Gold exhilarates, but perplexes and terrifies as well

On Friday, May 19, 2011, GFMS, one of the most respected information providers in the world on gold and other precious metals, issued a newsletter with a chart that sent a chill down the spines of many gold watchers. Gold suddenly seemed to be more precariously perched than ever before.

The chart related to Western jewellery consumption and scrap. Scrap gold refers to gold that is sold in the secondary markets as old jewellery and odd pieces of gold bars and coins. This scrap is then collected, filtered, refined, and re-used as pure gold for making jewellery, coins and even gold bars.

The chart confirmed what many had suspected. That the West had begun selling the gold it had held in the form of jewellery, bars or coins, and developing countries, particularly India and China, have continued lapping up this metal. 

Prima facie this could have been dismissed as another confirmation of the well-known fact that the largest markets of gold lie in India. India has been purchasing over 600 tonnes of fresh gold (excluding recycled gold) and China around 300 tonnes every year. 

What makes the current situation a bit more peculiar is that in spite of rising gold prices, gold mine output has kept on declining during the whole of the last decade. Normally, when metal prices go up, more mines open. And when prices climb as rapidly as they did in the case of gold, the incentive for boosting production is immense.

Curiously, therefore, even as gold prices climbed, gold mines reduced cumulative output, except in 2009 when it climbed marginally, and 2010 when figures are expected to show a further rise. Much of the demand, however, has been plummeting. Even more surprising is the fact that, increasingly, this demand was met through secondary gold (recycled gold or scrap gold).

“What this means is that while the gullible were buying, most savvy gold investors had begun offloading their own gold, and booking profit,” says a gold analyst who prefers to remain anonymous. “And now that the supply of scrap has begun to exceed the consumption of gold, we expect the market for gold to become increasingly wobbly.” 

This is due to the fact that scrap supplies have increased, mines have again begun increasing output, even while consumption at these high prices have begun to register sharp declines.
Many analysts believe that these developments points to turbulent times for the yellow metal.

What gold has in its favour is fear. Many investors are fearful of investing in the US dollar or any other currency. Even oil or real estate does not inspire confidence. Hence gold became the safe haven. But with declining consumption, and increasing supply, and with more and more people selling gold than purchasing the precious metal, an erosion of confidence could just be round the corner.