Third quarter gold demand in India continued to improve from the exceptional lows witnessed earlier in the year, but absolute levels of demand remained reasonably weak on a historical basis. Jewellery demand, at 111.6 tonnes, was down 42% on Q3 2008, while net retail investment demand, at 26 tonnes, recorded a decline of 67% over the same period. Total tonnage was down 49% relative to year-earlier levels.

Given that the annual decline in tonnage Q2 2009 was 38%, it may appear logical to conclude that the trend is continuing to deteriorate. However, such an assumption would be misleading, as Q3 2008 was exceptionally strong. A quarter-on-quarter comparison shows a very healthy 26% rebound, but once again, this is somewhat misleading due to seasonal effects. A more appropriate benchmark for comparison would be a “typical” third quarter. If one takes the average level of Q3 tonnage off-take over the five years to Q3 2007 (152 tonnes) and compares Q3 2009 against this average, the decline is a more moderate 9% (-5% for jewellery consumption and -25% for investment demand).

The high levels of the gold price continued to be the biggest constraint on jewellery demand during Q3 2009, along with the poor monsoon, which resulted in low levels of income for the rural community. Furthermore, the southern part of the country suffered the effect of a flood, which kept buyers at bay.

In fact, income growth generally has not kept up with the sharp rise in the gold price of the last year, and with the cost of living continuing to climb, consumers have compromised by buying lower weights. Whereas consumers buying for a special occasion would, in the past, have had a target weight in mind, a rupee budget has now become more common. The high gold price has also seen a shift into gem set jewellery, costume and imitation jewellery.

Investment numbers also recorded a significant decline relative to Q3 2008, with the high levels of the gold price deterring both long term investors and speculative buyers. A more in-depth explanation of Indian demand and supply numbers is included in this quarter’s focus section.

The fourth quarter is expected to mark a seasonal improvement in jewellery demand. While the comparison relative to year-earlier levels should start to show an improvement, this is, for the most part, likely to reflect a poor Q4 2008. The underlying trend is expected to remain weak while the gold price remains both high and volatile. Anecdotal evidence suggests that Diwali was, for the most part, disappointing.

Having sold significant amounts of jewellery earlier this year, consumers have cash on hand for purchases, but it is expected that a reasonable correction in the gold price would be required to unleash this pent-up demand. What is unclear is exactly where this support lies. For much of this year, pockets of activity have existed at price levels of around $US900-930/oz, but the more substantial volumes have been absent, with buyers targeting a price of around $850/oz, which of course, did not eventuate. With the trading range in the gold price having now moved higher, it is possible that the price floor that triggers a strong buyer response may have also moved higher.

India, like most other jewellery markets globally, has been weak through 2009. It was hoped that the traditional buying period that starts in late September/early October with the lead-up to Diwali would trigger the start of a resurgence in demand, and also a bout of buying by the trade to replenish inventory levels. In fact, while demand has enjoyed a sizeable recovery relative to the very low levels of Q1, it is fair to say that on a historical basis, absolute levels of demand remain sluggish.

Analysts who monitor the flow of imports coming into India as an early indicator of activity would, at times, have drawn misleading conclusions of a sharper recovery. In fact, imports can be a poor proxy for demand, most specifically due to the volatility that can occur in the volume of supply coming into the market from other sources. Occasionally, investor dishoarding can add to domestic supply, as we saw in Q1. A factor that impacts on a more regular basis is recycling flows, which can vary significantly from quarter to quarter in response to sharp moves in the gold price. Furthermore, at times when recycling flows are particularly heavy, a price discount can emerge in the local market that is large enough to make it profitable to export bullion i.e. arbitrage opportunities emerge. This happened in Q1, and although this is a reasonably rare occurrence in India, it happens regularly in other Asian markets.

In Q1 for example, high levels of recycling activity in an environment of very weak demand meant that there wasn’t much need to import bullion. Conversely, recycling flows fell off sharply in Q2, so any seasonal rebound in demand had to be met through imports. P>

Fluctuations in recycling activity are an integral part of the Indian market. Jewellery is sold by weight at a low margin, with consumers paying close to the spot price in rupee terms. Furthermore, many Indian families own significant holdings of gold, most specifically in jewellery form. Consequently, bouts of profit-taking are a relatively logical response to a volatile gold price in a market that has low transaction costs and a very low margin.

It is, of course, the volatility in the gold price that primarily drives the fluctuations in both demand and recycling flows.Tthe very low level of demand seen in Q1 2008 coincided with the first spike in the gold price to record highs in US dollar terms. In Q2, the gold price stabilised and demand improved. in Q3 2008, the gold price corrected sharply towards levels of around $US750/oz, which triggered the aggressive response from jewellery buyers and investors. Notably, this surge in jewellery demand occurred at a time when global economic uncertainty was at its peak. This shows just how important price levels and price volatility are in driving fluctuations in demand. By the latter part of Q4, demand ebbed again as a bounce in the gold price and a sharp fall in the rupee took the local price to record highs.

Gold price volatility can have such a strong effect on demand that traditional seasonality is obscured. Based on simple seasonality, one would expect the December and March quarters to always be the strongest, as this is where the effects of the key gifting occasions and the wedding season are concentrated. The two most obvious examples are Q1 2008, which was unseasonally weak, and Q3 2008, which was unseasonally very strong.

History shows that such fluctuations in Indian gold demand in response to price moves are not unusual. Demand eventually recovers as the price stabilises, even if the new trading range has moved higher. However, the process of adjustment to the price rise that has taken place since late 2008 has taken longer than usual - demand is still struggling to recover from the surge in the gold price of late 2008/early 2009. Several factors could be hindering that process of adjustment - global economic uncertainty, the drought (and resultant lower rural incomes), budget constraints and ongoing gold price uncertainty.

The budgetary impact of the higher gold price on jewellery demand has manifested itself in several ways - through lower average weights, sharply higher exchange activity, and at the bottom end of the market, a shift into imitation, costume and gold plated jewellery.

Whereas in the past, it was common for consumers buying for a special occasion such as a wedding to have a weight target in mind, anecdotal evidence suggests that a rupee budget has become more common. This has resulted in lower average weights purchased by the consumer.

Notably, the decision to move into imitation or plated jewellery is typically made out of necessity, not choice. The imitation jewellery that is produced in India is not the equivalent of costume jewellery in the west - it is a very close copy of 22k jewellery. A woman attending a wedding who cannot afford real jewellery may buy pieces of costume jewellery as a proxy. She hopes that no-one notices the difference. Clearly, her desire is to own the real thing.

Likewise, jewellery exchange enables a woman to wear that new piece of jewellery to a special occasion with little, if any, cash outlay. This exchange activity, which has accounted for up to 60% of retail turnover over recent quarters, does not impact on final demand for gold, nor is it included in the jewellery consumption figures. Nevertheless, it suggests a very strong desire by consumers to remain active in the market. Both exchange activity and recycling for cash contributes to the revenue of jewellery retailers and fabricators during a time of otherwise difficult conditions.

It is not just the high levels of the gold price that have been a constraint on jewellery demand - gold price uncertainty has also had a negative impact. When the gold price initially spiked in late 2008/early 2009, the local media were talking of a sizeable correction (not just in rupee terms, but also in $US terms). This is a key reason why recycling activity was so strong at that time - local scrap dealers reported queues stretching for blocks. The magnitude of this selling back reflected a belief that the jewellery could be repurchased at more attractive price levels at a later date. Of course, the price correction towards levels of around $US850/oz that was being widely talked about didn’t occur.

As the September quarter progressed, media reports predicting a rise in the gold price intensified and consumer price expectations adjusted upwards. Although the gold price climbed, levels of recycling activity during Q3 were relatively low. It appears that many consumers had, in Q1, already cleared the stock that they were willing to sell, while those with pieces still to sell were probably targeting a higher price.

Is the current weakness in Indian demand a reflection of changing times, or merely a cyclical issue? It is believed that the latter is the case. Gold continues to be an intrinsic and fundamental part of the wedding and gifting season, and the primary means by which women can protect their personal wealth. Wedding related purchases, in particular, are considered to be compulsory, not discretionary. The gold jewellery that a woman takes with her into a marriage is more than just a dowry. This jewellery, and any additional jewellery subsequently purchased, will legally remain hers even if the marriage breaks up.

Nowhere, globally, is the desire to own and accumulate gold stronger than in India. While there has been some dilution of this desire in the more westernised and less traditional cities, such as Mumbai and Delhi, these more western cities account for just 26mn out of a total population of over 1bn people. The southern and rural parts of India, in particular, are still very traditional, both in their customs and in their love of gold.

The crossover of the dual roles of gold – as both a means of adornment and a form of savings – is particularly strong, reflecting the way that gold is priced and the very low mark-ups in the industry. While investment in bars and coins, particularly locally produced product, can be more even more cost-effective than buying jewellery, the difference between the two means of exposure is extremely small by global standards. The premium paid for the extra adornment value makes jewellery an attractive option. In fact, in the southern part of India, coins will typically be purchased as a way of saving for significant jewellery purchases. The coins themselves may, therefore, not be the primary objective, although ultimately, the conversion into jewellery is as legitimate a form of savings as the bars and coins. Reflecting this focus on jewellery, it is women who are generally the primary decision makers in the Indian market.

While price levels are currently acting as a constraint on demand in India, gold will remain a key savings vehicle for consumers, and also for Indians in many other parts of the world. India is a nation of very high savers - an example which some western countries could learn from. We believe that the effect of a growing Indian population combined with rising per capita incomes will, over the long term, lead to growth in total demand for gold in that part of the world.

Global Trends:

• The volume of total identifiable gold demand in the third quarter of 2009 was down 34% on the levels of a year earlier at 800.3 tonnes, equivalent to a 27% decline in $US value terms to $US24.7bn.
• Of course, Q3 2008 was an exceptionally strong quarter, benefiting from the start of the safe haven investor flows in the west as financial sector concerns escalated as well as a surge in gold demand in several key non-western markets in response to a correction in the gold price. If we compare the 12 months to September 2009 against the corresponding period a year earlier, tonnage demand was up 2%. Alternatively, if we take the average Q3 result over the five years to 2007 (832 tonnes) and compare Q3 2009 against this benchmark of a more typical Q3, the decline in tonnage is just 4%.
• While the $US gold price in Q3 2009 was 10% higher than in Q3 2008, over the same period the gold price rose 22% in Indian rupee terms, 36% in Turkish lira terms and 27% in pound sterling terms.
• All three sectors of gold demand experienced an increase in tonnage relative to Q2 2009, but a decline relative to Q3 2008. The biggest decline relative to year-earlier levels was in identifiable investment, which fell 46%. Using the five year average benchmark described earlier, investment recorded a 73% rise.
• Bar hoarding, which largely covers the non-western markets, improved 41% quarter-on-quarter to 81.2 tonnes. In contrast, other identified retail investment, which largely covers the western markets, eased 6% to 43.1 tonnes - however, the absolute level of investment remained very healthy on a historical basis.
• ETF demand, at 41.4 tonnes in Q3 2009, was robust on a historical basis but nevertheless marked a significant reduction on the 149.5 tonnes experienced in Q3 2008. Relative to Q2, the decline was 27%.
• Jewellery demand in Q3 2009 was 30% below year-earlier levels. Most countries recorded a decline, the most severe being India, Russia and Turkey (-42%, -52% and -55% respectively). In each case, the magnitude of decline was exacerbated by an exceptionally strong Q3 2008. The exception to the trend was mainland China, where jewellery demand rose 8% in tonnage terms relative to year-earlier levels.
• Industrial demand recorded its second consecutive quarter-on-quarter improvement, and the magnitude of the decline relative to year earlier levels, at 11%, was almost half the decline recorded in Q2. The electronics sector was the main source of improvement.

Courtesy: World Gold Council