Gold Recycling: Can it Provide a MaterialCap or Floor to the Gold Price?

Some analysis of trends in the gold price implies that these are only ever determined by macroeconomic factors and how investors, particularly those we would classify as institutional, react to those factors.

There can be no doubt that these are the overwhelming drivers of price moves in the short-term, but Metals Focus, one of the world's leading precious metals consultancies, believe there are also times when gold's supply/demand fundamentals can play a supporting role.

One example of this was the recovery in the gold price from its early and late March lows in the $1,670s to over $1,800 by early May. It is clear that much of this rally was driven by macroeconomic developments, in particular the decline in real interest rates and more recently a poor US jobs report. However, in the early stages of this turnaround, it seems fair to argue that gold's fundamentals helped provide a floor for prices and background support to gains thereafter. There were certainly many headlines relating to an uptick in central bank buying (in particular Hungary's purchase of 63t, which was announced on 7th April). Similarly, much was made in the press of the rebound in jewellery consumption and net purchases of coins and bars in both India and China in the last few months. However, the marked fall in scrap seemed to generate much less interest.

Taking the bare numbers, this could be viewed as an oversight. From its recent peak in Q3/20 to Q1/21, recycling fell by 107t, whereas the rise in net official sector purchases over that timeframe was 98t and the increase for coin and bar purchases was 119t. (The melting down of old coins and bars is at times termed "scrap" by others, but we count that as disinvestment.)

Of the fundamentals, it was only the 201t jump in jewellery fabrication that far surpassed the change in scrap. As almost all scrap is from jewellery, we could extend this to the jewellery sector's net call on the bullion market (fabrication less scrap), which in Q1/21 was 308t higher than in Q3/20. To put this into a broader context, there was a swing of 450t for net inflows into ETPs. (For completeness, there was also a drop of 53t in mine production, but that is largely just picking up the seasonal dip in output that occurs each Q1.)

If recycling can get overlooked, why might that be? One explanation is that the figures are opaque; there are essentially no official statistics to quote on the subject. That stands in contrast, say, to US Mint sales of Eagle coins, or Indian gold bullion imports. A second reason concerns the interaction of the fundamentals with investors; some aspects of the supply/demand balance can boost or reduce investor confidence in their actions. The best example is perhaps official sector purchases as many institutional investors seem happier following suit to a central bank. As such, it is often the case that is not the tonnage removed from or added to the bullion market that matters for any fundamental, but its ability to influence investor behaviour.

A third factor is that recycling is arguably more than most other elements of the supply/balance just a price taker (and not a maker). In that regard, it is worth stressing the importance of local prices. One example last year was dollar weakness taking the edge off Eurozone gold prices and, with local prices failing to hold above ?,?50/g in Q1/21 (a level that consumers had seen as far back as April 2020), it becomes understandable how European scrap could fall more steeply than in the US this year despite a worse economic backdrop. An extreme example of this was Egypt's currency crisis in 2016 when a slump in the Egyptian pound led to gold scrap jumping to 93t from 30t the year before. There is, however, no guarantee that higher prices mean higher scrap; in normal times, Turkish scrap would be expected to surge should local prices exceed TL500/g but current political and economic uncertainties have made consumers in the country reluctant to sell hard assets.

Even if its role in shaping prices is even smaller than for the other fundamentals, what can we expect for gold scrap looking ahead? Our current forecast is that average quarterly volumes for the rest of 2021 will fall slightly from levels seen in Q1. This is largely premised on our view that prices will stay high and volatile, but fail to revisit the Q3/20 high. As a result, we are not expecting major changes in scrap for the rest of the year in comparison to Q1 in most countries. In China for example, we could well see an uptick in Q3 due to seasonal factors (this quarter often sees inventory melt to allow the distributive trades to refresh their product assortments), but this rise should prove imperceptible to the broader bullion market.

The clear exception to this at present is India. There, it is looking increasingly likely that the second wave of COVID infections will trigger a marked rise in selling back as the virus hits rural areas which were largely spared last year. This, in conjunction with any associated damage to jewellery fabrication and retail investment, would be reflected in weak bullion imports, which in turn might unsettle some investors.

To assess the potential for any country to trigger a supply shock, we need to take a look at so-called near-market stocks of jewellery. These comprise items with low sentimental value or no practical use (such as a single earring) that a consumer might readily sell. These stocks remain plentiful across emerging markets and it is only in the West that they have been heavily depleted. As a result, whatever happens to the gold price or to local economies, western scrap should never again provide more than 40% of the global total as it did in 2011 (last year, its share stood at just 23%).

In conclusion, recycling globally may act as even less of a drag than normal on any rally in gold this year. Firstly, countries outside the Middle East could copy their reticence to sell during times of heightened uncertainty and secondly consumers may hold off from selling initially in expectation of yet higher prices. Thirdly, there is the above-noted inability of western scrap to flex in line with the price to any material degree. However, this broad picture only holds true if a COVID-driven lift of consequence to scrap stays confined to India.

On the other hand, if the gold price weakens as the global economic recovery becomes more solid and wider uncertainties fade, the selling back of old jewellery might not fall as much as would be expected as the safe haven need to hold gold lessens. We could also see consumers rush to sell, fearing that prices could sink that much lower. With such outcomes, scrap's ability to provide any kind of floor for the gold price would be significantly undermined.

Editor's Note: Metals Focus is a leading, independent precious metals research consultancy. With a team spread across nine countries we are dedicated to providing world-class statistics, analysis and forecasts to the global precious metals market, www.metalsfocus.com.