November 2013

Third quarter gold demand of 868.5 tonnes was worth US$37bn. A year-on-year decline in demand reflected further depletion of western investors’ ETF positions. After reaching record levels in Q2, consumer demand remained very strong in Q3 and year-to-date has set a record pace. Central banks continued to add gold to reserves, but at a slower rate. Read more…

Overall demand changes (Q3’13 vs Q3’12, tonnes)

Source: Thomson Reuters GFMS, World Gold Council

www.gold.org

Contents

Contributors

Louise Street

louise.street@gold.org

Krishan Gopaul

krishan.gopaul@gold.org

Johan Palmberg

johan.palmberg@gold.org

Juan Carlos Artigas

juancarlos.artigas@gold.org

Marcus Grubb

Managing Director, Investment

marcus.grubb@gold.org

In value terms, Q3 gold demand was down 37% on the previous year at US$37bn (Table 1) – the lowest quarterly value since Q1 2010. The gold price increased throughout the quarter, as outflows from ETFs slowed and the incoming tide of Asian physical demand stemmed the Q2 price decline. Nevertheless, the average price for the period was significantly below the year-earlier average, which contributed heavily to the drop in the value measure of gold (Table 2). The same was true of prices in other currencies, although it is important to note that gold prices in many Asian markets were considerably higher at the end of the quarter than they had been at the beginning. Such price rises had a dampening effect on demand during the latter stages of the quarter.

2013: the story so far

Two key themes have emerged during 2013: the rising level of consumer demand off-setting outflows from ETFs, and the geographical flow of gold from western to eastern markets.

In addition, a key development of the third quarter was a quarter-on-quarter decline in demand, the first Q2-Q3 drop since 2007. Two key factors contributed to this decline, the primary explanation being the April and June price drops. The demand response to the sharp move lower in the gold price during the second quarter was so strong that it resulted in a degree of ‘cannibalisation’ of third quarter demand as gold purchases were brought forward to Q2. Furthermore, India’s contribution to demand in Q3 was affected as government measures to reduce gold imports, in an effort to control the current account deficit, began to take effect.

With one quarter of 2013 remaining, and given the unusual quarter-on-quarter dynamics and longer-term trends mentioned previously, it is more relevant to consider demand on a year-to-date basis to gain a clearer picture of the direction of gold demand for 2013.

Gold demand to the end of the third quarter was 12% lower than the corresponding period of 2012. This is almost entirely due to substantial outflows from ETFs, a topic we have covered at some length in previous issues of Gold Demand Trends. In brief, tactical investors in western markets exited their positions as they began to speculate on the early tapering of US quantitative easing amid signs of apparent improvement in the US economy. By the end of September, ETFs had seen outflows to the tune of almost 700t, with the bulk of this coming through in the second quarter as the gold price fell sharply. The pace of the outflows slowed during the last three months as momentum waned following the sharp Q2 washout.

Conversely, at the consumer level, demand for gold jewellery, bars and coins for the first nine months of the year was at a historical record of 2,896.5t, well ahead of the levels seen in the first nine months of 2012 (Chart 1).

A number of factors contributed to this growth in consumer demand: lower gold prices, which made gold more affordable for consumers; improving economic conditions in the US and the positive implications for the global economy; and strong brand promotion in the jewellery sector.

Additionally, consumers across the globe have shown an increasing preference for higher carat items, as investment considerations increasingly complement the emotional and aesthetic appeal of gold jewellery.

The vast bulk of the year-to-date growth in consumer demand for gold came from eastern markets: 90% of the 605-tonne increase was accounted for by Middle Eastern and Asian consumers, as gold continued to flow from west to east.

Gold continues to flow eastward…

As per our previous analyses, the recent dynamics of the gold market have worked to ensure that lower prices (caused, in part, by ETF outflows) boosted Asian demand to an extent sufficient to absorb the gold flowing from western markets. This trend continued in Q3 as ETF redemptions were again outweighed by demand from Asian and Middle Eastern consumers.

Gold continued to work its way through the supply chain, to be converted from London Good Delivery bar-form, via the refiners, into smaller, Asian consumer-friendly denominations of kilo-bars and below. This process is borne out by recent trade statistics. Data from Eurostat show exports of gold from the UK to Switzerland for the January – August period grew more than tenfold, to 1,016.3t.¹

This compares with a total of just 85.1t for the same period in 2012. A similar rise can be noted in gold imported from Switzerland to Hong Kong, a major trading hub for the Asian region. Data from GTIS and the Hong Kong census show that Hong Kong imported 707t of gold from Switzerland between January and September, up from 127t in the comparable period in 2012.

Although momentum in eastern markets waned following the exceptional second quarter, year-to-date growth has been remarkable. The fact that Q3 demand was well above the third quarter of 2012 is all the more remarkable because of the diminished role played by India.

…although much of it bypasses ring-fenced India

India’s gold market has been subject to much scrutiny in recent months, as the government has implemented a string of measures intended to deliver on its firm commitment to reduce gold imports.

With higher excise duties and import payment restrictions having had limited impact on the market in the second quarter, the government took a different approach in July. On top of a total ban on the import of gold coins, tight restrictions were imposed on gold bullion imports, tying them to a fixed level of exports. The 80:20 rule now in place stipulates that 20% of all gold imported must be exported before further imports can be made. The confusion over the complex new regulation hampered the market. So, too, did a sharp depreciation of the rupee, which pushed up local gold prices to near record levels, and the seasonal inauspicious period of Shradh (from mid-July and mid-August) during which gold purchases are typically postponed.

Imports, already at a low level in July, all but disappeared in August and September as the market struggled to adapt to the new parameters. Gold entering the country unofficially through India’s porous borders helped to meet pent-up demand, together with an influx of recycled gold that was drawn out by higher prices and promotions offered by retailers. Nonetheless, the third quarter was decidedly weak and it is testament to the strength of the first half-year that year-to-date Indian consumer demand is up 19% on 2012.

Heading into the fourth quarter, and the major Hindu festive season, latent demand among Indian consumers remains very strong, as reflected in the persistence of local price premiums above the international gold price. It is likely that unofficial gold will continue to find its way into the country to satisfy demand. Reports that a good market for ten tola² bars is re-emerging, due to the relative ease with which they can be concealed, reinforce this view.

Jewellery

Q3 jewellery demand totalled 486.7t, the highest third quarter since 2010. Although this was below the record volumes seen in the preceding quarter, on a year-to-date basis, at 1,644.5t demand was 20% above the corresponding period in 2012.

A 15% year-on-year decline in the value measure of jewellery demand was a function of the lower average gold price compared with Q3 2012. Third quarter demand was worth US$20.8bn, the lowest quarterly value since the third quarter of 2010. However, on a year-to-date basis, jewellery demand is valued at US$77.3bn compared with US$72.9bn in the first three quarters of 2012.

An almost universal phenomenon in the third quarter was the increasing popularity of higher carat jewellery. Across Asia, the Middle East and in the US, higher carat jewellery was noted as an area of particular growth as the increased investment properties associated with gold of higher purity came to

the fore. The fact that jewellery retailers in a number of markets were increasingly stocking investment products (small bars and coins) provided further evidence of the greater blurring of the jewellery/investment distinction.

Consumers in China generated 163.7t of jewellery demand in the third quarter, making it the largest single jewellery market by some margin. Year-to-date, demand of 518t already equals that for full-year 2012 as lower average prices this year elicited a powerful response. To some extent, exhaustion set in towards the end of Q3 after such a frenetic second quarter, but continued expansion of the retail network confirms that the trade sees prospects for growth. 24k (chuk kam) jewellery gained market share, as did – more notably – ‘four nines’ gold (gold jewellery of 99.99% purity, compared with the typical 24-carat purity of 99.95%) . The former is unique to China and has proved to be most popular with consumers in lower tier markets and rural areas, again reflecting the investment qualities offered by such jewellery.

Mainland Chinese consumers were also the driving force behind another quarter of exceptional growth in Hong Kong: up 28% year-on-year to 7.5t. A rise in the number of tourists visiting from the mainland, together with lower average prices, ensured another robust quarter for Hong Kong jewellery demand.

A relatively subdued quarter in India, as import restrictions took effect, saw demand drop by 23% year-on-year to 104.7t. Nonetheless, year-to-date demand of 452.2t is 13% higher year-on-year, and only 18% below the full-year total for 2012. Demand for gold jewellery among Indian consumers remains strong, but reduced supply has prevented this demand from being fully realised. Please see the Executive Summary for a more detailed discussion of the Indian market.

The smaller Asian markets experienced robust growth in jewellery demand during the third quarter. The exception was South Korea, where weak consumer sentiment and a sluggish domestic economy dampened demand. Across the rest of the region, a trend for higher carat jewellery pieces of relatively simple design was noted as consumers across the region took advantage of gold’s increased affordability. In Vietnam, the increasing popularity of plain 24-carat gold ‘chi rings’ as an investment proxy was fuelled by their relatively low premiums of around US$50/oz above the international price (compared with premiums of around US$150/oz on gold bars). Japanese consumers increased their demand for gold as consumer sentiment improved on the back of the government’s stimulus package.

The third quarter saw growth across the Middle Eastern region, with Egypt being the unsurprising exception. Although the earlier timing of Ramadan this year reduced demand during July, lower prices relative to last year resulted in robust year-on-year comparisons in Q3 demand for the UAE, Saudi Arabia and other Gulf states. Heavy promotion by big brand names resulted in major retailers performing better than smaller retailers. The emphasis on 22-carat gold at the expense of 21- and 18-carat diamond-set jewellery suggests demand was stronger among domestic consumers relative to western tourists. Demand for jewellery in Egypt shrank notably amid the volatile political atmosphere.

The traditionally strong third quarter in Turkey did not disappoint, with year-on-year demand growth of 14%. In value terms, demand was virtually flat at TL1.97bn, given a 12% decline in the local currency price relative to Q3 2012.

Turning to western markets, a transition in US jewellery demand was a key development. With the exception of fourth quarter demand (which is buoyed by holiday sales) Q3 was the first quarter for four years in which gross jewellery demand exceeded recycling – creating net positive jewellery demand. Since Q3 2009, gross new quarterly jewellery demand had been exceeded by the recycling of old gold jewellery as distress selling took off during the economic downturn. Increasingly positive sentiment among US consumers during the third quarter reversed this trend. Prices holding below US$1,400/oz (encouraging inventory build across the supply chain in preparation for Q4) also helped to boost demand to 35.3t, 7% above the 5-year average of 32.9t. A shift towards 18-carat from 14 cemented the growth. Given recent developments in the US, consumer sentiment has taken a hit early in the fourth quarter, but the seasonal impact, together with prices holding below US$1,400/oz, suggests a certain amount of resilience.

Russia’s growing middle class, armed with greater disposable income, helped generate 7% year-on-year growth in Q3 jewellery demand. Year-to-date, demand of 52.2t is 5% above 2012, but dwindling economic growth continues to overhang the market and suggests a slowdown in coming quarters.

European markets were again the exceptions to the more positive global picture, with both UK and Italy posting year-on-year declines. Year-to-date comparisons are negative as economic concerns continued to weigh on sentiment. Notwithstanding the decline in demand, UK hallmarking figures show growth in the higher carat segments, together with an increase in the weight of individual pieces being hallmarked.

Investment

Q3 was another mixed quarter for the investment sector, as the two key elements of gold continued to diverge: demand for bars and coins increased by 6% while ETFs saw a third consecutive quarter of net outflows. The net result was a 56% decline in Q3 investment demand. Inclusive of OTC investment and stock flows (which represents the less visible elements of institutional investment, as-yet unquantifiable stock changes and any statistical residual), total investment demand is broadly flat, down just 1% year-on-year.

The sizeable OTC investment and stock flows seen in Q3 had a number of contributory factors. A shift towards allocated accounts continued during the quarter, particularly among western high net worth investors, is reflected in OTC demand. The increase is also a function of the west to east shift we have noted previously. A drop in COMEX inventories during in the quarter, together with a surge in trade flows to Asia, is indicative of gold bars leaving western vaults as market participants attempted to take advantage of higher premiums in the eastern region. Re-stocking of the supply pipeline is also likely to have contributed to the number during the recent quarter, as the sheer scale and speed of demand since Q2 has

interfered with the measurement of re-stocking. As these flows are quantified through continued fieldwork, the OTC investment and stock flows number will be subject to revision.

The reasons for ETF outflows during 2013 have been analysed in depth in previous World Gold Council publications³ and the themes underlying the third quarter outflows were a continuation of the same. However, the trend lost considerable momentum in Q3, as the bulk of the tactical positions had already been closed during the wave of redemptions in Q2.

The volume of demand for bars and coins again outweighed ETF outflows during the quarter. Year-to-date demand for these products of 1,252t has surpassed demand in the same period of 2012 by 332.9t (growth of 36%) to almost match annual 2012 demand. The bulk of this growth has been generated by investors in eastern markets (Chart 5), with Turkey giving the strongest performance.⁴ China and India again dominated the market for gold bars and coins in Q3, although it is interesting to note that they accounted for a significantly smaller combined market share: 29% compared with 46% in both Q2 2013 and Q3 2012.

The year-on-year drop in demand in China was partly a function of the strength of the price response seen in Q2. Following the sheer scale of the reaction to the fall in the gold price in Q2, the market paused during August and September to digest the gold consumed between April and July. As evidence of the scale of demand in the first half year, demand for gold bars and coins in China to end-September is already 12% ahead of 2012 full-year demand. Looking to the fourth quarter, anecdotal reports are of cautious optimism among banks and retailers. Bearing in mind the extent of demand seen already in 2013 and continued uncertainty around US tapering, investment should nonetheless improve in the traditionally strong period.

Indian investment demand dipped sharply from year-earlier levels. Despite a strong start to the quarter, demand quickly tailed off as rallying local prices encouraged a wave of profit-taking. Demand for coins was restrained by the government ban and by restrictions imposed by the central bank preventing banks from marketing gold to retail customers. The main focus of demand during the quarter was on small bars; indeed, a shortage of 100g bars pushed premiums on these products significantly higher by the end of September.

A second consecutive quarter of net positive investment in Japan takes year-to-date demand to 3.2t. Activity in the market was quiet during the quarter: average prices being broadly unchanged year-on-year provided little incentive for profit-taking, while buyers waited for a clearer price signal.

Of the remaining Asian markets, Thailand staged the most impressive rally, more than doubling from year-earlier levels. This was in no small part due to Thailand being used as a route to channel gold into other markets, notably India and Vietnam. However, the prospect of a devaluation of the Thai baht boosted demand among domestic investors as a means of storing wealth. The increasing prevalence of small gold bars within jewellery retailers across the Asian region supported demand.

Investment in Turkey sustained the exceptional momentum from the first half of 2013; demand for the year to end-September is 92.8t, a figure that exceeds any annual total since our records began. Similarly, Middle Eastern markets generated solid growth. This was most clearly exemplified in Egypt, where high net worth individuals clamoured for safety amid the political upheaval. Year-to-date demand across the region is up by 73%.

Demand for gold coins in the US fell as investors were unable to sustain the momentum from H1 2013. Having piled in to the market after the Q2 price drops, investors sat on the sidelines in Q3, lacking fresh impetus to add to their holdings. Year-to-date demand is 42% up on the same period of 2012.

Modest growth in Germany and Switzerland was responsible for minor gains for the European region. Long-term investors focussed on gold as a strategic holding were the main drivers of the increase. In Germany, bars of between 200g and 1kg in size were noted as being particularly popular.

Central banks

Central banks added a further 93.4t of gold to their reserves in the third quarter – after 79.3t in the second quarter – bringing year-to-date purchases to almost 300t. The slightly softer pace of demand may have been driven by reduced demand for asset diversification from some central banks that have experienced a slower build up in foreign exchange reserves this year.

Purchases continue to be dominated by central banks within the CIS⁵ region, with Russia remaining the most prominent. The addition of over 18t during Q3 pushed Russian gold reserves to over 1,000t, while Kazakhstan (6t), Azerbaijan (6t) and Ukraine (3t) also made regular purchases throughout the quarter.

The penultimate year of the third Central Bank Gold Agreement (CBGA) came to an end in September. Sales of just 5.1t were the lowest in any annual term since the agreements began in 1999. Banca d’Italia Deputy Governor Salvatore Rossi reiterated gold’s importance as a reserve asset at the LBMA conference in September,⁶ a sentiment echoed by representatives from both the Banque de France and Bundesbank, as well as by ECB head Mario Draghi. This emphasises the commitment to gold that has been in evidence since central banks became net purchasers in 2010.

Technology

Gold demand in the technology sector reported a modest gain in Q3, increasing by almost 1% year-on-year for the second consecutive quarter, as lower average prices continued to support the sector.

Modest growth in electronics demand was again largely attributable to the continued popularity of smart phones and tablets (Chart 6). Inventory build along the supply chain was also a feature of the third quarter as lower average prices presented a compelling opportunity to re-stock. Automotive applications also bolstered demand in the semiconductor space, given the increasing prevalence of in-car infotainment systems, as well as safety and control systems. On the downside, gold continued to lose ground to copper – and increasingly silver – in bonding wire production.

Other industrial and decorative (OID) demand for gold was unchanged year-on-year. Domestic consumption growth in China triggered higher demand for plating salts (used for electroplating luxury goods). This outweighed a contraction in Indian demand for jari (gold thread), which fell as domestic prices rocketed.

Demand for gold used in dental applications ticked up fractionally for the first time since the downtrend began in Q1 2005. The significant year-on-year decline in the average Q3 gold price curbed substitution to cheaper alternatives, notably in the US, where improving economic conditions also helped.

Supply

Gold supplied to the market during the third quarter totalled 1,145.5t, 3% below the same period in 2012. The year-on-year contraction is largely explained by lower levels of recycling, outweighing modest growth in mine supply. Year-to-date the supply of gold is 4% lower than the same period of 2012 at 3,196t. The primary driver is a contraction in the supply of gold from recycling almost to pre-crisis levels.

Recycling underwent a sixth consecutive quarter of shrinkage when measured year-on-year; for the year-to-date period the supply of gold from this activity is 13% – or 158t – below the year-earlier period (Chart 7). The contribution from industrialised markets fell by almost 13% as supplies of old gold became increasingly scarce, and lower average prices failed to attract sellers. In the US, recycling is seemingly in terminal decline, having shrunk significantly in recent quarters. Conditions there are less conducive to recycling as economic indicators improve and gold prices remain below their previous peaks.

Among developing nations, India was alone in seeing an increase in recycling activity. In a market short of fresh supply – thanks to the government’s supply clampdown – a surging local gold price, together with promotional offers by the jewellery trade (which was short of metal) encouraged a sharp wave of selling, leading to a record quarter for Indian recycling. In other markets lower average gold prices were the main influence on recycling behaviour, making the prospect of selling gold possessions less appealing.

The prospects for the fourth quarter are somewhat price-dependent, but given the shrinking pool of available supplies of old gold (particularly in western markets) and the improving economic outlook for the US, it is likely there will be a notable decline in the full year supply of recycled gold from this source.

Mine production generated a 4% year-on-year increase in the supply of gold during Q3. Mine production continued to recover from the restrained conditions of 2012, a year of labour disruptions, operational issues and delays to project start ups/ expansions. The resumption of growth this year has resulted a year-to-date increase in the supply from mine production of almost 70t.

China was again the most prominent contributor to growth, generating around 7t of additional supply as structural changes in the industry (smaller producers being acquired by larger operations, modernisation, increasing operational efficiencies, etc) fed through to higher output. Continued growth at Pueblo Viejo ensured continued year-on-year growth in output from the Dominican Republic, accounting for an additional 6t. Elsewhere, Brazil, Canada, Australia and Indonesia also saw an increase in production compared with Q3 2012.

On the other hand, South Africa was the main protagonist in the list of countries seeing a decline in output, as operational disruptions and labour disputes hampered production.

Net producer de-hedging of 12t in the third quarter was reflective of an almost complete lack of gross new hedging activity. While one or two producers initiated fresh (or expanded existing) hedge positions, such activity was marginal. For the most part producers focussed on cutting costs and improving operational efficiencies in preference to using hedging to protect revenues.