Gold’s unit price elasticity is a powerful mechanism for clearing the market during periods of weak prices.
This is the view of Sandy McGregor, portfolio manager at Allan Gray, who says that the decline in the gold price since 2012 is best explained by Asia’s economic woes, as the continent accounts for the large majority of global gold consumption.
“When Asia is in trouble, gold is in trouble. Three years ago inventories in London were probably about 300 million ounces or roughly three years’ mine supply. A significant decline in Asian purchases left the market with excess inventories and prices collapsed. Surplus London inventories have now largely dissipated, which is reason to believe that as Asian growth recovers the gold price could appreciate significantly,” McGregor explains.
He says that, on average, gold has a unit price elasticity of demand. In other words, buyers of gold in the form of jewellery and as store of value tend to determine the quantity they acquire by the amount of money they wish to spend. If the price halves, as it did between 1980 and 2000, the amount purchased can double.
“After 2002, as Asian economies recovered from the emerging market crises of 1997, their demand for gold grew rapidly but over the same period mine production stagnated. Increased production outside South Africa was more than offset by a decline in South Africa due to resource depletion. With demand growing much faster than supply, consumers were rationed by higher prices and had to pay up to persuade those who held the inventory to part with some of their gold.”
Currently central banks own 1 039 million ounces of gold and private stocks in the form of jewellery and bars amount to about 4 200 million ounces. This estimate implies that private stocks are currently worth about US$5.4 trillion. This huge inventory has been accumulated partly because gold is the metal of choice for jewellery, and partly because it is regarded as a store of value in times of social and political disorder.
He adds that since 1980 gold demand has been mainly for the fabrication of jewellery and its role as a financial asset has retreated into the background. However, this may be changing.
“As governments seek to interfere in all aspects of economic activity and central banks have embarked on radical monetary experiments which distort asset prices, gold as a store of value is attracting renewed interest among a diverse group of investors.”
McGregor says that the amount of gold in private hands is large enough for it to play a significant role in the portfolios of investors who fear the consequences of the current fashion among central banks to promote inflation.
“We are heading back to the 1970s. Then it was the inadequate response of central banks to inflation which gave gold its attraction, while today it is their response to deflation,” concludes McGregor.