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Why the rise of China means gold should see long-term growth

31 January 2014

BullionVault’s Adrian Ash says reforms to be introduced in China will mean people start speculating on gold more, which will increase global demand for the metal.

By Adrian Ash,

BullionVault

With the world's second-largest economy buying gold hand over fist, why did gold just deliver its worst annual price drop in three decades?

Gold price in 2013

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Source: FE Analytics

The Chinese New Year now marks a key event for the global gold market. It rivals late autumn's Diwali in India as a peak in consumer demand.

Already the world's No.1 gold miner (as it has been since 2007) China is now the No.1 private gold buyer thanks to the 2013 collapse of legal Indian imports following New Delhi's attack on the trade deficit. ALT_TAG

Last year, according to the latest data from consultancy Thomson Reuters GFMS, saw the biggest movement of gold by value in history, as western selling was snapped up by Asian buyers.

Exchange-traded gold trusts previously used by European and US fund managers to escape the financial crisis shed more than 800 tonnes of metal.

China's net gold imports through Hong Kong matched and beat that by one-third. Chinese jewellery demand rose to new records, overtaking India by a fat margin and rising at the fastest pace in 20 years.

Compared with a decade ago, China's private gold demand has now risen 15 times in yuan terms, far outpacing the four-fold growth in its GDP.

The blunt lesson of 2013 is that such consumer demand doesn't move gold prices. People who buy gold because it is gold tend to want more when prices fall and vice versa.

The people who count are instead those who buy gold because it isn't anything else. That means investors with a broader choice of assets to reject, and with discretionary funds to keep buying as prices rise.

Witness the loss of India, former world No.1, from the global market in mid-2013. Driven by religious, cultural and social forces running back to pre-Roman times, Indian households were on track for a record year as prices slumped last spring.

India's huge call on physical gold got cut off from the world market however by the government's anti-import rules, aimed at reducing India's massive trade deficit. Yet with gold's heaviest consumers now missing (from the legal trade, at least), the back-half of 2013 then saw sideways price action.

Gold ended December where it stood at the end of June when India's import restrictions (effectively a ban) really got started.

What mattered more was that Western selling also slowed mid-year. By end-June the giant New York-listed SDPR Gold Trust (GLD) had already lost 70 per cent of the 550 tonnes it shed in 2013.

By then speculators in Comex gold futures and options had already slashed their net betting on prices rising by four-fifths, cutting it to what proved the low for 2013.

Equal to barely 100 tonnes and the smallest "net long" position in US gold derivatives since the late 1990s, that compared with peaks above 1,000 tonnes in 2011 and 2012.

Versus these price makers, even China's rampant gold demand has struggled to move the needle.

The Year of the Horse starts this Friday, 31 January 2014, but the lunar cycle can push XinNián back to late February.

Over the first three months of the western calendar year, China's private end-consumer demand has set new quarterly records 11 times in the last 12 years by value.

At current prices, a new record for the first quarter of 2014 would see Chinese households and investors buy more than 385 tonnes of gold – well over one ounce in every three bought worldwide.

And yet here we are, trading below $1,270 per ounce with the cheapest New Year's gold since 2010. This month's rally from $1,180 doesn't owe much to Chinese demand either, because wholesalers bought early (net imports through Hong Kong missed the 100-tonne level in both November and December).

Rising premiums in Shanghai have absorbed the impact of local demand over and above the world's benchmark London pricing.

So what might change China's lacklustre impact on gold prices? Public statements from senior officials at the People's Bank of China have put the gold market at the heart of China's broader financial reforms.

Beijing also continues to open up its domestic gold market to foreign players, apparently granting import licenses to both HSBC and ANZ Bank this month.

So the communist regime is serious about liberalising China's gold market, and about ensuring future supplies.

That will cut both ways, bringing more influence to the global market from the world's No.1 gold miner and end-consumer economy.

Most critically, China's broader financial reforms – confirmed by late-2013's third plenum of the current politburo – mean its fast-growing middle class will come to enjoy a broader range of investment products.

Some analysts think wider financial choices mean Chinese investors and households will buy less gold.

But it would most certainly mean people stop buying gold for its own sake, and can start buying (or selling it) because of what they expect will happen to other asset classes.

Unlike the constant consumer demand of Indian and Chinese jewellery buyers, that's just the kind of demand that does affect prices.

Adrian Ash is head of research at BullionVault. The views expressed here are his own.


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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.