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 .

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26 Responses

  1. 21/11/2012, David T wrote

    If they can dig it out of their own back yard at the rate of 300+ tonnes a year and the need 3000+ tonnes to bring them upto 10% as per most other nations that’ll take just 10 years without ramping up production.

    Why would they go and buy it for £2000 odd an ounce when digging their own costs just a few hundred an ounce ?

    So IMO the view being taken here is very one sided and missed the most obvious point I’ve just raised.

  2. 21/11/2012, cookie wrote

    Nice to see where Britain is on the list thanks to Gordo and his pals ie Balls/Milliband

  3. 21/11/2012, Cooldude wrote

    The reason they are importing so much gold is because they are very aware how fragile the global financial and currency system is and they are using gold and silver as protection. They have over $2 trillion US dollars in reserves and they have publicly stated that they are unhappy with the incessant debasement of the $dollar through QE, Zirp and the like. They have stopped buying US treasuries and are slowly trying to convert their dollar reserves for hard assets, such as gold and oil, without causing a run on the dollar or hiking the gold price too quickly. They are playing the long game at which they are experts unlike the dimwits in charge in the West.

  4. 21/11/2012, Le Brit wrote

    Is MW trying to give everybody heart failure the headline figure should be $1722 not $1272. I trust more care was put into preparing the article.
    Suprised to see that the Saudis have such a small proportion of their reserves in gold maybe they have faith in the almighty dollar.
    Thanks to Gordon Brown we hold the lowest amount of the European countries shown, what will all that paper be worth if things trend to the worse??

  5. 21/11/2012, wintergarden@sympatico.ca wrote

    Canada is not on the list. Are we not keeping any gold reserves? Are we selling it all?

  6. 21/11/2012, Chester wrote

    Central banks generally act after trends have turned against them, so sell gold when they buy. The time to get back into physical gold is not at the top of a crowded market, but when Gordon and his ilk are selling it for $500 / ounce, not before

  7. 21/11/2012, BrianA wrote

    Gold headline! Almost fell off my chair. I’ll buy lots at that price (actually I did at half that price)
    B

  8. 21/11/2012, BeTheMusic wrote

    Needless to say that other developing countries even as we speak are hording gold too …

  9. 22/11/2012, Boris MacDonut wrote

    I agree with DavidT @1. But if 1054 equates to 1.8% then they need 4800 tonnes more to reach 10% at current prices.That would take neaer 14 years to dig up, but I agree why buy it…just wait a decade or so.
    Interesting that Italy has the highest reserves per head of population(other than the outlier Lebanon) and Portugal looks quite comfortable too.

  10. 22/11/2012, NigelpH wrote

    Regarding China needing a decade or so to acquire gold from their own mining production – firstly not all mine production goes to the Chinese central or government bank, Chinese citizens also purchase a significant proportion, and secondly, and possibly most critical, can the Chinese wait that long before losing because of the debasement of their US Treasury holdings?

  11. 22/11/2012, NigelpH wrote

    Not all Chinese gold mine production is acquired by the Chinese central bank, Chinese citizens purchase a significant proportion. Also, can the Chinese government afford to wait a decade or so before converting their US Treasury bond holdings into more tangible assets?

  12. 22/11/2012, JuJu wrote

    C’mon Frisby – when’s this book going to be ready? You should have had it written BEFORE your pitch so YOUR supporters wouldn’t be left waiting. Does it include all this about China?

  13. 22/11/2012, Boris MacDonut wrote

    #12JuJu. He’s relying on one of those web publishing cloud deals where you need about 100,000 expressions of interest before they’ll agree to publish it. Last I saw he was about 60% of the way there. If it ever gets done we’ll have reason to doubt the “wisdom of the crowd”.

  14. 23/11/2012, Freddy Mays wrote

    Now there’s a surprise – a Dominic Frisby article with a punchline saying “Let’s get long of gold!”

    This time it’s a monumental increase in the supply of gold that’s supposed to push up the price. Give me strength.

    Everything Dominic Frisby writes is so loaded with self interest and bias I just can’t take a single word he says seriously. Someone have a word please.

  15. 23/11/2012, Boris MacDonut wrote

    #14 Freddy. And we thought it was boomerangs that kept coming back, not Frisbies.

  16. 23/11/2012, Ron wrote

    Xie Duo, director general of the financial markets department at the People’s Bank Of China, endorsed this view…

    Duo described how in 2004, China set out a ‘Three Transformations Strategy’…

    Xie says that the Shanghai Gold Exchange (SGE) is now the world’s premier spot and physical gold trading centre.

    Make your mind up.

  17. 23/11/2012, Phil wrote

    As well as buying up gold, the Chinese are also buying up London property, and other hard assets.

    So, Moneyweek, why are you bullish on the former but bearish on the latter?

  18. 24/11/2012, Guntum Siregar wrote

    Dear Genuine Buyer,

    We have 100 tons of Gold Bullion, International hallmark, discount 15 % gross, FOB, Indonesia.
    Serious buyers please contact me at: lobu_sir@yahoo.com
    Thanks and regards,
    Gunsir

  19. 25/11/2012, Mike wrote

    The Chinese want a gold backed Yuan to be the next reserve currency. To do this they need to accumulate about 10,000 tonnes of gold. This will take them some time and they are going slow to keep the price reasonable. The West is assisting them by suppressing the price.
    The other thing they need to do to be a reserve currency is to have a big trade deficit. That makes Yuan available to us to trade with. The Chinese will stimulate their domestic economy and inflate their currency. That will suck in imports and increase the standard of living of their people. That’s the game IMHO.

  20. 25/11/2012, Mike wrote

    The Chinese want a gold backed Yuan to be the next reserve currency. That is why they are accumulating gold. They will in time stimulate their domestic economy and inflate their gold backed Yuan. This will create a big trade deficit which is a necessary precursor to being a reserve currency. That will increase the living standards of their people. That is the game IMHO.

  21. 25/11/2012, Boris MacDonut wrote

    #19 & 20 Well said Mike. I make it 27 years until the Chinese have their wicked way.

  22. 25/11/2012, David McCabe wrote

    I would not believe the Chinese figures for how much gold they have. I bet they have 3 or 4 times as much as they admit to, perhaps even more. What with their citizens owning a lot of gold, when paper money loses its value they’ll emerge as the richest country in the world, ready to dominate. Unlike the West’s politicians and central bankers they are not blinkered by the delusion that because we have always had wealth & power this will carry on indefinitely.

  23. 25/11/2012, Boris MacDonut wrote

    #22 Don’t panic. Reds under the beds. It’ll be like Fu Manchu and Ming the Merciless rolled into one great evil.

  24. 25/11/2012, Xenos wrote

    Mike (19, 20) is right.

    Let me add : It’s all about about Chinese war philosophy. “Never go into a battle before you have won it.” They will gather enough gold to make their currency convertible and therefore be able to overcome the USD as a reserve currency anytime they want.

    Then they will go to the financial war. Or not.

  25. 27/11/2012, The Owl wrote

    The Bank of England was directed to sell a huge lot of its national gold treasure between 1999 and 2002 to mark the Gold market bottom. It was not sold, but rather handed to D-Bank in order to satisfy a big margin call. They aided both D-Bank and Goldman Sachs, each heavily short and at risk. The Gordon Brown action was done with two unusual signpost markings. The sale was announced in advance, thus permitting front running by London and New York bank buddies. It was done in auction, to assure the lowest possible price. The actions set the low. But the actions bailed out D-Bank secretly. The aid to GSax was one of a string of ugly pearls, which the arrogant elite firm never seems to mind and never bothers to cover up too effectively. They benefited from the TARP Funds as #1 son in the family. They did work feverishly in 2009 to conceal their Unix box for tapping into the NYSE for peeking at trades, front running them, and skimming pennies on billions of trades.

  26. 12/12/2012, BeTheMusic wrote

    The Chinese will not stop aquiring gold when they reach the 10,000 tons mark. They will likely go on until they sit comfortably on at least 25,000 tons bringing it up to 50% of their foreign reserves. Don’t forget the coutries, such as Saudi Arabia, Russia, Japan, India, Switzerland, Taiwan, Turkey, who must be dreaming about more gold in their vaults. And we are not talking about the middle class in all these countries slowly buying up gold… Come on, guys! The real price of gold must be at least 2000 bucks! See http://www.kitco.com/KitcoNewsVideo/index.html?v=12-12-06_Vince_Lanci_FINALE_1 on gold price manipulations.

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