Gold Demand Trends Q3 2016

Table 1: Data highlights for Q3 2016 demand (see Gold demand statistics for full details)

In a continuation of the pattern we have seen over recent months, investment seems to have been driven primarily by strategic motives suggesting that these are intended to be long-term positions. Field research has revealed that institutional investors with no previous history of investing in gold are increasingly seeking to initiate sizable positions in these products, alongside those who have been reopening positions that were closed out during the 2013–15 run-down in the gold price. The fact that inflows into these products continued in October despite the gold price falling by 10% early in the month, further highlights that a good part of ETF investment is driven by strategic motives rather than price momentum.

And the factors underpinning this investment were constant. Negative interest rate policies (NIRP) – and the general environment of historically low nominal and real interest rates – remains a primary factor driving these investment flows. Political uncertainty is also a key influence, not just because of the US Presidential election – which has supported inflows into North American ETPs this year – but increasingly in Europe, where – in the wake of the Brexit referendum decision – 2017 brings the prospect of elections in France, Germany, the Netherlands and, possibly, Italy.

Unsurprisingly, given this backdrop, the geographical focus of demand shifted. After US-based ETPs led the influx over the first half of the year, European investors picked up the baton in the third quarter: 78% of the inflows into ETPs were in European-based products. Elsewhere, Chinese investors added another 10t to their holdings of domestic products, equivalent to 39% growth, on top of the 287% increase in H1.

India’s tough transition to transparency

Indian consumers continue to face challenges – most pressingly, the government’s drive for transparency and accountability.

After a difficult H1 for India’s gold market, the third quarter continued in much the same vein. Consumer demand has sunk to multi-year lows due to a combination of:

• high and volatile gold prices;
• fragile sentiment among the rural population;
• and government regulation.

Local gold prices in the range of Rs30,000–31,000/10g were a deterrent to gold consumers, having last been at such lofty levels in 2013. And greater price volatility, as much as the price level itself, weighed on demand. Indian consumers will gradually adapt to higher prices – we have seen this many times before – but price volatility combined with higher prices is a damaging combination.

As well as having higher prices to adapt to, the rural population in India has been plagued by lower disposable incomes in recent years. While this year’s healthy monsoon should be positive for demand among this crucial gold-buying demographic, they are struggling to get their incomes back on track after the two preceding years of poor monsoon rainfall. And rural inflation continues to run above urban inflation, further squeezing household incomes.

But perhaps the biggest factor affecting demand is the continued push towards regulation and accountability that the government is levelling at India’s economy in general, including the gold market.

Various government measures have been implemented over recent months, in an attempt to regulate and formalise the gold industry. As discussed in Gold Demand Trends, Second quarter 2016, the government has levied a 1% excise duty on gold jewellery manufacturing and made PAN (Permanent Account Number) cards compulsory for jewellery purchases above Rs200,000 ². In addition, it is clamping down on undeclared income, which often fuels cash-based transactions, and working towards mandatory hallmarking legislation to standardise gold jewellery.

The intended long-term end-result of these measures is to improve transparency and accountability, which should promote a shift to an increasingly ‘organised’ gold industry. But such progress is rarely painless. The immediate effect of these new measures has been to unsettle both consumers and industry participants across the supply chain. Consequently, activity has been disrupted while they adapt to the new rules or look for ways to circumvent them, which has given rise to a surge in smuggling – up 12% year-to-date.

As a result of India’s demand crunch, the local price was persistently at a hefty discount to the international price for the duration of the quarter. Indeed, the discount widened out to a record US$53 in July, indicative of very quiet market conditions. And imports slumped: doré imports fell by a whopping 86% as the extent of the discount made importing it uneconomical for refiners. During October however, the local price moved into a premium as demand picked up. The fall in the gold price ahead of the onset of the key festive buying season has seen India’s fourth quarter get off to a good start.

Recycling reaches a multi-year high

High gold prices – and structural factors in India – drew out significant flows of recycled gold.

Some gold consumers aren’t shy in selling a portion of their gold holdings when advantageous to do so, often responding to near-term price movements ³. And the substantial increase in the gold price witnessed so far in 2016 has proven too enticing for some. The elevated levels of gold recycling seen in the first half of the year continued throughout the third quarter. Recycled gold amounted to 340.9t in Q3, surging 30% higher than the same period last year (261.6t). Year-to-date, recycling has added 1,042.3t to annual supply, compared to 882.7t between Q1–Q3 2015 (+18%).

As discussed in Gold Demand Trends, Second quarter 2016, this is a somewhat predictable pattern. Empirical evidence – gleaned through both regression analysis and direct consumer research – shows that price is a primary driver of recycling amongst consumers ⁴. With the local gold price hitting new highs in some currencies, it would be unusual not to see this type of response from consumers, who – in markets where recycling is most prevalent – are often keenly aware of the gold price.

India is a very good example of the increase in recycling. With local gold prices in the vicinity of Rs31,000/10g during the first half of the quarter, Indian consumers – particularly in rural areas – opted to cash in, swelling the supply of recycled gold to 39t, its highest level since Q4 2012. This boost to local supply enabled some jewellers to reduce their reliance on fresh imports to satisfy demand. One such example of this is Muthoot Pappachan Group’s Swarnavarsham Scheme ⁵. Over the past 18 months, Muthoot has reportedly collected about 200kg of gold through its nine recycling centres, which has been used to meet gold demand from consumers with lower incomes.

As the price started to soften towards the end of August, the supply of recycled gold tapered as Indian consumers anticipated that higher prices would be brought on by the festival and wedding season. With the onset of Raksha Bandhan and Janmashtami ⁶ (both auspicious festivals) towards the end of the third quarter, consumers opted to postpone further recycling of gold.

The price response was even more marked in China, where volumes of gold recycling have ballooned in recent quarters. Year-to-date, the supply of recycled gold is 45% higher than the comparative period of 2015 (123.5t vs 85t). In early July, the local gold price reached the highest level for three years, sending a strong signal to consumers to sell their holdings of gold. Continued economic deceleration, listless stock markets and a squeeze on disposable incomes provided added context to this recycling surge. As consumers faced increasing pressure on their income and limited opportunity for returns from other traditional avenues of investment, they found it hard to resist the lure of selling gold at higher prices.

Other markets also contributed to the gold recycling rush, Indonesia being an interesting example. The country introduced a tax amnesty at the beginning of Q3, which led some to cash in their holdings of gold at higher prices. The scheme may encourage investment in gold over the coming quarters, as it is one of the permitted investments for funds declared under the scheme.