Is Jewellery Killing the Price of Gold?

February 3, 2010
Price is what you pay...value is what you get
Warren Buffet                      

The chances are that if you bought a piece of jewellery in 2000 for $1,000 you would probably only receive the same amount today if you attempted to sell it through the usual channels. If however you had bought bullion valued at $1,000 your investment would be worth close to $4,000 today. The reason for this is that every $1,000 worth of gold that goes into jewellery requires anything from $300 to $3,000 for the manufacturer's and the retailer's profit, overheads and labour as well as whatever each jurisdiction imposes in terms of sales tax. The range in mark-ups reflects the quality of the workmanship, the type of item (e.g. wedding ring v necklace) and the place of manufacture and sale.

In 2008 a total of 2,186 tonnes of gold were used for fabricating jewellery. The value of this gold at the then average price of $972 per oz would have been around $68 billion dollars. Jewellery sales would have been anywhere from $88 billion to $200 billion. Value added in other words could have been around $20- $130 billion.

It is my contention that if consumers diverted their dollar purchases to bullion rather than jewellery then this would equate to anything from an additional 600 to 6,000 tonnes in gold demanded. As a result there would be a stratospheric surge in the price although I concede that demand would taper markedly as price escalated.

The recent surge in gold prices, combined with largely clueless housewives and financially strapped individuals has brought a lot of so called scrap onto the market. According to GATA a total of 1,126 tonnes of gold scrap were sold in 2006. In 2007 the figure was 958 tonnes and in 2008 it was 1,209. In the first three quarters of 2009 the figure was already 1,166 tonnes.

By buying bullion, individuals would not only get a better return, but they would also avoid the losses from liquidating old jewellery. While the price of a gold necklace may be $2,000 it does mean that that is also its value. Value to be value must have an enduring ability to at least keep pace with inflation. Clearly bullion has, whereas jewellery has not, in the last 10 years. Bullion will always outstrip jewellery in terms of performance. The only exception would be famous pieces owned by royalty etc.

There is no doubt that gold jewellery will always be made and sold but the escalating purchases of investment gold and investments in ETF's may be part of the process whereby gold is making a return as a financial asset across a broad spectrum of investors and individuals. As a result there is a slow but noticeable movement back to bullion as people become savvier with their hard earned dollars.

But what might we expect in the year ahead? Very briefly some of the factors that should be kept in mind are as follows:

  1. The percentage increase in the total supply of above ground gold as opposed to the increase in the world's population. If the rate of population increase exceeds the rate of increase in gold stocks, then the gold price should increase (all other things being equal.)

  2. The relative mix between jewellery demand and investment demand. If in percentage terms more of the dollars presently going to jewellery go to bullion purchases, the price of gold will rocket.

  3. Which nations will enjoy the high rates of increasing economic prosperity? Should increasing prosperity be experienced in China and Asia in general, then we will probably see much higher gold demand as these nations are working off a comparably much lower level of gold ownership and consumption.

  4. The course of the present global financial crisis. If the present downturn continues its downward trajectory in the west, the questions that will arise will be:

  • How much will jewellery consumption suffer in these nations?

  • How much more jewellery will make its way to the recyclers?

  • Will investors buy gold to retain value or will they be selling gold to meet debt obligations as the great unwind takes place?

  • One more consideration will be the stance that Central Banks and governments take. Will they print and borrow? Will they continue to be net buyers as has been the case in recent times or will they start selling if under pressure to meet obligations. Clearly no one wants to join Gordon Brown as the most unsuccessful "gold bullion dealer" in history.

  • A further consideration will be whether the world's financial structure and payment system is overhauled in some way and what role might be assigned to gold in the process. If the "masters of the universe" simply dish out another thinly veiled fiat money mutation then gold will have to again wait a little for its day in the sun. If however, gold is assigned a specific role or specific percentage of the currency task, then clearly its position will at the very least be underwritten.

5.Let us not forget the miners themselves as we ponder whether in 2010 circumstance arise whereby they panic back into hedging.

6. Other considerations, will relate to the various Gold ETF's. The January 2010 redemptions of 23 tonnes were in stark contrast to 63.36 tonnes being added in January 2009. It remains to be seen if redemptions are due to profit taking and loss of enthusiasm for gold by investors or whether there is a real fear about the integrity of these funds. Most of this fear is centred around the possibility that these funds are either just fronts which are sucking in funds that "buy" gold substitutes instead of physical gold, or whether they are buying gold which is held by other repositories which in turn could be "selling" to other buyers at the same time.

7. The issue of auditing the gold holdings of the US goes only to credit and not to substance. If the gold has been sold it will simply confirm what we have all suspected for quite some time and will explain why gold's price was butchered over a significant period of time. The USA's gold holdings of 8,000 tonnes are worth approximately $280 billion. If the gold is still in existence its current value is hardly enough to dent the total fiscal nightmare of the Federal Government. If the gold has all been sold, the loss of $280 billion is simply another AIG. The only true downside arises where the loss or severe depletion of the gold pile triggers a massive loss of confidence in the government and the system.

8. Movements in currencies will also be of significance. So while returns in US dollars may be meagre, they may be much more positive in Euro terms. Central to all this is the Mexican stand-off between the USA and China. At the moment no one is blinking but the moment they do, it could be goodnight to all paper currencies as sheer bedlam takes over.

In closing, I need to repeat that gold jewellery will always be made as it was precisely its beauty as an adornment that initially captured man's imagination. Man's imagination, greed and fear are still in awe of gold and woman's desire for something to complement her beauty will never wane.

What lies ahead appears to be shrouded in darkness so we can only take measured steps forward as we navigate a world where financial and economic outcomes have become more unpredictable than earthquakes. Then again it might pay to stand still but be able to react at a moment's notice.

Sydney Australia

China is poised to become world's biggest gold consumer.

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