There’s a new rule for gold bugs to understand: not even the shiny metal is immune to the laws of supply and demand, no matter the outlook for inflation or the global economy or the financial system.
If prices rise too quickly and stay there, as they have done for much of the past three to four years, demand eventually gives way and slumps.
Not even high levels of demand from investors can stop that.
It’s a warning that the current price of gold of around $US940 an ounce, is supported by some rather weak foundations.
Gold prices could very well experience a rapid fall until demand and the price come back into balance; that is demand from traditional users such as the jewellery trade, dentistry and manufacturing.
Figures this week from the World Gold Council (WGC) and the metal consultancy, GFMS surprised a lot of people with the revelation that demand for the metal fell to multi-year lows in the June quarter.
The council said demand ran at levels not see for five and a half to six years in the quarter as the recession curbed buying by jewellers and electronics producers.
Central banks were net buyers for the first time since at least 2000 as global consumption fell 8.6% to 719.5 tonnes from a year earlier, the London-based WGC said in a report this week.
That’s the lowest level since the first quarter of 2003.
Jewellery demand fell 22% and electronics, the biggest industrial use for gold, slid 26%.
The volume of total identifiable gold demand in the second quarter of 2009 was down 9% on the levels of a year earlier, equivalent to a 6% decline in $US value terms to $US21.3 billion.
That left the $US gold price in Q2 2009 just 3% higher than in Q2 2008.
But the WGC said that over the same period, the gold price rose 20% in Indian rupee terms, 28% in Turkish lira terms, 31% in pound sterling terms, and 18% in euro terms.
And that helped crimp demand, especially in India where the high prices have been having an impact for the best part of a year now.
The Council said the decline in tonnage relative to Q2 2008 "was attributable to weakness in jewellery and industrial demand, offset to a considerable extent by a significant increase in investment demand."
"Identifiable investment demand in Q2 totalled 222.4 tonnes, up 46% on year-earlier levels," it said.
"But net investment demand eased significantly relative to the highs seen during the previous three quarters when the level of uncertainty surrounding the economy and financial sector was at extreme levels, but still remained very healthy on a historical basis.
"The western-eastern divergence that was apparent in investment flows in Q1 continued into Q2.
"Bar hoarding, which largely covers the non-western markets, was down 36% on year-earlier levels, with investors choosing to take profits due to the high gold price.
"In contrast, other identified retail investment, which largely covers the western markets, rose from just 4.7 tonnes in Q2 2008 to 38.7 tonnes in Q2 2009.
Once again, this is below the levels experienced during the peak of the credit crisis but nevertheless healthy on a historical basis. Official coin demand was up 62% on year earlier levels.
"ETF demand, at 56.7 tonnes in Q2 2009, was robust on a historical basis but nevertheless marked a significant reduction on the 465.1 tonnes experienced in Q1 2009.
"Jewellery demand in Q2 2009 was 22% below year-earlier levels.
"The weakness was widespread, with western countries experiencing the ongoing effects of economic hardship and non-western countries suffering primarily from a high gold price.
"The exception to this trend was mainland China, where jewellery demand rose 6% in tonnage terms relative to year earlier levels.
"Industrial demand continued to suffer from the effects of weak economic conditions, falling 21% relative to year-earlier levels."
But a positive was that the sector "experienced an 18% quarter-on-quarter gain, reflecting a significant improvement in the other industrial and decorative and electronics components."
Central banks bought 14 tonnes of gold more than they sold, the first quarterly net purchases since at least 2000.
The official sector had net sales of 69 tonnes in the second quarter last year.
Central bank purchases aren’t counted in the 719.5 tonnes of total demand because they are considered a traditional source of supply,
Mine output rose 6% from the second quarter of 2008, and there was a 21% jump in recycled metal.
Recycling activity abated significantly in Q2 from the first quarter, but remained at high levels historically.
In India, the largest buyer, gold demand fell 38% to 109 tonnes, but it rose in China to 89.6 tonnes.
Germany was the biggest investment market with demand of 28 tonnes, the US saw demand of 23 tonnes for investment and there was 21 tonnes in India.
Gold supply in Q2 was up 14% relative to year-earlier levels.
The biggest contribution came from lower levels of producer de-hedging, with mine output and recycling activity making a smaller contribution.
Net central bank sales of 38.5 tonnes in the first half of 2009 (compared with 145.8 tonnes in the first half of 2008) were the lowest for 12 years.
The WGC said the outlook for gold at the moment can be explained "by splitting the world into two halves"
"Economic conditions in western countries are fragile and while this is the case, the outlook for jewellery and industrial demand will remai
