GOLD ANALYSIS

The importance of physical gold demand

As gold prices test the $1,700 support level, analysts are mixed on the likely impact of physical demand for the metal.

Author: Geoff Candy
Posted: Monday , 29 Oct 2012

GRONINGEN (MINEWEB) - 

Gold looks to be holding the $1,700 support level fairly well, despite concerns by some that a sharper fall is needed to see investors jump back into the market.

Part of the reason for this is the strength seen recently in physical demand, particularly from Asia but, analysts caution that this demand might not be as consistent as it has been historically.

According to UBS's Precious metals daily note, while physical demand is looking somewhat rejuvenated of late, it's not a consistent trend.

"Our flows to India indicated some days of strong demand last week, but continue to lack consistency. The key thing to watch for in India is if hefty levels are sustained, especially now that we are in the traditionally busy wedding season, or if demand remains erratic, as has been the case for most of the year," the bank writes.

Barclays Capital believes that this level of buying could well be sustained. In its latest Commodities Weekly report it writes that the key question for investors is "whether the downside support for gold will materialise from the physical market?"

It says, "Early signs look positive, in our opinion. In China, appetite has responded to lower prices, with volume traded on the Shanghai Gold Exchange picking up significantly this week to above the monthly and annual averages, matching levels seen before the weeklong National Day holiday. A similar trend has emerged in India, with local dealers citing a notable pick up over the past couple of sessions as prices have fallen to their lowest since end of August."

Adding, "Given the response thus far and the fact that key gold buying festival, Diwali, is still more than two weeks away, gold prices should be cushioned in the near term, providing a base for prices to re-challenge the $1800/oz milestone. Investor interest has shown signs of fatigue, with speculative positioning falling by the largest weekly decline since mid-March to a four-week low, while physically backed."

Standard Bank, on the other hand, is a little more cautious. While it agrees that physical gold demand has been improving since mid September, it adds that this demand remains below levels seen last year.

" An important reason for the weakness (relative to last year) in gold physical demand, from especially Asia, is due to jewellery demand. We estimate that jewellery demand will total 1,816mt in 2012, down from 1,973mt last year. According to Thomson Reuters GFMS, world jewellery demand for H1:12 was at 906mt-down from 992mt in H1:12. This implies that we expect jewellery demand to remain fairly flat during the second half of 2012."

According to Standard Bank, the income effect for jewellery demand is twice as strong as the price effect. By this the group means that prices would need to rise by more than double the rate at which incomes are increasing for it to curb jewellery demand - something, the bank points out, that has been happening over the last few months.

Thus, it says, "While seasonality should support gold jewellery demand in Q4, it is clear that jewellery demand is unlikely to support the gold price as it did in previous years. Investment demand will have to pick up the slack-and while we do believe that it is possible, it also implies one has to be more patient before rallies become sustainable."

Adding, "The faster the gold price rises relative to income growth, the more negative the impact will be on jewellery demand-this should provide a drag to the gold price."