Energy & Resources, Talking Point

Gold rush

Worried by inflation, Chinese discover the lure of gold

Gold rush

The ultimate in anti-capitalist bling: a gold bust of Chairman Mao

Just like the Indian marriage season – late summer and autumn – the Chinese New Year typically involves a lot of gold purchases.

Making headlines this year was one particular gift: the son of a wealthy businessman in Nanjing who spent Rmb600,000 ($90,000) on a bouquet of roses made of gold as part of a marriage proposal to his girlfriend. Some complained that the gift spoke volumes on the country’s growing wealth disparity. But others thought that the young man showed foresight: “While real roses lose their value in a week, the value of gold – at the rate it has been going – will only go up,” says the Manager’s Daily. “Who knows, the gold roses might be worth Rmb660,000 next week!”

As with many commodities, what happens in China is having a significant influence on world prices for gold, which have been going up on rising demand. Already the world’s largest gold producer, China, is on track to surpass India as the world’s largest gold consumer this year.

An appetite for all things gold?

Jewellery has conventionally accounted for the lion’s share of demand. According to HSBC’s precious metals strategist James Steel, consumption of jewellery makes up 50% of Chinese gold purchases and has grown at an average rate of 6% per annum for most of last decade. If the strong retail sales during the Lunar New Year are anything to go by, that number will go up further this year.

Beijing Caibai, a popular jewellery department store, said its sales shot up 96% year-on-year during the holiday season. And it noticed a new group of customers: “Many people who speculated on the stock and property markets are now buying gold,” an industry insider told China News Service. “They think it’s safer to buy gold these days.”

Investment demand is now a big driver, with many Chinese drawn to it as a store of value rather than as an adornment. One factor is growing uncertainty over property investment, as the government tries out different approaches to rein in prices. “Investment is really driving demand for gold,” Cai Minggang at the Beijing Precious Metals Exchange told the Financial Times. “People don’t have any better investment options. Look at the stock market, or the property market – you could make huge losses there.”

Another key motivator: growing inflationary pressures. Beijing announced a 4.9% rise in the consumer price index in January on a year ago, above December‘s 4.6% increase. Chinese investors, in common with their counterparts in the West, are turning to gold in their portfolios as a hedge against what are effectively ‘negative’ real interest rates (for bank deposits). As inflationary expectations grow, so will gold sales.

At the Shanghai Gold Exchange, trading volumes increased 43% to 5,015 tonnes in the first 10 months of 2010, exchange Chairman Shen Xiangrong told Xinhua. Gold futures trading on the Shanghai Futures Exchange has soared as well.

China’s central bank has also been stocking up on the metal of Midas, with the Federal Reserve’s loose monetary policy fuelling interest in gold as a hedge against the greenback’s decline. China’s State Administration of Foreign Exchange (SAFE), custodian of the national foreign exchange reserves, has accordingly been diversifying its holdings. SAFE revealed in November that its gold ownership had increased to 1,054 tonnes since the last such announcement in 2003, when it held 600 tonnes.

All this suggests that China as a whole is buying more gold than before. Demand from the country’s two largest sectors – jewellery and investment – reached a combined total of 430 tonnes last year, says Xinhua. This has helped push prices up: gold rose about 28% last year. Although gold prices softened in January on the back of better economic data in the US, prices for physical gold in Shanghai have still been at a premium of about $20 per ounce over those in London, underscoring the tightness of the market.

So who are the big beneficiaries of China’s gold rush?

Jewellery retailers are riding the boom. Department store Caibai told Economic Information Daily that the first eleven months of 2010 saw its own sales reach Rmb7.2 billion, a 60% increase on the year before (Caibai also sells investment-type gold bars, which are reported as frequently being out of stock).

Meanwhile, more gold-linked investment products are becoming available. For example, investors can now buy gold-backed exchange-traded funds overseas (although investors who buy shares in a gold ETF don’t ever see the real metal). Lion Fund Management, which is backed by the Sinochem Group, is the first to capitalise on the new opportunity. This month it reached its fundraising target of $500 million to launch the country’s first gold ETF, says Bloomberg.

“We will be the first fund in China to offer an access to invest in overseas gold-backed ETFs,” says Yang Zi, an executive at Lion Fund’s marketing department. “Given the inflationary environment we are in right now, Chinese investors have great enthusiasm for gold investments.”

How high could gold prices go?

Plenty of people believe that the price of gold will continue to rise. One reason: continuing purchases from SAFE. Sun Zhaoxue, general manager of China National Gold Corp, the country’s largest gold producer, points out that SAFE’s gold holdings still trail countries like the US and Germany by some distance in tonnage terms, and only amount to a mere 1.7% of its $2.4 trillion foreign reserves.

Another reason: demand for gold jewellery will likely continue its climb. In a report released by the World Gold Council in October, China’s per capita consumption of gold jewellery remained one of the world’s lowest when compared to other major gold consuming markets, at 0.26 grams. If it were to be consumed at the same rate per capita as in India, Hong Kong or Saudi Arabia, Chinese demand could increase by as much as 4,000 tonnes a year in the jewellery sector alone. To put that in perspective, not much more than 2,500 tonnes of new gold supply is mined annually (plus a bit more becomes available through recyling of gold scrap).

Last year China’s gold production actually hit a new record of more than 340 tonnes – an increase of more than 8% from the year before, says the China Gold Association. But it still wasn’t enough to keep pace with demand. Until recently, China was largely self-sufficient, with imports of only 45 tonnes in 2009. But almost five times that amount was imported in the first 10 months of 2010, the Financial Times reports. That was easily enough to absorb all of the IMF’s gold sales last year, as well as a much larger quantity than the additional amount purchased by SPDR Gold Shares, the world’s largest gold-backed ETF, according to Xinhua.

So is it possible that prices will hit $1,400 again, as they did in November? Reuters reports a brisk start to sales this year, with ICBC, a leading Chinese bank, selling nearly seven tonnes of physical gold last month, almost half of its sales total for full year 2010. Yes, prices fell on global markets for most of January after investors took profits on last year’s rally. But events in the Middle East seem to have reversed the temporary decline, and gold was selling at $1,375 an ounce on Wednesday. Steel at HSBC thinks it could move higher again, forecasting prices could reach $1,550 per ounce this year.

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