GOLD: DEMAND AND SUPPLY

Demand
The demand for gold is spread widely around the world. East Asia, the Indian sub-continent and
the Middle East accounted for 72% of world demand in 2007. 55% of demand is attributable to
just five countries - India, Italy, Turkey, USA and China, each market driven by a different set of
socioeconomic and cultural factors. Rapid demographic and other socio-economic changes in
many of the key consuming nations are also likely to produce new patterns of demand.
The demand for gold is driven by a number of factors. First, there is the demand for gold for use
in jewelry. Jewelry consistently accounts for around three-quarters of gold demand. In terms of
retail value, the USA is the largest market for gold jewelry, whereas India is the largest consumer
in volume terms, accounting for 25% of demand in 2007. Indians buy approximately 800 tonnes
of gold every year. India is also the largest importer of the yellow metal; in 2008 India imported
around 400 tonnes of gold.
Secondly, investment demand in gold has increased considerably in recent years. In 2001,
according to World Gold Council statistics, 400 tonnes were purchased for investment. By 2007,
that demand had climbed to just over 1000 tonnes. This demand is rooted in gold's ability to
insure against uncertainty and instability and protect against risk.
Thirdly, industrial and dental uses account for around 13% of gold demand (an annual average of
over 425 tonnes from 2003 to 2007 inclusive). Gold's high thermal and electrical conductivity,
and its outstanding resistance to oxidation and corrosion, explain why over half of all industrial
demand arises from its use in electrical components as a thin layer coating electrical connectors
of all kinds, thereby ensuring good connection. For example, gold is used in the connectors of
the more expensive electronics cables, such as audio, video and USB cables. Recent research has
uncovered a number of new practical uses for gold, including its use as a catalyst in fuel cells,
chemical processing and controlling pollution. As gold is a good reflector of electromagnetic
radiation such as infrared and visible light as well as radio waves, it is used for the protective
coatings on many artificial satellites, in infrared protective faceplates in thermal protection suits
and astronauts' helmets and in electronic warfare planes like the EA-6B Prowler. Gold is used as
the reflective layer on some high-end CDs.
The following table summarises global gold demand by usage:Uses
Jewellery
Retail Investment
Industrial
Total
Supply

1997
3311
459
419
4189

1998
3181
270
392
3843

1999
3151
360
411
3922

2000
3187
156
457
3800

2001
3064
349
357
3770

2002
2727
340
347
3413

[tonnes]
Average
3103
322
397
3823

Gold is produced from mines on every continent except Antarctica, where mining is forbidden.
Operations range from the tiny to the enormous. According to recent figures, there are around
400 operating gold mines worldwide. Global gold production peaked in 1999 at just over 2,600
tonnes, having risen steadily from a 1980 base of about 1300 tonnes. Today, the overall level of
global mine production is relatively stable, averaging approximately 2,525 tonnes per year over
the last five years. Lack of exploration expenditure in the 1990s, coupled with the inherent
delays between discovery and production mean than the gold supply will remain inelastic and is
likely to reduce slowly over the coming few years. New mines that are being developed are
serving to replace current production, rather than to cause any significant expansion in the global
total.
The largest producers of gold are South Africa, the USA, Australia, China, Canada and Russia.
The world's principal gold refineries are based near major mining centres, or at major precious
metals processing centres worldwide. In terms of capacity, the largest is the Rand Refinery in
Germiston, South Africa. In terms of output, the largest is the Johnson Matthey refinery in Salt
Lake City, US.
The world's oceans hold a vast amount of gold, but in very low concentrations (perhaps 12 parts
per 10 billion, e.g. every cubic kilometer of water could contain 10 to 20 kg of gold). But so far
no commercially viable mechanism for performing gold extraction from sea water has yet been
identified.
Once refined, the bullion bars (with a purity of 99.5% or higher) are sold to bullion dealers who,
in turn, trade with jewelry or electronics manufacturers or investors. The role of the bullion
market at the heart of the supply-demand cycle facilitates the free flow of metal and underpins
the free market mechanism.
The cost of mining and extracting gold has increased exponentially, and the industry has
struggled with declining ore grades and increasingly refractory ore bodies. The days of fabulous
discoveries of gold are not entirely gone. In Ruby, Alaska, in 1998, bulldozer operator Barry
Clay was stunned to see a 294-ounce nugget roll off the dirt pile ahead of his blade. Modern
commercial producers, though, aren't looking for fist-sized nuggets, or even the fingernail-sized
flakes that many 49ers hoped to find at the bottoms of their pans. Today, a major gold strike
might grade out at 5 grams per ton of rock, and economical recovery is routinely done at
significantly lower levels. The easy-to-get stuff is largely gone. With demand rising, miners are
struggling to produce ever more gold from ever-lower grades of ore. And they're falling behind.
There are a number of simple reasons for the production decline. The older, more productive
mines are playing out; newer mines tend to be lower grade; fresh mega-discoveries have become
rare; cost of extraction has soared; environmental regulations are more stringent; and greedy
governments demand a growing slice of the revenue pie.
From discovery to production, it can take up to ten years to develop a producing gold mine. So
as existing and long-producing gold mines continue to deplete their resources with many
shutting- or ramping-down production, a strong pipeline of replacement mines is just not there.

In 2007 China (with 276 tonnes) overtook South Africa as the world's largest gold producer, the
first time since 1905 that South Africa has not been the largest. Chinas production of gold has
risen at rate of 7 percent to 8 percent annually over the past five to six years.
Scrap
Unlike other metals that are consumed in industrial use, most of the gold ever mined is still
around. Recycled gold (or scrap) adds to the supply and helps to stabilize the gold price. The
value of gold means that it is economically viable to recover it from most of its uses; it is capable
of being melted down, re-refined and reused. Between 2003 and 2007, recycled gold contributed
an average of 26% to annual supply flows.
So-called "scrap gold" can be extracted from old electronics, too. A ton of discarded cell phones
will yield 150 grams of gold, 30 times what a miner gets from an average ton of ore. Scrap
sellers are bringing to market more than half as much gold as all the world's miners.
Central banks
Central banks and supranational organizations (such as the International Monetary Fund)
currently hold just over one-fifth of global above-ground stocks of gold as reserve assets
(amounting to around 29,000 tonnes, dispersed across 110 organizations). On average,
governments hold around 10% of their official reserves as gold, although the proportion varies
from country to country. Although a number of central banks have increased their gold reserves
in the past decade, the sector as a whole has been a net seller since 1989, contributing an average
of 520 tonnes to annual supply flows in 2003-2007.
Equilibrium
Average annual demand over the last 5 years has been about 3800 tonnes and mined supply is a
bit less than 2600 tonnes. A further 15% [600 tonnes] of annual demand is met from scrap
jewelry and bullion and the remaining significant shortage of almost 20% [about 800 tonnes] is
being met by sales of central bank gold reserves. Thus, with demand on the rise supply has
struggled to keep pace. It is no wonder that gold prices have kept on rising.
The forces designed to correct an imbalance are quite simple. Rising prices should encourage
suppliers to increase their output, and rising prices also serve to reduce demand. The problem is
that for commodities, precious metals in particular, supply and even demand-side tendencies
cannot change overnight.
Demand continues to grow steadily on a global basis. Over 60% of todays global population
resides in the fastest growing economic region of the world, Asia. One hundred years ago the
gold demand that came from poverty-stricken and economically-weak Asia was from a handful
of aristocrats. But today the 4 billion people in these growing economies will contribute a
sizeable share of todays and tomorrows gold demand. The Middle East petrodollars will also
need to continue to find refuge.

So as the world grows, its wealth will be distributed among a portion of the world that has
historically had little opportunity to buy gold. This could have a huge market impact on gold
demand. On the other hand, fundamental trends suggest that the gold market may be moving
from a period of general scarcity to outright shortages.
The steadily rising gold price has encouraged some mining companies (and forced others) to buy
back their previous forward sales -- a process called dehedging. Dehedging has accelerated and
become a major factor on the demand side of the gold balance sheet. In 2005, the mines
dehedged 86 tonnes of metal. By 2007 that figure had grown to 400 tonnes -- a 365% increase.
When a mining company dehedges, it reverses its previous role as a seller and instead enters the
market as a buyer. What was once supply which acted to hold down the price now becomes
demand and an impetus to the price. This role reversal has contributed significantly to gold's
steady rise over the past several years.
China, which became the top gold producer in the world this past year, is a net importer of gold.
Beyond direct retail demand which is likely to increase as China prospers (the Chinese people
have a particularly strong attachment to gold), there is the question what China is likely to do
with all the dollar reserves it has piled up over the past few years. There are constant rumors that
its huge sovereign wealth fund is buying gold. The central bank has also been cited in press
reports as a potential buyer. Should any significant tranche of gold be made available, there is a
strong chance that China might be a buyer.
So, in the case of the world's first largest gold producer, the gold in essence never leaves its
borders. What appears to be production that should grease the wheels of international supply is
actually gold hoarded by the nations which produce it.
If the supply side of a product is pinched, excess demand drives up the unit price of the product.
And who better to benefit from this situation than the suppliers, the gold producers/miners that
bring the metal to market. As the price of gold rises, positively leveraged gold producers should
be well-positioned to earn great fortunes for their shareholders as they earn more money for their
gold.
Source: Archana Sethia and Anindya Sen (2009), Gold: Supply and Demand, Mimeo, IIM
Calcutta.