The effects of Gold supply overshooting demand

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Mumbai: There was surplus global gold supply in 2009 for the first time in three years, as demand receded on soaring prices that hit consumers' disposable incomes badly.

This was contrary to the perception that miners would respond quickly to weak demand and reduce their production, thereby keeping supply tight. Data from the World Gold Council (WGC), the agency funded by global miners for the yellow metal's promotion, show that supply, at 3,890 tonnes in 2009, surpassed demand by 15 per cent. Total demand in the year was recorded at 3,386 tonnes.

The WGC attributed soaring prices as the primary reason for the weak result, as consumers' disposable incomes did not keep pace with the rising cost of gold jewellery. Total identifiable demand, led largely by a poor show in jewellery, industrial and dental consumption, fell by 11 per cent in 2009 at 3,385.8 tonnes, as compared to 3,805.7 tonnes in the previous year. Jewellery consumption fell by 20 per cent to 1,747.3 tonnes, while industrial and dental consumption dipped by 16 per cent, to 367.6 tonnes.

In the current turbulent market, investment and paper gold consumption (exchange traded funds) emerged as a preferred choice, with the former growing by a marginal seven per cent (1,270.9 tonnes) and the latter by 85 per cent (594.7 tonnes).

The case is similar in India. Against the domestic supply of 513 tonnes in 2009, total offtake was estimated at 480 tonnes. The offtake was also 33 per cent lower than the previous year, at 712.6 tonnes. Nevertheless, India held on to its position as the world's largest gold consuming nation in the year. Its jewellery demand in the fourth quarter of 2009 totalled 137.8 tonnes, up eight per cent from the previous quarter, and up 27 per cent from a very low fourth quarter of 2008.

Jewellery demand in the country in 2009 totalled 405.8 tonnes, down 19 per cent on the 501.6 tonnes in 2008. While this is the weakest result since 1995, it is worth stressing, yet again, the impact of the very weak first quarter result (due to the general gloomy economic mood).

Several factors came into play during that quarter, WGC said, to remedy matters subsequently. First, the announcement of a 200-tonne purchase by the Reserve Bank of India played a key role in underpinning sentiment and gold price expectations, reinforcing the perception that gold was reliable and safe.

Second, wedding-related purchases that had been put on hold finally started to come through.

Indian consumers sold back significant amounts of jewellery in the first quarter, expecting the opportunity to buy it back at a lower price. As the year progressed, "compulsory" wedding-related purchases were delayed as the waiting game continued and many consumers satiated their demand through exchange, i.e. exchanging old jewellery for new, WGC said.

The gold price in dollar terms in 2009, at an average of $972.35 an oz, was up 12 per cent on the $871.96 in 2008. In the fourth quarter, the price averaged $1,099.63 an oz, up a very strong 38 per cent on the levels of the fourth quarter of 2008.

WGC added that regardless of whether the economic recovery gathered momentum or stumbles in 2010, western investment demand would remain well-underpinned. If the global economy falters, then western investors would continue to look towards gold for its diversification and portfolio insurance properties, it added.

Commentary:

The article basically lays focus on the fact that the yellow metal-Gold has had more supply than the demand for it in the year 2009-2010. The World Gold Council (WGC) states despite the low demand, the supply of Gold has steadily increased by 15% with a production of 3890 tonnes while the demand was consistently at 3386 tonnes.

One of the main reasons cited for the low demand is the imbalance in the available real disposable income of the consumer. Besides this the turbulence in the market has created investment and paper gold consumption as a preferred choice of the consumer.

The demand for gold has been inversely proportional to its price resulting in large supply and less demand.

Price level

GDPreal/t

P1

P0

YFE

Y0

AD0

AD1

SRAS

LRAS

Figure 3

Figure 3 illustrates a decrease in aggregate demand for Gold from AD0 to AD1 due to the change in demand-side polices; Increases taxation, lower government spending in fiscal policies and increase in interest rates and decrease in money supply in monetary policies.

In the global market, the fact that gold industry has reported declined sales is acceptable to a large extent as the recessional phase which is prevalent has caused this scenario but in India where Gold is a primary purchased metal on account of the auspicious factor associated has too reported a decline in sales from 513 tonnes to 480 tonnes. The fact to be noted is that India has not been highly affected on account of recession as the European nations.

Demand for gold in India has not declined as other nations of the world on account of the belief that Gold is a safe investment with less volatility and the recurring marriage seasons where the purchase of Gold in large volumes for ceremonial affairs is a custom.

The WGC feels that despite all the factors such as recession, market failure, unemployment and many more which seems to affect consumer spending, yet Gold would always be considered to be a mode of investment and savings and hence the supply of Gold would continue to rise despite the current low demand for it and the current low demand is considered to be a momentary market condition.

This situation of low demand and high supply could be rectified by the Government of India

The government is using the contractionary demand-side policies which are broadly classified as monetary and fiscal policies.

Figure 2

If the Indian government increases the rate of interest then this would create increased savings and hence investments would resultantly decline. Also, the consumption declines to a good extent causing a fall in the aggregate demand. Fiscal policies such as change in taxes (T) and/or government spending (G) in the government can influence aggregate demand in the economy. In this situationthe government employs contractionary fiscal policy which basically is; government spending is lesser than the tax revenue (G < T). Increases the taxes leading to a reduction in consumption and hence, falls in aggregate demand. It also decreases the government expenditure which further makes the aggregate demand to fall.

This situation is currently prevalent in the Gold market and can be reversed by the Indian Government by decreasing the rate of interest and encouraging spendings especially in Gold. Taxation policies too could be revised. For example there could be less taxes impose on Gold purchases. This move could bring about a balance in the supply and demand for Gold in India.

On the Global scenario, as the recessional factor which has affected a multitude of industries declines, the Gold Industry is likely to pick up at a greater momentum.

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