How demand from China could send the gold price soaring

You could explain the entire commodities bull market of the noughties with just one word.

China.

That’s been the story. What’s the copper price going to do? Where’s iron ore going?

The answer, for many, lies in Chinese demand. It’s been the biggest consumer of just about everything from cement to rare earth metals.

But we would do well also to consider the Chinese demand for gold.

It’s my view that the Chinese take the metal very seriously indeed…

China is now the world’s biggest gold producer – and consumer

In 2010, China became the world’s biggest gold producer, mining 340 tonnes. This was an increase on the previous year, which itself was up on the year before that, and so on – as the following chart illustrates.

China - annual gold production

(My thanks, as always, to Nick Laird of www.sharelynx.com, the world’s greatest gold data wrangler).

In 2011 (not on the chart) there was another rise to 361 tonnes.

This is a very different picture to the output of the other major gold producers: the US (peaked around 1997), Russia (peaked around 1958), Australia (1997), South Africa (1971) and Peru (2003).

Chinese gold imports are increasing as well. Most come through Hong Kong. Between 2010 and 2011 they tripled.

Annual Chinese gold net imports from Hong Kong

According to the World Gold Council, China’s gold demand has risen by 27% a year since 2007. Its share of world demand has doubled from 10% to 21%. Earlier this year, it replaced India as the world’s biggest consumer of gold.

On the Max Keiser show a fortnight ago, I mentioned a remark one of the senior executives in HSBC’s precious metals department made to me at a dinner a year or three back. Much of the world’s traded gold passes through the vaults at HSBC. Yet he rarely if ever sees bars with Chinese stamps on them.

The inference is that China is not exporting, but hoarding its gold.

This comment was picked up by Warren James, a blogger at the Screwtape Files, and analysed in a way I never expected (I’ll be more careful about what I say in future). Exploring data, he found not one match for a Chinese-manufactured LBMA bar in the records for GLD (GLD is the world’s largest exchange-traded fund and the world’s largest repository of gold bars), nor in any of the other major ETFs, not in the Julius Baer Gold Fund, not at the Royal Canadian Mint, at the Perth Mint, nor at ViaMat (who store gold for the likes of BullionVault, Goldmoney, GoldMadeSimple and Goldcore) in London, Zurich and Hong Kong.

In 2009 there were reports of ads running on Chinese state TV recommending that citizens buy gold. Last week, Xie Duo, director general of the financial markets department at the People’s Bank Of China, endorsed this view at the London Bullion Market Association’s annual precious metals conference in Hong Kong. He said: “the central bank’s policy is to encourage residents to hold physical gold”.

Duo described how in 2004, China set out a ‘Three Transformations Strategy’ to gradually turn itself into a major gold player. Xie says that the Shanghai Gold Exchange (SGE) is now the world’s premier spot and physical gold trading centre. Its futures exchange is the world’s number four, behind New York, Tokyo and Mumbai. More and more gold products are being devised and marketed.

SGE chairman and president Wang Zhe declared: “As the domestic market matures and opens up, the exchange will launch over-the-counter trading, gold ETFs, Friday night trading and improve the leasing market.”

“Later on, we will further open up the market and quicken the steps to integrate into the international market,” added Xie.

Expect China to gather a lot more gold

Every few years China suddenly pops up and makes an announcement about its official gold holdings. The last time was in April 2009, when it said its holdings had reached 1,054 tonnes as of the end of 2008. This was an increase of 454 tonnes, or 75%, on 2003, making it the world’s sixth largest holder.

How much does it have now? We won’t know for sure until it makes its next announcement. But Bron Suchecki of the Perth Mint makes an educated estimate.

He looked at Chinese net imports and mine production between 2003 and 2009. He notes that about 26% of the total fell into official hands. Net imports and mine production between 2009 and 2012 will be just below 1,955 tonnes, 26% of which is 508. Hence he suggests Chinese official holdings may now be around 1,560 tonnes.

This would still leave China in sixth place on the international league. This currently stands as follows, according to the World Gold Council.

Tonnes % of reserves
1 United States 8133.5 76.6
2 Germany 3395.5 73.9
3 IMF 2814.0
4 Italy 2451.8 73.2
5 France 2435.4 73.2
6 China 1054.1 1.8
7 Switzerland 1040.1 11.7
8 Russia 934.5 10.1
9 Japan 765.2 3.4
10 Netherlands 612.5 61.1
11 India 557.7 10.6
12 ECB 502.1 33.9
13 Taiwan 423.6 6.1
14 Portugal 382.5 90.8
15 Venezuela 362.0 74.5
16 Saudi Arabia 322.9 2.9
17 United Kingdom 310.3 16.8
18 Turkey 302.4 15.4
19 Lebanon 286.8 30.9
20 Spain 281.6 31.0

What is so interesting about China is that, unlike the countries above it, China’s gold holdings make up such a small part of its foreign exchange reserves.

If it were to balance its portfolio up to 10% of its reserves, it would have to quintuple its holdings, assuming no other currency sales. That would mean buying more than Germany’s entire stock.

That’s got to be incredibly bullish for the gold price. No wonder they’re accumulating surreptitiously.

Which brings me to my next chart from Nick Laird. This shows China’s total net imports and production since 1930 – the cumulative amount of gold held in China.

Chinese gold production plus net imports

You can see how gold holdings were negligible until 1980 and that China only really began importing in 2001. Its economic growth and significance as a world powerhouse is reflected by its cumulative gold holdings. (As is the UK’s, by the way – but in reverse).

Here we see the last ten years in close-up.

Annual Chinese gold accumulation since 2000

Look at the growth in imports since 2004, when the ‘Three Transformations’ strategy was outlined.

If gold was a meaningless, antiquated metal whose only use is for jewellery, why would China be doing all this? That China is growing its gold holdings in such a dramatic way tells you about as much about the metal as it does about the country.

They say that he who owns the gold, makes the rules. It seems China could be doing that more quickly than we think. It takes gold seriously. We should too.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

Our recommended articles for today

Which profit figure is the most important?

Profit is vital to any successful business. But there are several ways to measure it. Tim Bennett explains what each one means, and which one you should use.

The real story behind the Irish oil rush

The news that there may be oil fields off the coast of Ireland has been whipped up into a frenzy of share buying. But it’s too soon to celebrate, says Tom Bulford. Here, he explains why.

66% off newsstand price

12 issues (and much more) for just £12

That’s right. We’ll give you 12 issues of MoneyWeek magazine, complete access to our exclusive web articles, our latest wealth building reports and videos as well as our subscriber-only email… for just £12.

That’s just £1 per week for Britain’s best-selling financial magazine.

Click here to take advantage of our offer

Britain is leaving the European Union. Donald Trump is reducing America’s role in global markets. Both will have profound consequences for you as an investor.

MoneyWeek analyses the critical issues facing British investors on a weekly basis. And, unlike other publications, we provide you with the solutions to help you turn a situation to your financial advantage.

Take up our offer today, and we’ll send you three of our most important investment reports:

All three of these reports are yours when you take up our 12 issues for £12 offer today.

MoneyWeek has been advising private British investors on what to do with their money since 2000. Our calls over that period have enabled our readers to both make and save a great deal of money – hence our position as the UK’s most-trusted investment publication.

Click here to subscribe for just £12