Time to scrap your old gold

It is well understood in the souks of Dubai that gold is a traded commodity. It can be crafted into fine jewellery and worn but it is also a liquid asset that can be sold when cash is tight or for profit.

The type of gold traded in the Middle East, India and Asia tends to reflect that attitude: it is high carat and low margin because consumers want their value in the metal rather than in fancy design work. The exact opposite is true for gold sold in Europe and North America. There, the metal is often little more than a setting for a precious stone and is usually low carat – sometimes only one third pure gold.

The low value of the gold found in Western jewellery means that the metal is rarely worth reselling and is instead handed down from generation to generation as a family heirloom worth more in sentiment value than in financial terms.

However, that is changing. The severe financial crisis of the past two years has encouraged people everywhere to take advantage of high gold prices and sell their second-hand jewellery.

According to GFMS, the leading precious metal analysts, the amount of gold scrapped last year rose by 27.2 per cent to a record 1,647 tonnes. The Middle East, India and East Asia accounting for a large percentage of this total as you would expect from regions well used to trading gold when prices are high and money tight. The surprise was that Europe and North America were also scrapping gold at unprecedented levels, particularly in the first quarter of 2009 when the recession was at its deepest in these regions.

Indeed, so savage was the downturn in this period that the amount of gold jewellery being scrapped actually exceeded the amount being made. The amount scrapped also exceeded the amount of gold that was being produced in all of the world's mines, which is an incredible indication of just how many people needed a bit of extra cash last year.

Given this flood of new supply into the gold market, the price of the metal might have been expected to fall. Not so: the price actually rose from an average of $871 an ounce in 2008 to $972 in 2009 and it has continued to rise this year, currently trading at over $1,150.

The increase in price is the result of massive investment demand as people have shifted their assets into gold – a traditional safe haven from collapsing banks and falling property and share prices. According to GFMS, investment demand quadrupled last year to 1,429 tonnes and it is likely to remain strong this year as fears of rising inflation encourage investors to buy gold as a hedge.

However, while investment demand may have been bullish in the past year other forms of gold demand fell sharply. Jewellery, which normally accounts for about 80 per cent of gold production, fell by 20 per cent to 1,759 tonnes and demand from the electronics sector (a big industrial user of gold) fell by 16 per cent.

Given the squeeze on household budgets and the high prices of gold, consumers put off buying new pieces of jewellery last year and only China registered any significant increase in sales. The fall in demand was sharpest in the Middle East, down by 200 tonnes in 2009 alone.

But what about this year? GFMS has said that it expects an average price of $1,170 an ounce this year, which is not much different from where gold is trading now. However, the price could spike as high as $1,300 as fears grow of a bout of global inflation. As with 2009, the price of gold will be balanced between high investment demand and low jewellery sales. Scrappage will also increase in the second half of this year as the price rises but we are unlikely to see a repeat of last year's amazing figures.

In the long term, current price levels are probably unsustainable. Gold is cyclical just like any other commodity and when investment demand drops as the world economy recovers, prices will fall. This is unlikely to happen in the next couple of years but from 2012 the price trend will probably be downwards and many analysts are forecasting that prices will be about $750 an ounce by 2014. So, now would be a good time to take advantage of high prices and trade in any old gold you may have lying around.

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