Every silver lining has a cloud, and sky-high gold prices are no exception.
While on the upside, the investment fund interest has driven the price for one ounce of the yellow metal above US$900, the downside is that the price spike has put a damper on physical demand, notably imports of gold into India in 2008. Many families in India tend to hold family wealth in gold assets, in the form of jewelry.
Demand from emerging markets is very price sensitive, showing declines at prices above US$700 per ounce, with a more pronounced decline above US$900, said Jim Steel, a New York-based analyst at HSBC Securities Inc., who spoke Sunday in Toronto at the annual convention of the Prospectors and Developers Association of Canada.
"You really see an incredible choking off in physical demand," Steel said. "If we continue to see weakness in the jewelry market, it's going to be a drag on the price going forward," Steel said, noting jewelry represents about 75% of demand for gold. In comparison, "we've seen a sharp increase in ETF demand," Steel said.
While some observers have wondered why gold doesn't spike above US$1,200 an ounce or more, given it serves as a safe haven in the global flight to safety, Steel isn't bullish on further significant price hikes.
Although gold prices are currently, deflationary times ahead, says Steel, citing a recent comment by Ben Bernanke, the chairman of the Federal Reserve, that he expects to keep inflation under control.
"Gold historically does not rally during a deflation," noted Steel. "Our view is you're going to see a steady, but modest, decline in the gold price."
In terms of output, Steel says he expects production to continue to go down due to a lack of new projects, declines in output by major producers and problems with getting financing.
Gold's poor cousin, silver, is also seeing a similar dynamic in its demand outlook, with strong interest from investment, but physical demand -- with industrial uses driving more than 50% of total demand -- declining significantly. Silver is used in electronics, and data show, for instance, that global semi-conductor sales have fallen off quite sharply, Steel said.
"It's really very hard to paint a positive picture for industrial demand for silver," Steel said.
Gold prices tend to lead silver prices, and Steel said he expects the strong correlation to continue.
Steel said ETF demand remains strong, without which there would be a significant surplus in the silver market. He said he has had to cut previous forecasts for production downward, from an expected increase of 30 million ounces in 2009, down to a "still fairly healthy" increase in production of 15 million ounces, Steel said, adding that is due to the drop in global base metals production. (About 75% of silver output is as a byproduct of base metals -- mostly copper -- or gold production). Any increase in silver output is expected to come from mines where silver is the primary product, Steel said.
Laura Bobak is a business and investing reporter based in Toronto, Canada. She has worked for a wide range of media outlets, including the Canadian Press wire service, the Investment Executive newspaper for financial advisors, and the Toronto Sun. Her business writing has also appeared in the Globe and Mail and the Toronto Star and she has made numerous appearances on both radio and television. She graduated from the Carleton University School of Journalism in Ottawa in 1993.