China Gold Demand – Surmise And Reality

We have reports of key party officials pointing out that the country’s gold holdings are vastly underweight in comparison to most of the major Western nations, and that China should be building its reserve base accordingly. On the other hand, we have had a recent categorical statement from Yi Gang, Vice Governor of the People’s bank of China, that the nation’s official gold holdings remain at 1,054 tonnes – the stated level last time the country restated its gold reserve back in April 2009.

The answer is that both positions could be technically correct in politician-speak; it very much depends on interpretation of the way China treats its gold internally.

China is currently reckoned to be the world’s largest new gold producer, with production from mines and as a byproduct from its big base metal smelting and refining industry. It is also almost certainly the world’s largest importer of gold given India, which used to be the No. 1 importer, is battling to control gold imports due to their size having a totally distorting effect on its balance of payments position and subsequent deficit. Real gold import figures, particularly those coming out of China, have tended to be a little obscure with imports through the much more transparent Hong Kong, being seen as a proxy for total Chinese imports, but these figures may ignore imports through other channels, and it is likely there are some.

India’s true gold import figures too may increasingly become rather more obscure given the government moves, and restrictions which are certain to result in a huge increase in smuggled gold which will, by default, not find its way into official data.

But whether India or China is the world’s largest gold importer is somewhat immaterial as the huge surge in Chinese imports after the sharp gold price fall in mid-April (matched in India, but not to the same extent) will undoubtedly boost China’s position in this respect this year. Indeed it appears that not only did Chinese gold buying surge hugely in the immediate aftermath of the events of April 12 and the following couple of days, but again right at the end of the month and early May over the May Day holiday. One has to reckon that if the prices drop back significantly from where they are now, another flood of demand in the gold-oriented areas of the world – mostly Asia and the Middle East, but particularly in China, will underpin the market.

Gold currently seems to be in a position where a dive in price will stimulate interest in the East, or a surge upwards will stimulate short covering in the West.

Back to China and its official holdings.

The likelihood has to be that the country is indeed increasing its gold holdings, but they are not yet finding their way into official reserves and being held in some other non-publicized government account. This is the kind of subterfuge China can undertake, while continuing to deny that its official reserves are being increased.

They would see this as true, but all the while gold may well be being accumulated nonetheless. Since its 2009 reserve upgrade, China has produced close on 1200 tons of gold, and given it does not export its gold production – and all that is produced is sold to the state in some form or another – then it is not unreasonable to suggest that it has actually doubled its gold reserves over this period near to 2,000 tonnes.

If the state is also buying gold from other external sources, then this figure could be even higher – some reckon far higher, given the high levels of imports seen over the past 2-3 years, years which have seen overall gold imports into the country rise dramatically. While much of this may have been taken up by burgeoning public demand, it is certainly not inconceivable that some – maybe a considerable amount – is also finding its way into state controlled coffers.

But, of course, this is purely surmise. What we do know from World Gold Council estimates – and even this could be subject to some undercounting given the only figures readily available are the imports through Hong Kong, is that China imported at least 661 tons in 2010, 809 tons in 2011, and a similar amount in 2012, while in the first quarter of the current year it has already taken in over 300 tonnes. However, contrary to expectations, April announced figures of net imports through Hong Kong amounting to only 80 tons,have shown a fall-back from the strong March net figure (136 tons), put down by some observers to an actual shortage of bullion avaiability at the time after the high levels of sales in the previous month.

Whether or not there are other imports through other points of entry remains obscure for the foreign observer, as mainland China does not publish these statistics, so the WGC figures are probably the best available.

Together with domestic production, these figures suggest that Chinese gold consumption has been around 1200 tonnes annually, and could even be far higher this year – perhaps accounting for around a third or more of global supply on its own.

There are those who believe that China may be in the process of building its domestic gold holdings to the kind of level the U.S. officially holds – 8,133.5 tonnes and that the country will achieve this by 2015. Why? The theory is that China, long term, is looking to replace the dollar as the world’s principal reserve currency with the yuan.

It is already slowly allowing the yuan to rise in value against the dollar, and make it convertible against a broader range of currencies. This China sees as giving it all kinds of global trade advantages, but perhaps most of all would give it a hugely enhanced global status which is very important to a people where status is extremely important in the national psyche.

But, of course, there is a huge ‘unknown unknown’ here in that the analysts are not accurately able to assess how much of the gold flooding into China is actually going into private investment hands, and how much, if any, could be being diverted into government controlled accounts. Ultimately, when China wishes to do so, it will moved into the official reserve data.

Interestingly, since the massive buying surge in China in the aftermath of the April price collapse, physical gold premiums have remained high signifying the continuation of strong demand at current price levels below $1400. Perhaps significantly, in the West, outflows from the big gold and silver ETFs have slowed to a trickle, after significant offloading in April and May. Comex short positions on gold also seem to being reined in indicating that the big money may be banking on a gold price recovery. With Chinese demand seen as backstopping, the pro-gold analysts are indeed looking for a price rise, although China, if it is building its gold reserves off the books may be happy to see prices remaining where they are for the time being, enabling it accumulate more at the lower price.

Suffice it to say, that if China has been, and is still, taking in significant amounts of gold into its government holdings then the gold price could be very much in its hands. Any announcement of a significant increase in its official reserves would indeed give the price a healthy upwards kick.

There will be a likely fall-off in global gold production to add into the equation. We are already seeing near term projects being delayed, some smaller mine closures as the gold price is close to the marginal cost of production for many. Labor dissent will likely increase as hoped-for pay rises may not be implemented. What few seem to have noted, is that Freeport’s Grasberg copper/gold mine, at times the world’s largest single gold producer, may well be suspended for up to three months while a serious spate of accidents resulting in a number of deaths is being investigated by the authorities.

While gold could continue at or around its current low levels, fundamentals suggest that further downside risk is very limited. Maybe now the only way is, indeed, up.