Asian Consumers Driving Demand For Gold

Here's a shocker: according to the World Gold Council, all the gold that has ever been mined still exists today in one form or another.

Oh sure, there is stuff that is lost in the ground, or under the sea, but it's still there, waiting to be recovered.

How much gold are we talking about? About 165,600 metric tons (a metric ton is 1,000 kilos, or about 2,200 pounds), or 5.3 billion ounces, according to GFMS Limited.

To understand it visually, imagine two or three Olympic-sized pools. All the gold ever mined would only fill them. (An Olympic swimming pool is 50 meters long, 25 meters wide, and two meters deep, which is 2,500 cubic meters.)

What form does all this gold take?

Mostly, it's in the form of jewelery. Here's a breakdown.

According to the World Gold Council, gold sales in 2010 reached a ten-year high of 3,812 metric tonnes — about 135 million ounces. Jewelry demand remains strong, demand for gold bars is increasing rapidly, while demand for gold held in exchange traded products, ETFs , after increasing rapidly for several years, appears to be leveling off.

Who's buying all this gold?

India is far and away the largest consumer of gold in the world. It accounts for about one-third of all gold purchased — that is, consumer demand, not from central banks or government agencies.

Demand in China is also increasing rapidly, accounting for about 20 percent of global demand. Demand for gold in the Middle East is also increasing.

Why are the Chinese and the Indians, so keen on gold? Some of it is cultural, but some of it is a lack of alternatives. Other investments have proven to be poor bets. Bank deposits are returning negative rates of return, and stocks were not stellar performers in China last year.

This is also partly because of India's sheer size — 1.2 billion people, second only to China's 1.3 billion (and third to the U.S.'s 313 million), but also because gold ownership is part of an ancient tradition there.

Gold in India is not just viewed as a decorative item, or a faddish hedge against inflation; it is viewed as a store of wealth.

"There are no social welfare nets in India. The social welfare net is the extended family and the gold that they contain to support a family member when they get in trouble," says Mark Cutifani, CEO of Anglogold Ashanti, whom I visited in Johannesburg, South Africa.

Cutifani also says that of the more than 200 million households in India, 40 million are active purchasers of gold; he estimates in the next ten years the number of households buying gold will more than double. Even with those relatively small numbers, about 7 percent of household savings in India are already in gold.

Gold Production

Of course, there is supply coming on all the time, from two sources — mine production, and gold that is recycled. Mine production, which is "new gold," added 2,586 metric tons in 2010, about a 1.5-percent increase to supply.

But that's not enough to satisfy recent demand. Indeed, the World Gold Council notes that "since 1984, the amount of new gold that is mined each year has been substantially lower than the level of physical demand."

That's where recycled gold comes in. With gold at $1,700 an ounce, and with many facing financial hardship in western countries, recycling gold — mostly from melting down jewelery — has become big business. About 1 percent of the global supply, 1,645 tons, was recycled last year.

Gold Prices

Why has gold risen so rapidly in the last few years? Several factors:

• Constrained supply: Gold production is increasing only modestly. It's getting harder to find, and is more expensive to mine. Total gold production — which included mine production plus recycled gold — in 2010 increased only 2 percent from 2009.
  
• Increasing demand: The economies of India and China are growing rapidly, and so is their demand for gold.
  
• Central banks: Around the world they have become net purchasers of gold for the first time in 21 years.
  
• Decline of the dollar: Because gold is dollar-denominated, a decline in the dollar makes it cheaper to purchase gold in a currency that is appreciating against the dollar, and a weakening follar is inflationary.

You can see this most clearly in the case of India. Two-thousand and ten was a record year for Indian jewelery demand, according to the World Gold Council.

In tonnes, annual demand was up 69 percent, but since the rupee appreciated 20 percent against the dollar in 2010, Indians went on a gold buying spree.

Total demand in dollars doubled. "The rising price of gold, particularly in the latter half of the year, created a 'virtuous circle' of higher price expectations among Indian consumers, which fueled purchases, thereby further driving up local prices."

Other savvy observers of gold have also claimed that the currency markets hold the key to where gold is heading. They include John LaForge and Chay Norbom at the respected Ned Davis Research. In a recent report to clients, they wrote:

"Gold's bull run reflects a lack of trust and credibility in governments and central banks worlwide to stop printing paper money at will. We believe this because gold continues to rise versus every currency we track—developed country and commodity country currencies alike. Until governments start enacting more sound money policies, gold should continue to rise. Gold's ultimate demise will come when confidence in paper currencies returns, which forecast is not today."

Where will gold go from here?

Here's a group to watch: The women of India. As noted, they are the largest purchasers of gold in the world, but they are no fools. The issue is not whether gold will go up or down, but whether it is currently cheap or expensive compared to other investments.

Mark Cutifani of Anglogold, who has spent a lot of time talking to Indian gold consumers, notes that they view gold strictly as an investment, and compare it to the cost of other commodities and investments. Like onions. Like fuel. And like real estate.

"So they're triangulating a basket of commodities against the price of gold, so with inflation going up, for thousands of years, they've worked out what gold is in relation to the things that matter in their life and they see gold as volume against the price. And that's how they get to the price of gold. At the moment, they're saying, gold looks pretty good. On a relative basis, it's holding its value."

Notice how carefully Cutifani chooses his words. At the moment, gold looks pretty good. On a relative basis. That means that if inflation stops, and gold keeps going up...it will be less attractive as an investment to Indian investors. Or if real estate suddenly drops in price, while gold keeps going up, real estate might be a better investment.

Indeed, there is already signs of "buyer fatigue." In the fourth quarter of 2010, sales in some parts of Europe, Asia and the Middle East were down. The World Gold Council noted that while sales of jewelery in China were still strong, "Gold jewelery demand throughout the rest of the Asian region was weaker relative to 2009 levels as consumers were deterred by soaring gold prices."

And gold has competition from its eternal nemesis, silver. This is happening in the United States, where demand for gold jewelery again declined in 2010 as consumers shifted to more affordable silver jewelery.