A Surprise Response: Gold Scrap’s Reaction to Price Moves

It might be expected that, given the surge in the gold price from mid-August, we would have seen a marked acceleration in the volume of old gold scrap being generated. Furthermore, it might be assumed that the reaction would be strongest in traditionally price sensitive regions, such as the Middle East or the Indian sub-continent.

However, recent field trips have shown that the overall response of scrap to the price rise has been comparatively subdued and that some supposedly price insensitive areas, parts of western Europe for example, have demonstrated a relatively strong reaction.

Perhaps the greatest surprise here concerns India. The received wisdom is that India is a highly price sensitive market where higher prices would typically equate to lower jewellery demand and higher scrap volumes. And whilst at times this stylised fact has indeed shown up in the data, scrap volumes in the main have been on a declining trend for much of the bull rally. Consider, for example, that average scrap volumes were over 30 tonnes per quarter in 2003 but, so far this year they have fallen to under 20 tonnes on average. The most simple explanation of this appears to be that, as expectations of higher (and ever higher) prices have taken hold, consumers have reduced the amount of old jewellery they are willing to sell back.

Similarly in the Middle East, the reaction to the rise in the metal prices has been controlled, with current scrap supply supported by the distribution chain unloading slow moving inventory rather than individuals offloading gold assets as was the case for much of 2006. A large portion of individual stocks were shaken out in the first half of 2006 and metal prices would need to return to levels close to $850 to encourage a further surge in recycling. Demand for jewellery in Dubai, the trading hub of the region, has been modest with consumers buying solidly on dips in the gold price but they do not appear at this stage to be selling, or exchanging jewellery, with the expectation of higher prices on the horizon.

In East Asia, both trade and individuals have been active recently in taking advantage of any significant price volatility with scrap flows from the beginning of October notably higher. These markets are typically very price sensitive and with modest margins applied to the retail trade (often below 5%) any significant fluctuation in the gold price allows for a quick turnaround and the recycling of the jewellery item. That said, a lot of the material currently being recycled is “new” gold rather then old jewellery items, with this jewellery (mostly chain) purchased by individuals as a short term investment vehicle with the intention of selling back the item should the price move in an upwards direction.

Having mentioned earlier that the industrialised regions had seen a comparatively strong response, this does not change our view that their scrap supply in 2007 fell. This is largely because this year has seen a lesser clear-out by the jewellery distributive trade and fabricators, especially in Europe, of slow selling or old fashioned stocks, in contrast to the major re-melt that followed the April/May 2006 price spike.

Instead, we have seen a marked build up in the volume of scrap coming back to the market from individuals. There are several drivers behind this. There is, for example, an element of distress selling thanks to the credit crunch and we are beginning to see the start of selling back of inherited pieces, purchased originally when western consumption boomed post-War.

The rise in the gold price, even in euro terms, obviously features but its direct importance should not be overstated, given ongoing consumer ignorance of the gold price and the hefty discount received. This is a clue to perhaps the most important factor, namely the improvement in facilities for the recycling of old jewellery. This in turn stems from both the rise in the gold price and the very buoyant margins currently available, with individuals selling facing a discount that can easily reach 35-40% of the world price.

Such margins have led to new entrants to the business (such as French companies setting up special events in hotels at which they buy old jewellery), to retailers adding the service of buying back consumers’ old pieces (the now ubiquitous ‘compro oro’ - I buy gold - signs in Italian jewellers’ windows being a good example) and to greater marketing efforts by existing players’ (witness the higher advertising spend of US pawnbrokers).

In summary, the greater weighting of the developing world in total scrap and its sluggish response plus the smaller western world trade re-melt mean scrap supply in 2007 could well still show a fall when results are published in Gold Survey Update 2. Looking further ahead, enhanced scrap facilities in the West in conjunction with prices holding at elevated levels should keep this element of scrap at a surprisingly sustained level. Developing world scrap would be highly likely to grow significantly in the event of a marked rally in the price, or greater volatility, though, as shown in 2007, volumes might well undershoot conventional expectations.