Gold prices had seen an upward price trajectory early this year reaching six-month highs in March. The price revival for gold from the lows below $1,200/oz in December 2013 was arguably supported by a myriad of factors as gold came back in favor with investors as an insurance against emerging markets turbulence, potential escalation in Ukraine, less than upbeat economic data in the U.S. and China, and downturns in the equity markets. However, one factor that stands out with respect to gold’s resurgence this year has been the continued demand for the metal in Asia, and most notably, in China.
Last year was a watershed for the gold market as the 12-year run in annual gains for the yellow metal came to an end following the price collapse in April. The aftermath was a large-scale cutback in gold holdings in the Western markets evidenced by the sharp sell-offs in gold ETFs in conjunction with the diminished speculative length in the COMEX futures market. As an example, gold holdings backing the world’s biggest ETF, the SPDR Gold Trust , fell a massive 550 tonnes last year.
Gold Holdings at the SPDR Gold Trust (GLD)
But as prices retreated to test fresh lows last year, buyers in Asia stepped in providing much-needed price support to help offset the steep drop in demand in the Western world. More importantly, while there had been a secular growth in physical demand in Asia last year, the biggest demand growth came from China. The gathering pace of Chinese gold consumption can be visualised in the information provided in Exhibit 2 that shows net exports of gold into China from Hong Kong, where a vast majority of physical flow of bullion into the Mainland originates. According to data released by the China Gold Association earlier this year, gold purchases in China climbed 41 percent last year to an estimated record of 1,176 tonnes and this is reflected in the monthly net imports of almost 92 tonnes from Hong Kong in 2013. The magnitude of gold imports last year made China the biggest gold consuming country in the world, surpassing India.. Feeding this frenetic Chinese buying were steadily increasing gold shipments from the West, including ETF gold, primarily to Hong Kong with much of it going through the refiners in Switzerland where the heavier Western gold bars were transformed into the 9999 kilo gold bars preferred in the Far East markets.
Net Exports of Gold from Hong Kong to China
Sources: Bloomberg, Hong Kong Census & Statistics Department
Last year, Cameron Alexander from Thomson Reuters GFMS wrote in OpenMarkets about the Chinese gold buying phenomenon. Clearly, rising incomes and greater disposable wealth amongst Chinese consumers resulting from years of strong economic growth have played an important role in stoking demand for gold in jewellery and other forms. Limited investment opportunities in the Mainland and concerns about the PBOC’s monetary policy are also important contributing factors in inducing Chinese consumers to purchase gold as a means of wealth protection.
To further understand the nature of the Chinese gold market and its future prospects, we invited two well-regarded analysts to share their thoughts and insights on the subject: Robin Bhar (RB), Head of Metals Research at Societe Generale, and Joni Teves (JT), Metals Analyst at UBS.
How can we quantify the impact of demand from Asia and China in the context of overall gold demand and price action in the market?
RB: The impact has been very significant with buying from India and China for fabrication (mainly jewellery) purposes and for investment. We monitor imports into China and India, physical premia, borrowing rates, etc., to determine these flows together with price action to determine the impact of physical demand from Asia.
JT: Chinese demand for physical gold directly impacts the global supply and demand balance, but it is less straightforward to quantify the impact on prices. Physical demand in general tend to offer support during corrections or at most cause a slow grind higher in prices; it does not drive sharp rallies. This dynamic was evident in gold price action last year.
What have been the primary drivers of the pick-up in gold demand from China we have seen in the past couple of years? What in your opinion has been the role of Chinese economic growth and greater economic prosperity in the country?
RB: Primary drivers have been jewellery demand to a great extent and investment demand as well. Clearly, strong economic growth and rising wealth have prompted buying, as well as cheaper prices.
JT: Chinese demand for gold has been driven by several factors; this includes negative real interest rates and the lack of alternative investments. The fact that the Chinese have strong traditional/cultural affiliation with gold has also helped the underlying appetite.
How do you see the main drivers of Chinese demand for gold evolving this year – would you expect continued physical demand in the country as we saw in 2013?
RB: We expect physical demand to remain robust but not as strong as last year due to slowing economic activity, weakening yuan and gold prices forecast to be lower. Also, it now seems that last year’s record physical demand was attributed to demand for gold-backed financing which may therefore overstate the actual level of physical demand.
JT: We expect demand from China to remain robust, but 2013 was an exception in terms of volumes – the sharp price collapse in Q2 last year at a time when most of the global market was calling for much higher prices meant that there was a tremendous rush to scoop up significantly cheaper metal. There is no urgency at the moment given more subdued price action and price expectations for gold.
China is arguably a special case market given the limited investment options open to domestic investors and its closed capital account. How will China’s financial liberalization and outbound investment flows play out on gold demand?
RB: These factors should see more buying interest over time. In recent years, Chinese banks have successfully launched many gold-linked wealth management products that have contributed to growing the market for gold. Thus, investors should have many more options in which to acquire exposure to gold.
JT: There are many changes in the pipeline in China’s gold market which make it difficult to anticipate the impact on demand. The underlying retail interest is likely to remain intact and robust, as there is still room for growth in regions where penetration remains low. For the more sophisticated investors, attitudes towards gold are likely to become more dynamic depending on the availability of different types of gold exposure and alternative investments.
There has been considerable focus on the relationship between gold and inflationary expectations and the U.S. Fed policy of quantitative easing. At the same time, as we look to China’s influence – how important are the monetary conditions in China as a factor relating to gold prices and demand for the metal?
RB: I would say it’s unclear how much of a driver these really are. Monetary conditions/policy and inflationary expectations and their impact on gold are minor influences in what still is a largely controlled economy. But as the shackles are gradually loosened and thrown off completely then these factors should grow more in importance as the economy becomes more open.
JT: One avenue through which monetary conditions in China affect gold is through real interest rates – negative real interest rates encourage investment in “real” assets like gold.