Gold demand growing as supply starts to fall

(February 28, 2018 - by Lawrie Williams)

Gold investors should be looking at gold for the long term.  Demand growth fundamentals are looking positive to this writer, while there is, in parallel, the prospect of diminishing supply.  It is the combination of these factors that makes gold so appealing in the medium and long term.  Even in the short term the general consensus among many analysts is that the gold price will likely rise as well – perhaps not by much but many are predicting a $1,400 gold price, or higher, by the year end.  The recent price drop is seen as a blip in an overall upwards path for the yellow metal.

The big factor to take into account is the sustained move into the middle class earnings category in the world’s biggest population nations – China and India – both of which currently have around 1.3 billion people.  By contrast the USA only has a population of some 320 million and is currently experiencing very slow population growth.

By contrast, China, currently the world’s largest gold consumer, is seeing huge growth in numbers entering the middle class classification.  Total population is estimated at over four times that of the USA.  Major, and well respected, consultancy McKinsey recently went on record as predicting that by 2022, 76% of China’s urban population will have moved into the middle class bracket.  That nation’s urban population numbers around 750 million, so 76% represents around 570 million people in what McKinsey describes as the middle class earnings bracket – more than one and three quarter times the total population of the USA.  McKinsey, however, classifies the Chinese middle class as urban households earning between US$9,000 and US$34,000 annually – which may seem low by U.S. standards, but purchasing priorities tend to be hugely different with many Chinese middle class families, even at the lower end of this income bracket, buying small amounts of gold on a regular basis as their prime savings mechanism.   The Chinese banks make this an easy process.

In the West gold is mostly seen as a tradable asset and is perhaps more readily sold as and when the price rises.  There are some in the West, notably large investors, who may see gold as a safe haven form of wealth protection, but in China that tends to be the norm rather than the exception and gold holdings there tend to be, consequently, in firmer hands than in the West and only released back into the market in cases of dire need.  Gold may also be held as jewellery and artefacts which, again in the East, tends to be a realistic option because price mark-ups are very low.

The gold purchase pattern in India, the world’s No. 2 gold consumer, somewhat mirrors that of China, although probably coming from a lower base.  But the birth rate is higher and the total population is set to exceed that of China in the next year or so - it may already have - and continue to grow at a significant rate.  Gold hoarding is an integral part of the Indian psyche, perhaps more so than anywhere else in the world, so it wouldn’t surprise us to see Indian gold demand move back above that of China in the next few years, despite the government’s attempts to thwart this because gold imports are a substantial component of the country’s current account deficit!  This year we have already seen a recovery in Indian gold imports to over 900 tonnes after an exceptional low of just over 580 tonnes in 2016.  The 2017 figure is still below those of 2010-2012 and 2015, but is indicative of a possible return to the old higher levels.

As a proxy for gold flows from West to East we only have to look at Swiss gold export figures with around 80% of these gold exports tending to be destined for Asia and the Middle East.  The Swiss figures are particularly significant because the Swiss gold refineries provide the key conduit for converting doré (impure) bullion, received from mines around the world, and large gold bars (mostly imported from the UK) into the small bar and wafer sizes in demand in the East.  Overall, Swiss refineries currently process a volume equivalent to around two-thirds of global new-mined global gold output annually.  These huge gold flow percentages are indicative of the total gold flows leaving depositories in the West for stronger hands in the East.  Sooner or later these will generate a shortage in the West which will ultimately positively impact prices beyond the capabilities of the powers-that-be to hold them down.

Asian and Middle Eastern demand alone would seem to be more than sufficient to keep the gold train rolling, but it is all in addition to some still decent gold demand throughout the rest of the world.  When the gold price came down from its 2012 peak, supply was boosted by huge liquidations of gold out of the big gold ETFs, but this source of supply has dried up and, if anything, gold is beginning to flow back into the ETFs – perhaps not at a high rate but the overall flow has very definitely seen a reversal to the positivel.

 At the same time, the volume of new mined gold supply at around 3,200 metric tons a year, may well be beginning to fall .  Peak gold may well be with us.  The drop in the gold price following its 2012 peak led to cutbacks in capital projects and gold exploration around the world.  While any output decline may be very slow at the moment, with some countries like Russia, Australia and Canada still seeing growing new mined supplies, the overall global trend is definitely downwards.  It will take the industry some time – and probably much higher prices – to recover from this downtrend in output, particularly given the long lead times in bringing a new mine into production from scratch.

So, the twin effects of continuing high demand (in the East in particular) driven by the growth in the middle classes in the high population countries like China and India, coupled with a decline in new mined gold production – seen as likely to accelerate – are likely to increasingly put a strain on the supply/demand balance.  This may not initially lead to a big price boost for gold, but it should keep prices rising at least gradually over the years ahead.  Should the equities markets and bitcoin collapse, as many experts are predicting, then this could drive more investment into perceived safe havens like gold. 

Looking at these gold fundamentals, the prospects for gold over the next few years look good – and given gold’s propensity to react positively to disruptive global geopolitical and geo-economic events we could even see much bigger increases than the general picture, as noted above, might suggest.