This is a guest commentary written by Stefan Wieler of Goldmoney. Disclosure: Goldmoney maintains a strategic investment in a new company called Menē Inc, which is briefly discussed at the end of this report.
The media, industry experts and research analysts often report on changing demand from the gold jewelry industry. In those reports, it is usually implied that lower jewelry demand is a sign of weakness of the gold market and vice versa. However, this reveals a fundamental misunderstanding of gold.
“Demand” for gold cannot be compared to demand for input commodities such as oil, steel or grains. Commodities are produced, transported, stored, consumed and then disappear (or have a material recycling/repurposing cost relative to their use cost). Gold is produced and used over and over again (in economic calculation as a result of it being money) with almost no marginal cost of usage, little maintenance or holding cost, and it never disappears. Gold is thus accumulated rather than consumed because of its usefulness as money (a store of value relative to other commodities that are first produced, then used and then disappear).
Most of the gold that is bought in the form of jewelry is nevertheless bought because it works as a store of value. This jewelry is thus a substitute for a gold coin or bar. Hence it makes little sense to look at “demand” for gold in the form of jewelry while ignoring “demand” in the form of bars and coins (usually referred to as investment demand). Indeed, it turns out that “demand” for gold jewelry almost perfectly inversely correlates with investment demand (see figure 1). But if demand for gold jewelry is just another form of investment demand, how come the two fluctuate so wildly, thereby revealing this strongly inverse correlation? For that we must take a closer look at the global gold jewelry market.
THE GLOBAL GOLD JEWELRY MARKET
According to data from the World Gold Council (WGC), gold producers mined about 3100 million metric tons of new gold per year on average over the past five years. A further 1300 tons of supply came from recycled gold, thus the total gold supply was about 4400 tons per year. About 2400 tons of that was manufactured into jewelry. However, this jewelry demand is very unevenly distributed around the globe. Emerging markets – particularly in Asia - accounted for about 89% of total jewelry demand while western countries only accounted for the remaining 11%. China, the largest gold jewelry market, accounted for 32% alone while India, the second largest market, for a further 25%. Usually it is argued that this is due to historical and cultural reasons. In India for example, gold is normally given as present to newlyweds or at birth. However, we believe tradition alone cannot explain why western consumers accumulate so little gold in the form of jewelry compared to their eastern counterparts.
In order to get a better understanding why western gold jewelry demand is so weak, we first take a step back and analyze a country which boasts a vibrant and working gold jewelry market: India.
THE INDIAN GOLD JEWELRY MARKET
According to the World Gold Council, India fabricated around 600 metric tons of gold in the form of jewelry on average over the past five years. On top of that, India accumulated also about 250 tons of coins and bars per annum. The first thing one notices is that gold jewelry sold in India has a very high gold content. In a 2014 interview, Rajesh Khosla, then managing director of MMTC-PAMP2, stated that “scrap gold that we receive for refining has varied from 80% to 85% [gold content]”.
That means the average fineness of recycled gold jewelry in India is about 20 karats. The average fineness of gold jewelry sold is likely even higher than that as brides traditionally wear 24k gold at their weddings. Recycled gold also does not account for all the gold jewelry that is resold in its original form, rather than being recycled (melted and re-casted in a refinery). There is also a substantial incentive to buy higher purity gold when it comes to recycling. According to the WGC, sellers of gold jewelry for recycling typically receive 100% of the gold value on 22k+ gold, 85% on 21k gold and only 75% for 18k gold.
So why is it that gold jewelry is such an integral part of Indian society? In our 2016 report “Indian gold jewelry demand reacts to prices, not vice versa”, we explained that is important to understand Indian gold jewelry in a portfolio context.
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“Gold is simply a money stock in these portfolios—not a luxury good or commodity—an inventory that stores value and effortlessly maintains commodity-purchasing power against exogenous inflationary pressures.” |
In the report, we coined the term “perpetual savings demand” highlighting the importance of gold as a savings vehicle in Indian society.
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“It is key to understand that some sources of “demand” in the gold balance are price markers and some are price takers. When we think of gold jewelry we typically think of expensive watches and designer-necklaces. However, most jewelry is produced with a small markup over the gold price and bought as savings in emerging markets such as India. It’s very different from gold jewelry in the West where the manufacturing and branding costs often exceed the value of the gold. A large part of the Indian public has no other way to save money than in gold. They often lack access to bank accounts and inflation leads to a constant decay in purchasing power. Thus Indian farmers and other laborers will simply turn their profits or wages into gold. Most of it will be in the form of jewelry, but it also comes in the form of coins (medallions) and small bars. To our knowledge there is no standard name for this source of demand in the gold industry. For simplicity we call this “perpetual savings demand” for the remainder of this report. It’s a permanent source of gold demand. Importantly, when the INR depreciates, wages and profits of farmers don’t catch up right away. Hence as gold prices go up in INR, Indian gold jewelry buyers can simply buy less gold (yet the same amount in INR).” |
Importantly, in India the level of “perpetual savings demand” is inversely correlated with (predominately) western “investment” demand in the form of ETFs, bars and coins. When western “investment demand” goes up, “perpetual savings demand” in India goes down. In other words, when real-interest rates fall and “investment demand” - mainly from the developed markets – increases, jewelry buyers in the developing economies to give up some of their demand. The mechanism by which jewelry buyers are pushed to reduce their gold purchases is simply the price.
To save in gold jewelry rather than Indian Rupees has been (and remains) the prudent thing to do. The Indian Rupee has lost 99.4% of its value since 1973 compared to gold and there was no low-risk interest-bearing instrument in rupees that would have compensated for that, as my colleague Alasdair Macleod pointed out in an earlier report. On top of that, a large part of the Indian population does not have access to a bank account to begin with.
It is obvious that Indian gold jewelry buyers are simply assiduous savers rather than fashionistas. That is not to say that Indian gold jewelry is not fashionable or beautiful. Everybody that ever had the pleasure to attend an Indian wedding can attest to the contrary. The gold jewelry worn by Indian brides is of the utmost beauty and emits a color only 24k gold can produce. Indian jewelry buyers have simply realized that saving in 24k gold produces vastly better returns than holding a government bond, has no counterparty risk and certainly looks better at a party.
THE US GOLD JEWELRY MARKET
This brings us to the western gold jewelry market. We use the US gold jewelry market as a proxy for the western gold jewelry market because the availability of data is a bit better than for other markets, even though it’s still surprisingly poor given the size of the industry. One can only think the lack of data is deliberate so as to deceive jewelry buyers.
The US Bureau of Economic Analysis reports that Americans spent over USD85bn on jewelry and watches in 2016, of which an estimated 90% was on jewelry. However, according to the data from the United States Geological Survey (USGS), this jewelry contained less than USD5bn of actual gold. How much of the USD85bn was spent on gold jewelry? This question is not easy to answer. The World Gold council estimates that “fine gold sales” were in the order of 14.6bn in 2016, using 2013 data from the US Chamber of Commerce5 as basis for their estimate. Hence, if all the gold sold as jewelry was accounted for in the “fine gold jewelry” category, it would imply that is sold with a markup of slightly over 200% to the value of the gold it contains. In other words, the gold value (and thus resale value) of an average gold jewelry piece sold in the US would be only about 30% of its retail price.
However, the remaining USD61.5bn of jewelry sales (categorized as something other than fine gold) most likely contains substantial amounts of gold as well. In the US, Diamond jewelry accounts for the lion’s share of jewelry sales. According to De Beers, Americans spent USD39bn on diamond jewelry in 2016. De Beers however does not disclose how much of that is spent on the stones itself and how much of that is spent on the pendants and rings.
Hence, a substantial part of the gold sold as jewelry in the US probably ends up in diamond (and other) jewelry as well. This means that the average US consumer spending on gold jewelry was likely substantially higher than just the USD14.6bn spent on fine gold jewelry, which in turn means that the average markup over the gold value in US jewelry is substantially more than 200%. In other words, the value of the gold in gold jewelry sold in the US is probably significantly below 30% of what customers pay. We estimate it’s probably closer to 10-20%. Compare this to a market like India where it is closer to 80-90%.
Hence, for US buyers, gold jewelry is not an efficient store of value. The minute they leave the store, their jewelry has lost 80-90% in value. Thus, gold prices must go up 500-1000% in order to make up for that loss. In other words, the average piece of gold jewelry bought before 1979 is still not worth it’s price in gold today! This is very different for an Indian buyer. A gold ring bought in India before 1979 is up over 5200% in Indian rupee over what was paid back then. Importantly, it’s also up 470% in USD, the reason simply being that Indian jewelry buyers get a lot more gold for their money than Americans. Therefore, Americans today purchase gold jewelry mainly as a fashion item, not as an investment. In turn, Americans seem to be reluctant to spend too much on gold jewelry.
On average, Americans, on a per capita basis, have bought only 0.35 grams of gold in the form of jewelry each year over the past five years. That is worth about USD15 and we estimate that the buyers have paid around USD75 for that jewelry, which is still only a minor part of total jewelry spending of USD250 per person.
Importantly, Americans buy much less gold in the form of jewelry than they did just 20 years ago. According to data from the World Gold Council, demand from the US jewelry sector has declined 42% since 1997. And the picture is even bleaker in other western markets: In Japan, demand from the jewelry sector down 63%, in Germany 72% and in Italy a whopping 78%, and that is not adjusted for economic and population growth. At the same time, demand from the jewelry sector in both India and China are flat to up (see figure 5).
It is not that Americans have no interest in gold either. While gold demand from the jewelry sector has continuously declined, demand in the form of ETFs, bars and coins has increased significantly in the West. Americans accumulated around 1100 metric tons of gold in the form of bars and coins over the past 20 years. Investors accumulated a further 2200 tons globally in ETFs over the same time horizon, a significant share likely to be held by US citizens. And services like ours, giving people an easy and efficient access to own physical metal fully insured, audited and without any counterparty risk, have seen large inflows as well. But – unlike in India – accumulating gold in the form of jewelry has simply not been an easily accessible option in the West.
Until today, that is. On June 15, 2017, Goldmoney announced a strategic investment in a new company called Menē Inc. The new company is a direct-to-consumer fine jewelry venture with the aim to manufacture 24 karat gold jewelry and to sell it online using a transparent pricing model. More specifically, gold jewelry is sold on the Menē website showing the exact weight of each piece and also the current value of the gold it contains. Menē then adds a fee in the order of 10-20% for design, manufacturing and packaging. The price model of Menē is thus very atypical to the western jewelry market and, for the first time, allows anyone to start saving in gold, while also to appreciate the beauty of 24kt gold jewelry every day. At Goldmoney, we advocate for sound money.
In a similar fashion, Menē can be said to produce sound jewelry. To go back to the original question: If demand for gold jewelry is just another form of investment demand, how come the two fluctuate so wildly, revealing this strong inverse correlation? The answer is that western gold demand is very different from the perpetual savings demand we see in the East. Western gold demand comes in waves, usually when large investors - concerned by macroeconomic and monetary events - seek refuge in gold, which then in turn must lead to lower gold jewelry demand.
If the gold jewelry market in the West would play as an important role as it does in the East, those dynamics would most likely look totally different. For example, when monetary events such as the 2008 global financial crisis and the subsequent extraordinary monetary policies from central banks lead to increased gold demand in the affected economies, there is no economic reason why this demand has been entirely in the form of bars and coins. If gold jewelry were as good of a store of value as a gold coin, it is reasonable to assume that gold jewelry demand in that region would be impacted just the same.
It will be very exciting to see how Menē will change the way we view gold jewelry in the West. The great monetary experiment by central banks that started in 2008 has clearly led to a search for an alternative to fiat currencies. My colleague John Butler wrote about this extensively in a recent report. This was further exacerbated by the concerns over the global banking system. The recent price action in cryptocurrencies is now the most visible indicator of this, although the general run-up in liquid asset prices provides further, more traditional evidence. It was for that reason that Goldmoney was created, to allow people to save outside the fiat currency system and outside the banking system.
For a lot of people, buying physical gold and storing it independently is the preferred method. Until recently, buying coins and bars was the only way to do so. But not everybody is interested in owing gold coins. Owning jewelry is a much more intuitive (and attractive) way to save in gold. With Menē, this finally makes sense from an economic perspective and with high convenience. We believe the Menē philosophy could eventually lead to a trend reversal in western gold jewelry demand. This would have a profound impact on how global gold jewelry demand and gold investment demand interact. At one point, the two could become indistinguishable, as it likely was throughout much of history.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor research note written by Stefan Wieler for Goldmoney Insights. Wieler was previously a senior commodity strategist at Goldman Sachs. This piece does not necessarily reflect the opinion of Hedgeye.
