Investment bank Société Générale is calling gold down to below $800 by the end of this year as a stalling in investment is unlikely to be offset by an equivalent recovery in jewellery demand. The fact that prices fell very sharply when investment faltered over the turn of February and March is cited as a potential precursor to more of the same later in the year.

The latest quarterly Commodities Review from the bank notes that in late March the major Exchange Traded Funds held 1,589 tonnes of gold, which was a twelve-month increase of 656 tonnes [since then they have added a further 14 tonnes], but that more significantly they had acquired 390 tonnes since the turn of investor appetite in mid-January. Between then and early February there were only nine days on which there were net redemptions and six of these were concentrated between February 24th and March 6th. During that period, just four tonnes were sold from the funds, but the loss of this inward investment momentum took 10% off the price over that period plus a further three days.

Noting that investment activity is clearly not the only price driver in the market, the bank points out that it is currently one of the few bullish influences. Absorption of 198 tonnes into the funds in the first three weeks of February accompanied a price increase of $80 or 9%, and then flat activity in the two following weeks saw that gain wiped out, highlighting the importance of sustained investor purchasing if international prices are to remain high.

At the retail level, coin demand has been extremely strong (although it is much smaller than ETF or Over the Counter investment activity) with US Mint figures showing sales of gold in American Eagle coins running at nine tonnes in the first twelve weeks of the year, more than three times the amount in the full first quarter of 2008. This coin demand had helped to put substantial pressure on refinery capacity earlier in the year, but this has now changed as a result of a supply-side response to high local prices.

The bank comments that the flood of old gold scrap from jewellery means that refineries are now well-furnished with gold supply and the liquidity in the market is reflected by low lease rates - although rates have generally been low for some considerable time, with market demand showing up more in terms of extended waiting lists and elevated physical premia.

The supply-demand analysis suggest that the surplus of physical supplies over fabrication demand and bar hoarding will be as much as 635 tonnes this year as jewellery demand will remain depressed in the face of high prices and the economic environment. The banks review contains an in-depth analysis of the regional and global economic background and is relatively sanguine about the state of the Indian market (given the global environment); consumption in general in the country is holding up well, with seasonally-adjusted consumer spending in the fourth quarter of 2008 running at its long-term trend of 6%, up for m3% in Q3. Industrial production was hit by the OECD downturn but was down just 2% year-on-year in December., The bank is looking for growth of 4.2% in India and 6.8% in China this year, roughly half the rates of 2007, but substantially better than the rate of growth in the OECD economies that are mired in recession.

Even so, the Indian jewellery market has been hard hit with local Indian prices averaging almost Rp14,500 per ten grammes between the start of the year and late March. They are currently just over Rp 15,100 per ten grammes and the study points out that while the market is gradually becoming used to these prices, the price range over the quarter was a wide 24% and that had a negative impact on sentiment. There were times in the quarter when Indian jewellers stocked up into price weakness; at other times there were reports of resting orders in anticipation of lower prices.

The bank points out that India acts as a microcosm of the price-elastic jewellery market as a whole and suggests that demand will improve when price volatility ebbs away. For the time being, however, it remains slow and well-supplied by scrap return.

This is a key feature behind the high tonnage that the market is expected to have to absorb if international prices are to remain high. Industrial fabrication is under a cloud and dehedging has dropped substantially - although so have central bank sales. Société Générale questions whether investors, who have so far been up to the task of absorbing all the metal that the market can throw at them, can sustain this level of activity. For the short term, further investment activity is likely and higher prices are expected to come with it. For the longer term, though, the investor is expected to take his foot off the pedal and this will put gold prices under substantial pressure.