Column: Gold rally's Achilles heel may be soft China, India demand

LAUNCESTON, Australia (Reuters) - There is little doubt that gold has had a stellar year so far, surging almost 28 percent, but there may be some areas of concern emerging that could act as a brake on further gains.

A salesman helps a customer (R) to select gold bangles at a jewelry showroom in Mumbai, India, May 21, 2015. REUTERS/Shailesh Andrade/File Photo

The rally in spot gold to Monday’s close of $1,352.85 an ounce has largely been driven by what may generally be termed the fear trade, as investors sought the safety of the precious metal amid mounting economic worries, predominantly in the Western world.

The price spike in the wake of the surprise vote by Britain to abandon the European Union is a case in point, with gold jumping as much as 8.2 percent on June 24 as the results came in.

The winding back of expectations for U.S. interest rate hikes, volatility in equities, some bond yields turning negative, the possibility of Donald Trump winning the U.S. presidency and general fears around the global outlook have all contributed to gold’s solid performance and constructive outlook.

So what is standing in the way of further gains for the yellow metal?

The main obstacle that appears to be discounted by the market is lackluster demand in the world’s top two physical consumers, China and India.

China’s gold demand for jewelry slumped to 83.8 tons in the second quarter of 2016, down almost 36 percent from the first quarter and 24.1 percent from the same quarter last year, according to data from consultancy GFMS.

Jewelry demand represents about 60 percent of total demand in China, the world’s top gold consumer, and GFMS said the second-quarter performance was the worst since 2009.

“The further bad news is that there is still no sign of the sector bottoming,” GFMS said in its second-quarter outlook published on July 28.

Underscoring the concerns about China’s gold demand was the 38.5 percent decline in imports in June from Hong Kong, the main conduit for gold entering the mainland.

China’s net gold imports fell to 70.886 tons in June, down from 115.29 tons in May, according to data emailed on July 26 to Reuters by the Hong Kong Census and Statistics Department.

The situation in India is little better from a physical gold demand perspective, with imports falling for a sixth straight month in July, according to GFMS.

India’s gold imports in July are estimated at 20 tons, GFMS data showed, the lowest since March and down 79.3 percent from a year ago.

The weak July numbers came after data showed that India’s jewelry consumption was 69.2 tons in the second quarter of 2016, down 5 percent from the first quarter, but a whopping 56.3 percent weaker than the same quarter last year.

Put another way, last year India’s total jewelry demand was 674.5 tons, while the first half of 2016 has seen just 142.1 tonnes.

While demand in the world’s number two consumer is traditionally higher in the second half of the year, it would seem virtually impossible for 2016’s total to get anywhere near the amount reached last year.


India’s gold demand has been hurt by higher prices for imported metal, which have trimmed domestic demand and led to discounting that has also served to render imports uncompetitive.

Weaker economic growth in China, and especially in the struggling manufacturing sector, has probably served to limit consumers’ appetite for gold, especially since prices are up by about 30.5 percent in local currency terms, which is stronger than the gain in U.S. dollars.

Overall, physical demand for gold has been soft in the first two quarters of 2016, totaling just 1,479 tons, which is down 23 percent on the same period in 2015.

Gold probably wouldn’t have enjoyed much of rally if it wasn’t for the fact that exchange-traded funds (ETF) had recorded an inventory build of 771 tons in the first half, up from a mere 4 tonnes in the same period in 2015.

In all likelihood gold’s short-term future hinges on whether ETFs continue to attract investors, and there is a strong correlation between the spot price and the total ETF holdings.

ETF holdings have leveled off in recent weeks, after rising to 56.6 million ounces on July 11 from 40.1 million at the end of last year.

There are still good reasons to expect investors to support ETFs given the evaporation of expectations of U.S. interest rate rises and the plethora of global economic and political risks.

But unless physical demand rejoins the party, it becomes harder to make a convincing case why gold should continue its strong rally of the first half of 2016 into the second.

(The opinions expressed here are those of the author, a columnist for Reuters)

Editing by Richard Pullin