Despite fewer purchases overall, demand is still historically high, paced by central banks stuffing reserves with the yellow metal.
[This article previously appeared on HardAssetsInvestor.com and is republished here with permission.]
The Big Picture
Total gold demand in the second quarter was down 7 percent from a year ago, to 990 tons, making the third-straight quarter of declines. Part of that decline is due to the near-balanced inflows and outflows in the ETF sector, with the sector seeing net demand hit -0.8 tonnes. But declines were greater in the all-important jewelery sector.
Expanding the time line, the first six months of the year also show gold demand down 5 percent compared with 2011, with total gold demand equaling 2,090.8 tons, a number still above the five-year average of 1828.7 tons. So while gold demand may be slightly lower compared with the highs we've seen recently, it's still historically high.
However, there's no denying that appetite for the yellow metal is in decline everywhere. Everywhere, that is, but the official sector — the only market segment to post an increase, rather than decrease, in demand.
The second quarter of 2012 was a record for central bank purchases. A total of 157.5 tons of gold was snapped up by various countries, up 63 percent from 96.7 ton in the first quarter of this year and more than doubling the amount purchased in Q2 '11.
In fact, it's the highest amount since the trend of net purchases began back in the second quarter of 2009. Official-sector purchases have become a respectable portion of gold demand—16 percent this last quarter, up from 7 percent the prior quarter.
The central banks of developed as well as developing countries continue to bolster their gold reserves. As the World Gold Council states:
"The rationale for any central bank holding gold is that it can be used as a source of capital if a currency is not redeemable or if a country falls out of favor with the international capital markets."
Given the world economic picture, central banks—just like investors—are hedging their bets with gold.
Of the top 10 countries with the largest gold reserves, half of them hold more than 60 percent of their foreign reserves in gold.
One country, Russia, held more than 60 percent of its reserves in gold as recently as 1993, but that number dropped below 5 percent as its foreign reserves grew from 2004 onward.
That trend seems to be reversing. During the second quarter, Russia bought 22.3 tons of gold. The country also had the largest increase in central bank purchases in the five years ending June 2012, with more than 500 tons purchased.
Other big purchasers were China, with 454 tons, and India, at 200 tons. The World Gold Council reports that official comments from Russia show they intend to increase their gold reserves by approximately 100 tons during this year. That could be just the beginning. If Russia were to increase its percentage of foreign reserves held as gold from its current level of 9.2 percent to 20 percent, it would translate to almost 1070 tons at current dollar amounts.
The WGC notes, "If Russia decides to rebalance its books to its previous peak gold holding as a proportion of reserves of 60.1 percent in January 1995, we estimate it could account for total incremental demand of nearly 5,000 tons at today's gold price."
That's potentially a lot of demand that could materialize in the years to come, especially if Russia continues the way it has been going. The WGC reports that in the past three years, Russia's central bank has been purchasing an average 10.2 tons of gold per month.
But central bank purchases aren't enough to completely counteract declining demand in other sectors—mainly jewelery.
If central banks are apparently buying regardless of price, jewelry buyers are keenly focused on price—and let's face it, prices are high.
Demand for gold jewelry made up 42 percent of demand in the second quarter of 2012. India, as we have written about previously, shares the top spot with China as the top consumer of gold jewelry due to its role both as a store of wealth and its cultural role in gift-giving during various important festivals.
One such festival, Akshaya Tritiya, occurred near the beginning of the second quarter, and while demand was strong prior to the festival, if fell off afterward as prices rose.
And rise they did. As the Indian rupee depreciated against the U.S. dollar, local gold prices in India rocketed to over 30,000 rupees per 10 grams, discouraging price-sensitive investors from buying and prompting profit-taking. Additionally, high interest rates, domestic inflation and slow GDP growth combined to dampen demand for gold jewelry to the tune of 30 percent less than a year previously.
China's gold jewelry demand dropped 9 percent, compared with this time last year, to 93.8 tonnes. Chinese gold buyers tend to buy into rising gold prices, which they see as confirming their decision to invest. Between no clear upward price trend and a slowing GDP, that purchasing didn't materialize. But 2012, the year of the dragon, is an auspicious year for marriages, and demand for wedding jewelery was strong, tempering the jewelery demand drop.
One can't talk about demand without at least mentioning the other side of the equation—supply. Global gold supply stands at 1,051.1 tonnes for Q2 '12, down 6 percent compared with this time last year, but flat compared with the first quarter of 2012.
Flat is likely where supply will stay. Mine production will eventually increase, but the major new mines aren't scheduled to start production until next year, and current production ran into various problems ranging from uncooperative severe weather to production interruptions at various mines.
Recycling has dropped 12 percent, compared with Q2 '11, to 367 tons. Recycling supply is extremely sensitive to price spikes—people wait until gold is seemingly at crazy highs before hocking grandma's jewelry. As gold prices have settled down, fewer people are offering up their scrap for sale. The exception is in India, where price increases above the 29,000 rupees per 10 grams mark flushed gold into the market.
Once again, watching official-sector purchasing has become a very important part of understanding the gold market, and one where, unfortunately, there is precious little data—that and tracking the Indian rupee.
It's clear the worlds' governments are nervous, and that they're buying almost regardless of price. How long that continues remains a critical question for gold demand, and thus prices.