Gold has had the best start to a year since 1983, rallying about 10 percent year to date. Maybe it is simply a medium term short covering rally. It could be the physical demand for the yellow metal arising from the Lunar New Year celebrations in China or the weaker dollar index, which has been trending lower due to poor economic data releases in the United States.
To try and predict the longer term price trend in gold, we must analyse the supply demand dynamics in detail. The World Gold Council released a report yesterday, titled "Gold Demand Trends" that gives us an insight into the global demand trends for the yellow metal.
The main finding of the report is that the lower prices in 2013 were used as a buying opportunity by value investors. Demand for gold in the form of jewellery, bars and coins, which is collectively referred to as consumer demand, hit an all-time high.
Further, Chinese consumers of gold set a new annual record while Indian demand was still resilient in the face of import restrictions. The result was annual gold demand of 3,756.1 tonnes, valued at $170 billion. However, as the report highlights, "outweighing the impressive consumer demand were the effects of ETF (exchange traded funds) outflows and lower central bank buying, resulting in 2013 demand 15 percent below the strong volumes recorded in 2012."
Most hedge funds and institutional investors in gold ETFs liquidated their positions after the US Federal Reserve's announcement to normalise monetary policy and taper back on its Quantitative Easing program. Hedge fund tycoons from George Soros to John Paulson offloaded their long positions in gold via their ETF holdings.
"The main feature of gold investment throughout 2013 was the contrast between ETFs, which acted as a source of supply to the market as sizable institutional positions were sold (-880.8 tonnes) and the demand for bars and coins, which surged to an all-time high (1,654.1 tonnes)," the WGC report said.
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"This pattern was repeated during the fourth quarter of the year, although the demand for small bars slowed, following the exceptional pace of demand in the first three quarters. Notwithstanding the surge in bar and coin purchases, annual investment demand was down 50% in 2013," the report highlighted.
Meanwhile, central banks made net purchases of 368.6 tonnes of gold in 2013, adding a further 61 tonnes in fourth quarter (Q4) -- the twelfth consecutive quarter of net central bank demand. The pace of purchases slowed towards the end of the year due to the heightened volatility of gold and a slower rate of foreign reserve accumulation according to the WGC report.
An important takeaway was after seven years of negative net investment demand (generating cumulative outflows of 266.1 tonnes), Japanese investors generated net positive investment demand for three consecutive quarters in 2013, according to the World Gold Council.
This reaffirms gold's status as an inflationary hedge as Prime Minister Abe looks to steer Japan out of a deflationary trap via its own quantitative easing programme. Due to their respective currencies depreciating against the dollar, India, Japan and Turkey did not witness the magnitude of losses in gold in terms of their domestic currency.
Over the past year, with the liquidation in gold ETFs and monetary tightening in the US factored in the price of gold, speculative positions are not as large as they were in the aftermath of the financial crisis. Gold has been picked up by long-term investors who wish to protect themselves against inflation and global systemic risk. We have seen strong physical buying coming in at every decline in the price of gold.
Whether or not gold resumes its uptrend this year is a moot point. But what is certain is that the next up move will not be built on such shaky grounds -- as the bulk of buying in gold at the recent lows has been from central banks, Chinese and Indian consumers and long term value investors.
(Vatsal Srivastava is a senior market analyst. The views expressed are personal. He can be contacted at vatsal.sriv@gmail.com)