GFMS has released its "Gold Survey 2010 - Update 2", in which the research house highlights the critical role of investment in the gold market last year and forecasts powerful western investment this year, strong enough to more than offset some of the fundamental headwinds that will be generated by higher prices.

The annual average price was 26% higher than in 2009 and a series of record high prices were posted as investment was driven by a raft of influences, most notably initially were European sovereign debt concerns and, arguably, rising concern about fiat currencies in general. GFMS as a house does not subscribe to the view that the major fiat currencies are destined to fall and that all government debt obligations will become worthless. It does note, however, that this view is relatively widespread and is informing gold investment activity, with gold regarded as the best hedge against official policies that are seen as undermining the three major currencies.

The report also points out that last year's trends in scrap supply, jewellery fabrication and bar hoarding demand were actually pretty positive, given the price action that we saw last year.

Taking the picture as a whole, traditional forms of demand (jewellery, other fabrication and bar hoarding) fell substantially short of traditional forms of supply, i.e. gold mine production and old gold scrap, leaving investment to mop up the balance. Although sizeable, this excess fell short of that of 2009 by more than 500 tonnes; this was a result, in part, of a recovery in jewellery demand, a jump in bar hoarding and a small fall in scrap.

Our readers will note that we have not so far mentioned official sector transactions; there is a very good reason for this, which is that, from 1989 to 2009 inclusive, the official sector was a net seller of gold into the open market. In 2010, however it was a net purchaser despite the IMF gold disposals.

Jewellery demand gained 16% in 2010, although it was a strong recovery in India that was responsible for the vast majority of this improvement, masking indifferent or poor results elsewhere in the world. GFMS is expecting world jewellery demand to fall by some 7% in the first half of 2011.

Scrap return in 2010 fell by 1% last year, despite the increase in prices; GFMS suggests that although this may seem counter-intuitive, the fall in scrap can be ascribed to price acclimatisation, reduced distress selling, and some consumers postponing resale in the expectation of yet higher prices in the future.

Even so, even after the demand from the official sector has been added into the equation along with the figure for mine dehedging (an ever diminishing influence), there was a substantial pool of metal to be absorbed by investment activity.

The report details how last year's recovery in jewellery demand, especially in the first quarter of the year, was a key element in providing price support, as it effectively offset the fall in World Investment from the exceptionally high levels of 2009. GFMS does not expect jewellery demand to provide any real price support for price gains this year, although good jewellery related buying and a recovery in bar hoarding in Asia are both expected to emerge on any price dips; jewellery and bar hoarding will therefore be likely to defend downside price risk.

The upside price potential for this year still has to come from investment, especially given how the underlying fundamentals of the market have deteriorated over the past nine years, during which time the price has been in a sustained bull run (jewellery demand has dropped by a third since 2001 and has occasionally almost been matched by surges in scrap). As Philip Klapwijk, GFMS' Chairman, has noted, the economic crisis "could easily cross the Atlantic as America's QE2 steams on" and also that "inflation may seem quite a distant threat today, but there's many an investor out there who sees real longer term danger in current US policy and the lack of political will or consensus to start tackling deficits". These two elements should provide a powerful force for investment.

Although there is a cautionary note that any sharp rise in price is likely to generate resale of the metal that has been withheld in the expectation of higher prices, the bull case is augmented by the shift in attitudes of the official sector, with net purchases expected to rise again in the fist half of this year.
Investment will be the watchword for the coming months as the fundamentals of the market will be throwing off excess metal. In GFMS' view, investment activity is likely to be able to absorb what that market throws at it.


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