maximum of 28%). In a sharp deviation from the trend, H1 2013 demand grew by 48% year-on-year. 2014 demand therefore appears to have reverted towards more of a trend level.

Reports indicate that Chinese consumers are more interested in buying gold from reputable brands for a specific reason, rather than the indiscriminate acquisition that was seen last year. A weaker RMB pushed up domestic prices, which also contributed to the more muted environment. Competition in the sector remains fierce after the dramatic expansion that took place in 2013 and the industry is set to contract throughout 2014 as much of the excess capacity in manufacturing and retail is squeezed out. This process has already begun and is likely to continue for the remainder of the year.

Demand in India unsurprisingly fell short of Q2 2013’s surge, but remains robust in a historical context, exceeding its five-year quarterly average. Relatively stable prices helped consumer sentiment. Akshaya Tritiya-related buying was healthy, particularly in Southern India, and wedding-related purchases were steady, notably among high-end retailers.

However, the big story of the quarter was the general election in mid-May. High value purchases had been restricted in the run up to the election, which kept a lid on demand and helps to explain the prevalence of ‘new for old’ activity (exchanging old jewellery to help fund purchases of new jewellery) during the quarter. Demand tailed off quite sharply following the election as the market waited to see whether the newly-elected government led by Prime Minister Modi would relax the import restrictions on gold. An immediate measure was introduced by the Reserve Bank of India allowing 5 star trading houses⁴ to import gold, which had the instant impact of releasing supply pressure, as evidenced by the sharp drop in domestic market price premiums (Chart 5). However, no further relaxation of the restrictions were forthcoming and, combined with the onset of the seasonally quieter gold buying period, demand was very subdued for the rest of the quarter.

Notwithstanding this drop in consumer demand, unofficial flows of gold into India continued apace during the second quarter, particularly during the first half as premiums were pushed up. Such flows will likely build momentum over the coming months as the market moves into the seasonally stronger period of Diwali and the wedding season. The one caveat is the monsoon season, which is key to overall market sentiment and, although improving, is currently still below average levels.

Among the smaller East Asian markets, Thailand has been notable for its weakness year-to-date, amplified by a comparison with last year’s relatively strong performance. However, the decline also reflects the country’s recent period of political instability and its impact on consumer sentiment, tourism and economic health.

The 20% year-on-year decline in Turkish jewellery demand, as well as reflecting 2013 strength, was the result of domestic issues. A tough clampdown on payment by credit card instalments curbed demand: repayments were subject to strict time limits – or in some cases banned. The lower end of the market felt the impact most keenly, while larger, more-established brands were relatively resilient. Ongoing political turmoil continued to hurt consumer sentiment, which had a clear knock-on effect on gold jewellery demand.

Over the year-to-date, jewellery demand in the Middle Eastern region is 8% below 2013. The escalation of violence in Iraq had a deleterious impact on demand across the region as a whole and demand slowed in June ahead of Ramadan. Nevertheless, the region as a whole remains relatively healthy, particularly as non-resident Indians provide a steady source of demand for the 22-carat segment.

In a marked departure from the weak year-on-year comparisons seen among the eastern markets, US jewellery demand saw a fifth consecutive quarter of year-on-year growth. The market continues to absorb higher imports of gold jewellery, notably from India, China and Italy, the strength of which indicates growing confidence across the domestic supply chain, aided by higher margins. Promotions such as ‘May is Gold Month’ generated a good response among consumers, who continue to feel the benefits of an improving domestic economy.

UK consumers remained similarly upbeat – jewellery demand for the first half is 25% ahead of the same period last year, albeit that absolute volumes remain very low. Hallmarking statistics show growth across all carat segments, which has been helped by a stronger currency keeping the sterling price down.

Investment

The re-balancing of gold investment that occurred in Q1 carried through into the second quarter as flows continued to pull back from the extremes witnessed last year (Chart 6). Bar and coin demand was well below Q2 2013’s record high and likewise ETF outflows moderated significantly compared to the unprecedented outflows of last year. The net change in year-to-date investment demand was minimal: 1% higher than the first half of 2013.

The huge purchases of bars and coins made in the first half (and particularly the second quarter) of last year continued to overhang the market, creating a general reluctance among investors to add further to these holdings so far in 2014. The sideways range that defined the gold price for much of the second quarter also contributed to the subdued environment for bar and coin demand as investors globally looked for stronger cues as to its future direction.

ETF outflows in the second quarter were far below year-earlier levels, at just under 40t. The bulk of the quarter’s outflows occurred in April, diminishing in May before turning to a marginal inflow in June. This continued in July, with data showing net inflows of around 9t. Net reductions in gold ETF holdings over H1 2014 amounted to 42.5t, a figure that pales in comparison to the almost 580t of net outflows seen in the same period of last year.

Total investment demand in the second quarter amounted to 341.1t. This includes the Over-the-Counter (OTC) investment and stock flows line item, which – in addition to being a statistical residual – captures the less transparent elements of investment demand (such as transactions in the OTC market and flows into and out of gold deposit accounts) in addition to any as-yet unallocated shifts in gold stocks.

The data seems to bear out reports that, among the institutional and High Net Worth investor space, 2014 has seen a shift towards a more ‘balanced’ view of the market with investors reportedly being comfortable with current gold holdings and asset allocations more generally. While the washout of 2013 seems to be behind us, with investors showing limited interest in adding substantially to short positions, the impetus to initiate sizable purchases is lacking.

The atmosphere of calm consolidation following the sharp swings of last year is likely to continue throughout the remainder of 2014, barring any significant and unexpected economic or geopolitical events.

China and India together accounted for over half of the 56% year-on-year decline in bar and coin demand, a fact that highlights both the sheer size of these two markets and the unusual nature of last year’s demand. Chinese investment demand declined to its lowest in almost four years, with both commercial banks and jewellers seeing a slump in sales of bars and coins. Price-sensitive investors were discouraged by the lack of price volatility in gold during the quarter. Another reason for the decline was the recent crackdown on bribery and corruption, which has strongly discouraged purchases of bars and coins, along with other luxury gift items.

Indian investment demand, already enormously overshadowed by last year’s record levels, continued to be hampered by government policies banning coin imports. Sales of coins and investment products during the auspicious Akshaya Tritiya festival were very muted, with many consumers instead shifting their attention to jewellery. As with the jewellery segment, coin and bar purchases were impacted by pre-election restrictions on the free transport of large amounts of cash and assets, as well as by uncertainty over whether the incoming government would loosen import regulations.

The progress of the monsoon, which is currently below average levels, will be an important factor in determining whether investment demand recovers back to longer-term average levels towards the end of the year.

Thailand and Vietnam also saw considerable falls in bar and coin demand. The fall in Thai investment owed much to the size of demand in the year-earlier period, as well as to the stable price environment. Bar and coin demand in Thailand is dominated by a number of investors who trade actively and the lack of price volatility offered fewer opportunities to do so during the second quarter. We would expect any increase in price volatility to generate a corresponding pick up in investment activity.

Vietnam’s investment market remains under state control, with gold bars auctioned by the State Bank of Vietnam at regular intervals. Unofficial flows continue to supplement the official supply and reports suggest that demand remains solid, albeit at much lower levels than were seen during last year’s declining price environment. 2014 has seen a pause in the schedule of the central bank’s gold auctions, causing a supply squeeze that has kept the domestic price premium high at around US$100-150/oz. As a result, interest in chi rings (plain, gold rings with low mark-ups) as an investment proxy remains high and will increase if tight supply conditions persist in the bar market.

Investment demand in Turkey, although significantly lower year-on-year, was in line with its five-year quarterly average. Reports suggest that prices closer to 80TL/g are

viewed as better levels to buy and would encourage a pick-up in demand.

European bar and coin demand witnessed a major slowdown in the second quarter, to the bottom end of the post-financial crisis range. The drivers of investment in these markets remain little changed – namely, concerns over economic growth, wealth diversification and, in some cases, mistrust of the banking system. However, new entrants were few and far between during the second quarter and existing investors largely remain comfortable with their already high levels of gold holdings, particularly following 2013’s upsurge.

The second quarter also witnessed a strong decline in US bar and coin demand. This was partially a result of the fact that demand was, to some degree, brought forward during the first half of 2013. Furthermore, price stability, along with uncertain price expectations and an improving economic environment, meant investors lacked a strong incentive to add to holdings during the quarter. That said, good levels of activity were reported in the secondary coin market during the quarter. Retail investor behaviour has undergone a noticeable change in recent quarters, with more of an emphasis on two-way coin trading.

Central banks

Central bank net purchases in the second quarter totalled 117.8t, the 14th consecutive quarter of net buying from this consistent category of demand. This marks a 28% increase over the same period in 2013, and brings H1 total net purchases to 242.1t (Chart 7). In value terms, net purchases in Q2 were worth US$4.9bn.

Economic and geopolitical events throughout the world are sources of ongoing instability and uncertainty. Such events reinforce the requirement for appropriate risk management by central banks through holding gold reserves for asset diversification.

Emerging market central banks remain the dominant reported purchasers, with Russia (54t), Kazakhstan (7t) and Tajikistan (3t) being the most significant within the last quarter. Smaller (less than 1 tonne) net increases to gold reserves were also seen in Mexico, Serbia and Kyrgyzstan amongst others.

During Q2, Ecuador reported it was using its gold reserves to engage in a three year gold swap in order to raise favourable liquidity. At the beginning of June, the Banco Central del Ecuador stated it had entered into a swap

agreement with Goldman Sachs, which would see a proportion of its gold reserves being swapped for securities which would generate greater returns. While the details of the transactions are not in the public domain, given Ecuador has been out of the bond market since 2009, it seems very likely that this transaction helped to improve its domestic financing situation. The gold swap was followed later in the month with its first bond issuance since 2009, where they successfully raised US$2bn.

The announcement of a fourth Central Bank Gold Agreement (CBGA) in May, coming into effect towards the end of September, was a key event in the quarter. The statement was unambiguous in that “Gold remains an important element of global monetary reserves” and further asserts that signatories currently “do not have any plans to sell significant amounts of gold.” During Q2, sales under the current – third – agreement totalled less than 2.5t, with Germany again accounting for the majority of this owing to their coin-minting programme.

Technology

A more robust economic environment and improving consumer sentiment helped to stem losses from substitution in the Technology sector. Demand recorded a modest 3% year-on-year decline.

Mixed factors resulted in a 2% fall in gold used in electronics. Gold continued to lose market share in the production of bonding wire (to copper primarily), due to ongoing substitution by fabricators to cheaper alternatives. Silver has also recently emerged as a competitive material in this space. More positively, growth in the production of semiconductors to some degree insulated gold from the losses in bonding wire. The latest figures released by the Semiconductor Industry Association (SIA) reported 11% growth in the value of global semiconductor sales in Q2, after record monthly sales of US$28bn in June. Year-to-date sales are up 11%.

“Through the first half of 2014, the global semiconductor market has demonstrated consistent, across-the-board growth, with the Americas region continuing to show particular strength,” said Brian Toohey, president and CEO, Semiconductor Industry Association. “The industry posted its highest-ever second quarter sales... Looking forward, macroeconomic indicators... bode well for continued growth in the second half of 2014 and beyond.”

Other industrial and decorative uses for gold slipped 4% to 23.3t, in line with the five-year quarterly average. China and India were largely responsible for the decline. In the former, demand for electroplated giftware continued to shrink as a result of anti-corruption legislation. In the latter, jari thread (used in clothing) was constrained by the ongoing trade restrictions.

Dental demand for gold remains in secular decline; down 7% year-on-year. Gold used in dentistry has in been decline since the late 1990s. Rising gold prices and the emergence of increasingly reliable alternatives drove substitution away from gold to more affordable materials over this time, although changing societal trends and health insurance policies have also played their part. The initial prevalence of base metal alloys such as cobalt:chrome has been overtaken by a shift to ceramic applications in more recent years.

Supply

During the second quarter, 98.2 additional tonnes of gold were supplied to the market compared with Q2 2013. This 10% increase was almost solely due to growth in mine supply; recycling was little changed. Year-to-date, supply is up 5% as the impact of fresh hedging and mine production growth outweighed an 8% decline in recycling activity.

Mine production increased by 4% for a second consecutive quarter, although 2014 is likely to be the peak. Producers have, over recent quarters, implemented a range of operational measures to manage costs and improve efficiency. This trend continued through Q2, but we expect this impact to tail off throughout the remainder of 2014 as the scope for producers to implement further measures recedes.

Mine production over the year-to-date has benefited significantly from positive base effects in the supply pipeline. A number of new operations came on stream over the past year or two, notably in Canada and the Dominican Republic. Incremental growth generated by the ramp up in production at these projects has had a considerable impact on total supply. However, as these operations mature, year-on-year growth will decelerate as the base periods drop out of the comparison, further exaggerating the slowdown in supply in the second half of the year.

In terms of individual contributors to growth, small-scale additions were seen in a fairly wide range of countries, including Indonesia, where Grasberg continued to increase production after the labour disruption that impacted production in 2012.

Canada, as already mentioned, saw continued growth at new operations including Detour Lake, Canadian Malartic, Young-Davidson and Westwood. Similarly, Pueblo Viejo in the Dominican Republic generated growth, having started commercial production in late 2012. Future growth at these projects will, however, have a diminishing impact on total supply in the coming quarters. Continued consolidation in the Chinese mining industry contributed to an increase at the country level.

Net producer hedging of 50t in Q2 compared with negative hedging of -15.1t in the same period of 2013. The 50t of net hedging implemented during the second quarter was the result of a project-based transaction announced by Russian producer Polyus Gold International. Although different in nature from the small-scale, project financing that has largely comprised the hedging activity of recent quarters, the position is project-related in that it aims to safeguard revenues as the company continues to develop its pipeline – notably, the sizable Natalka project.

Hedging activity over the year-to-date has contributed 58.6t of gold to total mine supply and is likely to be net positive for the year as a whole. In a long term context however, the extent of the fresh hedge positions is minimal (Chart 8). The outstanding delta-adjusted hedge book has been slashed from the peak of over 3,000t in 1999, to stand at just 75t at the end of last year, making it difficult – if not impossible – for deliveries into existing positions to continue to outweigh even small-scale project hedging. A return to ongoing strategic hedging is still seen as unlikely given market conditions and continued investor scepticism.

Recycling in the first half of 2014 was the lowest since H1 2007 and close to average pre-crisis levels, a time when the gold price was some 50-60% lower. Gold supplied by the recycling of above-ground holdings was more or less flat year-on-year as the steady gold price environment removed an incentive for consumers to sell their holdings. Supply from this sector continues to drift downwards from the peak levels of 2009 and 2010.

Continued recovery in industrialised economies led to a further decline in recycling in these markets. Scrap dealers in the US and UK, which multiplied and flourished as recycling boomed, have seen their businesses dry up over the last year or two and closures have been widespread. The prospect is for secular decline in these markets as readily-available stocks are already severely depleted, flushed out by the sharp wave of distress selling that was seen in the peak years, a repeat of which seems unlikely.

Developing markets, meanwhile, remain more adaptable to market conditions and changes in the gold price in particular. Indian consumers recycled greater quantities of gold in Q2, much of which was concentrated in the first six weeks of the quarter – ahead of the elections – as the price premium was squeezed higher. This was mirrored in the ‘exchange’ activity noted in the jewellery space, as consumers helped to fund Akshaya Tritiya and wedding-related purchases by exchange and sale of existing jewellery items.

While recycling has settled back from the peak levels, it has the potential to react swiftly to changing market conditions and price levels. Particularly given the outlook for supply growth to slow, recycling will continue to play a fundamental role in maintaining market balance.

Gold demand data providers

We aim to provide a holistic view of the gold market. As discussed in Gold Demand Trends Q1 2014, due to the breadth and complexity of the gold market, we believe a comprehensive analysis is best supported by a hybrid data sourcing model. In addition to supply and demand data sourced from GFMS, Thomson Reuters, we use a large number of supplementary data sources to help inform our view of the market and provide additional insights. The gold market, however, is constantly evolving. We must assess continually how gold market data is sourced and presented to ensure its relevance and to maintain our ability to provide valuable market insights.

Three of the leading gold supply and demand data providers are CPM Group, Metals Focus and GFMS, Thomson Reuters. Chart 10, below, presents these consultancies’ estimates for 2013 gold jewellery fabrication demand for China, India and the US.

As would be expected, country level estimates across providers are broadly consistent. Despite each data provider employing its own methodology, estimates across all three consultancies are similar. The biggest area of difference is China. This is perhaps to be expected given the tremendous growth in demand China saw in 2013. Our recent note, Understanding

China’s gold market, discussed the size and opacity of China’s gold market, which further explain why differences in estimates might be larger than for other, more transparent countries. The message they all convey, however, is clear: China is the world’s largest gold market.

Recognising that differences in supply and demand data exist, we use several criteria to assess data quality. We evaluate the provider generating the data in terms of experience, resources, and market coverage, amongst other factors. We also cross-check the data to ensure it can be explained in relation to other publically available sources of information and that it is consistent with our knowledge of local markets. We have offices in India, the US, and China (including Hong Kong), and our connections with local industry provide further insights.

In Gold Demand Trends we present a broad-based view of the gold market. Sharing this information as broadly as possible is a key part of our mandate as the global authority on gold; it helps a range of people around the world understand how the market is evolving. Equally important, however, is ensuring the data we use is best in class. High quality data on the gold market is good for all market participants and is an objective we continually work towards.