Why Is the Price of Gold Falling?

China's problems are gold's problems 


Investors who love gold tend to think of it as a sort of bomb shelter. It's supposed to be a secure place to park your money when the rest of the financial world is blowing up.

So some may find it surprising that in a year when Europe's troubles have thrown the global economy into fits, gold has been a loser's bet. The price per ounce of everyone's favorite rock is down about 7percent for the year and is off 15 percent from its September peak. According to a report released yesterday by the World Gold Council, total demand for gold fell 7 percent in the second quarter of 2012 compared to the year before.

Let this be a reminder that, no matter how long it's been around, gold just isn't that special. It's a commodity that responds to the laws of supply and demand. Unlike commodities such as wheat or oil, which you can at least eat or burn for fuel, gold pretty much lacks any inherent value beyond what the market assigns to it. And in the past decade, much of the new demand that set gold off on a wild tear from around $300-an-ounce at the turn of the century to almost $1,900-an-ounce last year has come from two places: India and China. Combined, they account for 45 percent of the world's demand for gold jewelry and bars.


For today, let's focus on on China, which passed India as the world's top gold market earlier this year. The country deregulated its gold market in 2001, and since then, it has gone from consuming about a third as much gold as the developed west to overtaking it by 2011. Let me repeat that: the Chinese buy more gold than the entire west combined.

There were a few factors motivating China's gold rush. Most obviously, the country got richer, meaning there were more shoppers in the market for jewelry.  But as the Wall Street Journal reported yesterday, gold used to be one of the limited investment options Chinese families had at their disposal:

In the past, Chinese households had a choice between volatile equities, expensive property and gold to park their cash. Now investment options are broadening.
At the end of the second quarter, Fitch estimates around 10.4 trillion yuan ($1.6 trillion) was invested in wealth management products, equal to 11.5% of deposits in China's banking system and up fivefold from 2008. Unlike gold, wealth management products often offer principal protection and guaranteed returns.
At the same time, the capital account is becoming more porous. Chinese households are already making investments in real estate everywhere from Hong Kong to New York.

Just as China's rich have found new places to invest, the country's economy has been slowing down frighteningly, which dropped demand for jewelry this last quarter by 9 percent from a year earlier.

As goes China, so goes gold. How's that for a safe haven these days?