Bullion market: Gold price linked to Dollar volatility

St. LOUIS (ResourceInvestor.com) -- Not surprisingly, gold demand in 2007 was much like the gold price: mostly steady in the first eight months before seeing a sharp turn and experiencing some extreme bouts of volatility in the final quarter.

According to the World Gold Council’s (WGC) “Gold Demand Trend” for the full year and fourth quarter of 2007, dollar demand for gold rose to a record high of $79.2 billion in 2007 - its fourth annual record in a row. In tonnage terms, identifiable gold demand increased by 4% over 2006 to 3,547 tonnes.

But when considering the fourth quarter alone, gold’s record-breaking run to $850 and severe volatility actually caused identifiable demand to fall by 17% in tonnage terms from the fourth quarter in 2006. Because of gold’s high price, however, 2007’s fourth quarter identifiable demand in dollar terms rose 7% to hit $21.3 billion - a new quarterly record.

“On a yearly basis we have a seen a 4% tonnage rise in identifiable demand for gold and record levels of demand in dollar terms, which is pleasing,” said WGC chief executive James Burton in a statement. “However, high and volatile gold prices in recent months have meant we have now entered a period of challenging trading conditions in the gold market, which have heavily impacted consumer demand for gold especially in the jewellery and retail investment sectors.”

Challenging Conditions?

Jewellery demand was hardest hit by rising gold prices and volatiltiy. In India, the world’s top gold consuming nation, total demand fell 64% year-on-year in the fourth quarter - despite 40% growth in the first three quarters of 2007. Demand in the fourth quarter totalled just 83.9 tonnes, down from the 230.1-tonne level achieved in the fourth quarter of 2006 following a fall in the gold price.

Indian investors are known for being quite sensitive to volatility in the gold market, which subsequently affected jewellery demand, as jewellery consumption made up 72% of India’s total gold demand in 2007.

“Consumers in India pay more attention to the stability of the gold price than the outright price and may delay purchases until the price has settled down, even if it stabilises at a higher level,” the WGC said in its report.


Indian jewellery demand in the fourth quarter of 2007 amounted to 54 tonnes, down 67% year-on-year from 164.5 tonnes in Q4 2006.

In addition to high prices, the weakening economy led to a 14% drop in U.S. jewellery demand for the whole year in 2007. This fall in demand allowed China, which recorded jewellery demand of 302.2 tonnes in 2007, to overtake the U.S. as the second largest gold jewellery consumer in the world behind India.

These “challenging trading conditions” for consumer demand - rising gold prices, extreme volatility and a possible recession in the U.S. - are likely to continue characterizing the gold market for at least the first quarter of 2008, the WGC reported.

“Given that gold price volatility has escalated during the opening weeks of 2008, the outlook is for consumer demand, and jewellery demand in particular, to remain subdued during the first quarter of the coming year,” the council said in its report.

“However, sentiment among consumers remains strong, particularly given rising income levels, and solid buying is likely to emerge on any short term corrections in the gold price.”

Investment Demand - Down for the Quarter, Up for the Year

Investment demand felt a similar reaction to volatility and the upward trend in the gold price in the fourth quarter, though not as extreme as consumer demand.

In dollar terms, net investment in the fourth quarter of 2007 hit a record high of $8 billion, thanks to the high gold price. But in tonnage terms, the picture wasn’t as rosy.

Although it was up 2% year-on-year in 2007, net retail investment in the forms of bars and coins was down 39% at 67 tonnes in the fourth quarter compared to the same time in 2006. In addition, exchange-traded fund demand, which was at a record high in the third quarter at 139 tonnes (see RI coverage here), tumbled to 78 tonnes in the fourth quarter. For the year, total ETF demand in 2007 was down 4% from 2006 at 251 tonnes.

“When consumers see a parabolic rise in prices, driven by bad news that eventually has some anticipated resolution, they become skittish on the issue of sustainability in values and hold back from the market,” explained analyst Jon Nadler of Kitco Bullion Dealers.

Industrial demand, however, was the shining star of the fourth quarter. It rose 2% year-on-year in both the fourth quarter and the whole year in 2007. Total demand was 77.4 tonnes in Q4 2007 for a total of 465 tonnes for the year.

Will Demand Continue to Lose its Lustre?

As a possible recession continues to hang over the U.S. economy - a recession that is likely to slow down the rest of the world economically as a result - investor demand is likely to remain high in dollar terms, the WGC said.

Jewellery demand, on the other hand, will probably stay weak while gold prices adjust to dollar volatility and threats of inflation. “The combination of record prices and high volatility is a deterrent to jewellery buying by both the trade and consumers,” the council said. “This form of demand will not therefore be strong in the first quarter of 2008 and will remain under pressure while prices remain volatile.”

But bright spots remain for gold demand worldwide. Russia’s jewellery demand rose 11% in 2007 compared to the year prior, and the country’s fourth quarter demand was almost 25% higher than Q4 2006, making it the fastest growing gold consuming country in the fourth quarter last year. In addition, China recorded a 26% growth in demand in 2007 compared to 2006, consuming a total of 326 tonnes. And if China can decouple from a U.S. recession - and many analysts are saying that is increasingly possible - then gold demand could be in for a big rise in the country.