Having just returned from another visit to China, where I had the opportunity to talk with a number of “insiders” in the Chinese gold community, I am more convinced than ever that the country will continue to have a profound influence on the world market and future price for years to come.
Growth in aggregate demand from jewelry buyers, private investors, and the People’s Bank of China will continue to outpace growth in total supply from mine production and secondary sources. With both domestic supply and demand relatively price inelastic, the market will require a growing stream of imports, imports that will be available only at higher prices.
Slower economic growth – even a “hard landing” with GDP growth well below the official target of 7.5 percent this year – would not likely dent private-sector gold demand. Instead, an economic slowdown much below the official target would raise unemployment, prompt unrest among job-seekers, depress equity prices, and cause anxious investors to buy more gold. In the unlikely event that China goes down this economic path, we should expect the central bank to respond quickly with more stimulative – and gold friendly – policies.
Visiting China, one has the feeling that they are doing a better job managing the macro economy – smoothing the business cycle and containing inflation – than are policymakers in the United States or any of the other older industrial nations.
Measures to lower food inflation, increase wages, curtail real estate investment, promote public works, manage gradual currency appreciation, and even encourage gold investment as an alternative to real estate or equities seem likely to produce a softer, shorter landing.
Moreover, China (unlike the United States, Western Europe, or Japan) is still in the early stages of a secular economic expansion that will soften the blow from the short-term cyclical downturn now unfolding.
Looking beyond the slow-growth scenario now unfolding, jewelry and investment demand will likely enjoy continued robust growth over the years ahead, reflecting the rising incomes, a growing middle class, and a wealthy elite with deep pockets and ostentatious spending habits.
Longer term, as it prospers and its share of global income and wealth continues to increase, China will demand a growing share of the world’s above-ground stock of gold for jewelry, for investment, and for additions to central bank reserves.
Private gold investment was banned in China and the local market was tightly controlled for more than five decades following the Communist Party victory and ascension to power in 1949. Ever since the legalization of private gold investment and the gradual liberalization of the market beginning in 2002, China’s appetite for gold has been growing steadily year after year – reflecting both pent-up demand and rising prosperity.
The government’s continuing liberalization of the domestic market, its support for new channels of distribution, its orderly regulation of spot and futures markets, and its encouragement of private gold investment have contributed to the country’s rise to prominence in the world of gold.
In recent years, China’s central bank, the People’s Bank of China, has also been a significant buyer. Three years ago – in April 2009 – the PBOC revealed it had bought some 454 tons of gold over the preceding six years, an average of about 75 tons per year.
Since then there has been no hard evidence of additional buying . . . but my guess is that the PBOC continues to buy regularly from domestic mine production and scrap refinery output – perhaps as much as 50 to 100 tons or more per year. For its part, the PBOC not long ago said it will “seek diversification in the management of reserve assets,” possibly signaling their intention to accumulate gold without actually saying so.
As a result of China’s sizable appetite for gold, it has become a powerful driving force in the world gold market – and its influence on the future price of gold is likely to grow in the next few years reflecting demographics, economic growth and rising personal incomes, episodes of worrisome inflation, the continuing development of the domestic gold-market infrastructure, and, importantly, continuing central bank reserve diversification.
CHINA’S GOLD STATISTICS
For several years now I have expressed the view that China’s actual annual gold-mine production, jewelry consumption and investment, imports, and central bank accumulation have each been running considerably higher than generally believed or publicly acknowledged – see my December 2009 speech to the annual China Gold and Silver Summit.
To begin with, China’s total gold supply from domestic mine production and other sources is probably much higher than reported or discussed by analysts and observers of the Chinese gold scene. Actual gold-mine production – and supplies from other sources – could easily be close to 400 tons and possibly much more. Here’s why:
My understanding is that the mine-production numbers from the China Gold Association (CGA) include mine output by their members only – but not non-members such as many small, rudimentary, unofficial mines operating in the “underground economy.”
The CGA data also excludes production from mines owned and operated by the military as well as by-product output from the country’s copper, silver, and other metal-mining activities.
Also missing from the CGA reports are the very significant quantities of gold contained in copper and precious-metals bearing concentrates imported from abroad but processed by Chinese smelters and refiners.
In addition to these unreported sources of supply, many analysts and commentators seem to forget about secondary supply – that is metal returning to the market from the recycling of old jewelry, investment bars, and industrial scrap. This alone could easily contribute 30 to 40 tons – and quite possibly much more – to total annual supply in the Chinese gold market.
Next, what else can we say about China’s gold imports? Western analysts estimate China’s total gold imports last year were around 490 tons – but there is little mention of “illegal” imports – that is gold smuggled into China. We know smuggling is quite significant in some countries – Vietnam and India, for example. We can only imagine how many tons of gold in the form of tael bars, wafers, coins, investment-grade jewelry, etc. is carried into China each year by travelers and professional smugglers.
What about net central bank purchases and total official reserves held by the People’s Bank of China? Don’t expect an announcement of their buying program anytime soon. After all, an announcement could boost the yellow metal’s price and raise the PBOC’s acquisition costs.
Nevertheless, it is reasonable to conclude that the Chinese government may be squirreling away perhaps 50 to 100 tons a year into accounts that will eventually be included in the country’s reported official reserve figures – and one day in the future we should not be surprised to see an announcement that actual official gold reserves are considerably higher.
WHAT GOES IN, WON’T COME OUT
Continuing Chinese gold accumulation has important long-term significance that is not generally acknowledged by many gold analysts and market pundits. Simply put, China’s private- and official-sector gold purchases are unlikely to be sold back to the world market any time soon, certainly not for many years to come and not even at much higher prices.
Not only are gold exports from China illegal – but many, if not most, Chinese savers and investors buy gold with no intention of selling sometime in the future just because prices rise, inflation subsides, equity prices tumble, or any of the other drivers that might typically trigger sales by Western investors.
For the Chinese, these are long-term, quasi-permanent holdings – removed from available supply or what I call “free float” available to satisfy future physical demand in the world gold market.
Jeffrey Nichols is Managing Director of American Precious Metals Advisors and Senior Economic Advisor to Rosland Capital. The above article appear also on Nichols’ own website www.nicholsongold.com