The Gold Economy

Last week, the World Gold Council launched its quarterly Gold DemandTrends report, and it had lots of lovely statistics to ponder as it surveyed what the gold market looked like for the second quarter of 2010.

ETF Buyers Outweigh Jewelry Buyers

So first off: Who wants gold? Everyone, it seems — particularly investors.

Total gold demand was up 36 percent from this time last year, with gains seen in electronics, physical investment and ETFs. Demand from the jewelry and dentistry sector declined, however, 5 percent and 6 percent, respectively:

But by and large, ETF investment contributed the most to the total increase in gold demand. The second quarter saw a huge jump in ETFs inflows, at least for the funds the World Gold Council monitors (which includes the mega-ETF, the SPDR Gold Trust, or GLD). In total, 291.3 tonnes of the yellow metal flowed into ETFs around the world, the second-largest quarterly inflow after Q1’09′s record of 465.4 tonnes. That’s in spite of average prices remaining in roughly the same ballpark from Q1 2010 to Q2; the average price during the first quarter of this year was $1,109.12/oz, while the average price for the second quarter rose to $1196.74.

In part, ETF gains in Q2 2010 seem huge because the first quarter of 2010 was so anemic, with a net of only 4.5 tonnes of gold flowing into ETFs. But it’s also hard to deny the impact of declining confidence in the economic recovery, and renewed fears about a “double-dip” recession. Gold is, and always has been, a safe haven in times of investor stress.

This is particularly clear in the fact that retail investment in gold — as in all those lovely golden bars and coins — also rose 29 percent in the second quarter. Chinese retail investors were especially interested in gold, purchasing 37.7 tonnes of it — 121 percent more than the 14.7 tonnes purchased in the second quarter of 2009. As the WGC tells it, poor performance in stock and property markets encouraged Chinese investors to go for gold.

That said, a number of investors engaged in profit-taking as gold prices rose — those in Japan seemed most keen on the idea. The WGC reported Japan saw a net sell-back of 20 tonnes of gold during the second quarter.

Other Demand Sources

This increase in investment demand is noteworthy in that it outweighed jewelry demand; in fact, not since the first quarter of 2009 has investment in ETFs, bars and coins been larger than that in jewelry. But make no mistake: Jewelry is still an important demand driver, accounting for 39 percent of total usage for gold.

I found it funny that the WGC gave a laundry list of reasons for slow or low jewelry demand, everything from those you’d expect — such as high prices that discourage jewelry spending — to those not exactly on your radar as gold drivers. Among some of my favorites: heavy rains, extreme heat in China, even the distraction caused by the World Cup.

Some of you might be wondering: What about industrial applications? While industrial usage is not a huge driver of gold demand — in fact, it only accounts for about 1 percent of the total — it is a growing sector, as many modern electronic devices contain tiny bits of gold: smart phones, LCD TVs, netbooks, e-readers, iPads and so on. It’s definitely something to keep your eye on.

Supply Remains Flat

Gold supply has gone up 17 percent compared with last quarter’s levels. For the second quarter of 2010, 1,131.6 tonnes of gold were available. The majority of that, or 644 tonnes, is from total mine supply – 659 tonnes of gold were produced during the second quarter of 2010, but 15 tonnes were held back for producer hedging purposes.

The interesting thing to note is that mining production has remained fairly flat since 2005, even as the price of gold has risen over 125 percent. Gold producers don’t seem to be jumping on the get-rich-quick train, and have instead opted for steady production.

In fact, an important thing to keep in mind when looking at the price of gold vs. gold production is that some companies use times of high gold prices to mine out ore that is more expensive to reach, therefore extending the life of their gold mines and leaving less-costly-to-mine gold in the ground for later. Of course, gold mining is a finite activity — at some point we’ll either run out of gold to mine, or gold that can be mined will require astronomical prices in order to be feasible. But that’s a topic for another day.

The Quarter and Year Ahead

Reading through the Gold Demand Trends report, one is left with a pretty positive feeling about the future of gold prices. China and India continue to be poised for further gold demand growth — especially in gold jewelry — as their economies continue to grow. After all, as they get richer, more of the population will have income to buy gold and electronics.

Gold supply, while still positive, is fairly tight, and mine output has remained relatively flat, but as prices rise, more “old gold” — those bars, coins and gold jewelry investments — will come into the market as people cash in on higher prices, though the WGC believes, at least for a while, investors will be holding onto that gold and it will possibly take much higher prices to get that gold into the market.

(Click to enlarge)

Looking forward, what can we expect to see? Well, the third quarter is traditionally (minus 2009) a good one for gold demand, especially in gold because India’s traditional wedding month is September. Perhaps higher demand — and higher prices — lie ahead.

Disclosure: No positions