All that glitters is not gold for traders
Soaring prices have sent Gulf gold-buyers running for cover. Can the regional industry bounce back? A report from the souks. --------------------------------------------------------------------------------
The annual Hajj pilgrimage is traditionally a time of peak gold demand in the Gulf. Muslims making the holy journey to Mecca invariably mark their odyssey with a trip to Saudi Arabia's gold souks, stocking up on jewelry to commemorate their once-in-a-lifetime trip.
Elsewhere in the Gulf, those who stay home flock to their domestic gold markets to buy gifts for friends and family as they celebrate the Eid al Adha religious holiday. In each of the three years to 2002, Middle East gold demand peaked in the first three months, thanks largely to Hajj and Eid demand.
This year it's a very different story. Official figures are not yet out, but anecdotal evidence suggests demand has slumped. 'We expect lower offtake in tonnage terms,' says Moaz Barakat, Middle East director of the World Gold Council (WGC), an organization funded by gold producers to promote the metal.
The same is true across the region. In the UAE, home to the region's most dynamic gold market at the Dubai gold souk, demand is down by up to 50 percent on last year. 'Our business has shrunk substantially,' says Joy Alukkas, managing director of Alukkas Jewellery, one of the leading networks in 22-karat jewelry. 'There is no hiding the fact that the gold jewelry business this time around is very poor.'
The Dubai Shopping Festival (DSF), which ran for a month from mid-January, saw a flurry of gold promotions as retailers tried to lure shoppers back. But the word on the street is that they enjoyed little success. While overall visitors to Dubai were up 40 percent on DSF 2002, jewelry sales were at best flat, at around 275 million dirhams ($75 million). Of that figure, a far greater amount was spent on gold's precious rivals, particularly diamonds, than in previous years.
What caused such a dramatic collapse in gold demand? In short, the price. The price of gold, set by traders on international commodity markets, has rocketed in recent months. In February 2002, gold was selling for around $280 per ounce. By February 2003, it hovered just below $380 per ounce, though the price briefly dropped to $340 per ounce by mid-March.
'Only those who cannot postpone buying are spending on gold jewelry, such as for a wedding,' says Tushar Patni, chairman of Abu Dhabi Gold and Jewellery Group. He says, 'Business at Abu Dhabi's gold souk is down by at least 50 percent.'
The surge in the gold price over the past 12 months throws up a number of searching questions. What forces have sent gold prices skyward? Where is the gold price headed in 2003? And what are the likely implications for the region's gold industry?
A host of factors have conspired to send gold prices ever higher in recent months. But if one word could sum up the reasons, it's 'uncertainty.' Investors view gold as a safe haven in times of political and economic turmoil. Recent months have seen both escalate, as military tension mounts in Iraq and global capital markets continue to languish in the doldrums.
Investor skepticism about buying shares in the wake of the Enron and WorldCom scandals has forced them to look for alternative asset classes. At the same time, the weakness of the US dollar has given gold a further shot in the arm (they traditionally move in opposite directions, and the current downturn in the dollar's value has proved no different).
Ironically, the surge in the gold price has come at a time when demand for gold is at an historic low. How is this possible? Because the gold price is set by traders dealing financial derivatives in New York, London and Hong Kong, not by shoppers buying necklaces in downtown Doha.
'This is a 'new' gold market,' explains Leonard Kaplan, gold analyst with Prospector Asset Management. 'The price is being determined not by the actions of the users or producers in their purchases and sales of physical product, but by the psychology of the investor and speculator.' Speculative 'long' positions are at their highest level in history, while bullish sentiment on the gold desks at investment banks has not been so rampant since 1980.
It is clear that powerful forces have driven prices to current levels. But can they sustain gold at $370 per ounce indefinitely? As ever, crystal ball gazing is fraught with difficulty. Some analysts feel a 'bubble' is inflating on the back of gold hysteria that, like the technology equity bubble of the late 1990s, will burst sooner or later.
'Internationally, the funds are long by some 13 million ounces,' says Tawhid, chairman of the Dubai Gold and Jewellery Group. 'I believe that if not today then tomorrow, they will have to offload those long positions.' That would send the price of gold spiraling down. 'It might be a drop as large as the increase we have seen.'
Others argue the current gold price is sustainable. 'In the absence of science [in predicting] economic recovery of markets, analysts expect a strong gold price for the remainder of 2003,' says WGC's Barakat. Indeed, some bulls believe the price has a long way to go before it reaches a plateau.
'Gold is, in my opinion, most certainly in a long-term secular bull market, for all the right reasons,' says Kaplan. 'As the US dollar continues to falter, as the equities markets continue their slide, as the paradigm shift from 'paper' assets to 'hard' assets builds a bit of momentum, as the budget deficits of the United States swell, it becomes apparent that gold must rise in response.'
What does the consensus say? A recent poll by news agency Reuters underlines the uncertainty in the market. It asked some 20 trading houses for a best guess on the average gold price for 2003. Forecasts ranged from $300 per ounce to $400 per ounce, a significant margin. The average was around $342 per ounce.
Kaplan argues that Iraq holds the key to future price movements. 'A peaceful solution to the Iraqi war, whether it comes as a result of a quick and decisive war or by other means, will turn investor psychology around very quickly and a vicious drop will be seen. On the other hand, if the Iraqi situation becomes worse than the market believes, the gold market will scream higher. All depends on the news at this point.'
For Gulf gold traders, it is a case of wait and see. They are 'price takers' in the gold price equation, and have to get on with their business whatever the yellow metal fetches. But for some, any change in the gold price – or change of heart by gold buyers – may come to late.
In early February, Dubai-based Gulf News reported that one gold trader with shops in Dubai and Sharjah had already been forced out of business by the sharp downturn in trade in recent months. The report was unconfirmed, but such stories are increasingly common among gold sources in the UAE.
Indeed, the timing of the recent downturn could hardly be worse for gold sellers: physical gold demand in the Middle East has been falling steadily for years. In Saudi Arabia, consumer demand fell from 250 tons in 1997 to 165 tons in 2001, according to WGC figures. Full-year figures for 2002 are not yet published,
but no one doubts that demand in the kingdom took another big hit. Some observers argue that it is only a matter of time before shops are boarded up across the region's gold souks.
Not everyone agrees. Regional gold heavyweights, such as Dubai Gold and Jewellery Group Chairman Tawhid Abdullah, insist the impact of recent demand pressures is being overplayed. He puts the downturn in business in Dubai's gold souk at nearer 10-15 percent.
Crucially, he makes the distinction between traders in 22-karat gold, targeting the Indian market, and those selling 18-karat gold, aimed at the high-end Arab and Western markets.
'The impact has been very minimal at the high end,' says Tawhid. 'For these people, it doesn't matter if something costs $400 or $500. Asian buyers are more price-sensitive, and we have seen demand about 10-15 percent lower at this end.'
WGC's Barakat is similarly bullish. 'Dubai's gold trade is experiencing lower traffic compared to the earlier part of 2002, mainly for local customers. tourist sales are still going at the same levels as in the past due to the large differential in prices between Dubai and Europe.' Barakat argues that the recent high gold price will ultimately convince buyers of the metal's true worth.
'The current high prices will only create a positive impact on the customer,' he insists. 'No matter what the price, gold offers a store of value like none other and continues to be seen as an investment rather than expenditure.'
Barakat and Tawhid have a vested interest in talking up the gold market. But they have a point, and it would be wrong to overstate the drop in regional gold demand. The Gulf remains one of gold's most buoyant markets. A recent report by Saudi Arabia's National Commercial Bank pointed out that in 2001, the kingdom was the world's fourth biggest gold consumer. Consumers in Saudi Arabia bought nearly 8 grams of gold each, compared with the global average of around 0.5 grams.
On the technical side, bankers in Dubai are in talks with many of their gold-trading customers about ways to ride the current storm. Jeff Rhodes, of Standard Bank in Dubai, says few of the city's gold traders hold much cash in the bank – they prefer to hold their wealth in gold inventory. While this is understandable, it can lead to cash flow shortages in times of crisis.
'When business is booming this is fine, albeit shortsighted,' says Rhodes. 'But when the market is slow, the gold jewelry held in stock can become a passive and wasting asset.' He is encouraging traders use their gold inventory as collateral, a move that will help them manage their cash flow better in the lean times.
PR campaigns and innovative banking techniques should help most Gulf traders cope with short-term downturns. Whether they will help them survive in an era of structurally reduced demand is another matter entirely. All eyes will be on the regional gold market when Hajj comes around again in January 2004. But only the most optimistic gold traders are banking on a speedy return to the good old days.
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