Euromoney: gold and China

Euromoney, September 2012

Until the second quarter of this year, Chinese demand for gold had increased every single quarter since 2003. Two questions: what has been driving this decade-long streak? And what’s changed this year?

The long-term picture is explained by several elements in combination.

First, there’s the growth in individual wealth in China, and the need to diversify it. The principal repository of wealth in China has historically been real estate, and still is; as the stock market has grown over the last decade, that has provided another avenue, while mutual funds – particularly money market funds – have also enjoyed wide take-up. But still there has been an unhealthy concentration in residential property, and gold has grown in popularity as a method of diversifying exposures into a commodity that has little correlation with any domestic investment. Most individual Chinese have modest international holdings at best – the international equity funds that can be accessed by ordinary Chinese have, in the main, troubled histories – and so for them gold is, in many respects, a way of building a presence in an international asset class.

Then there is the growth in sovereign funds and foreign exchange reserves. Gold isn’t actually a very large proportion of China’s foreign exchange reserves – just 1.6%, compared to far higher figures in the west and over 70% in the USA – but the scale of those reserves ($3.2 trillion when last disclosed) make the overall volume significant.

Additionally, gold is linked to the steady internationalization of the RMB. There is a view – though not a unanimous one – that for any currency to be truly international, it must have significant gold backing. This is likely to drive continued demand for the metal.

All of these things have driven demand for gold in China, and demonstrate the importance of gold trading in the country.

One begins to see the next stage of China’s relationship with gold in the news that China National Gold Corporation is in talks to buy a majority stake in African Barrick Gold.

Moreover, China National’s president, Sun Zhaoxue, has written an article in Qiushi magazine, the academic journal of the Chinese Communist Party’s Central Committee, explaining his views on gold – which, given the author and the publication, could perhaps be seen as representing national policy thinking. The web site beyondbrics ran a translation of the article in August; in it, Sun argues that China should view gold as “a strategic resource as important as petroleum energy”. He also says: “As gold is a currency in nature, no matter if it’s for state economic security or for the acceleration of renminbi internationalisation, increasing the gold reserve should be one of the key strategies of China.”

China National’s proposed acquisition should be seen in this light: not just an opportunity for a company seeking new sources of revenue, but a matter of national policy to increase the availability of gold to the sovereign. Alongside this, China’s domestic gold mining industry is likely to be boosted; Sun himself suggests doing so through consolidation and increased investment in technology and infrastructure.

But if all of this is true, then why the decline in the second quarter? It was a big decline: 7% year on year.

Partly, it’s because of the obvious answer: slowing growth in China, plus investor reticence to invest in the metal as prices have fallen (which, naturally, exacerbates the fall). On top of that, the increasing number of investment options for ordinary Chinese, such as principal-protected wealth management products, have captured some of them demand that would otherwise have gone to gold; all major banks now have sophisticated wealth management arms with increasingly powerful marketing. Also, although a more international RMB has been argued as a prompt for more purchases of gold by the Chinese sovereign, a counter-argument can be made: that a more open capital account is allowing Chinese investors easy access to real estate internationally, again at the expense of gold holdings.

Still, there appears to be considerable headroom for further growth. Sun, in his article, cites data from the World Gold Council saying that Chinese people buy less than 5 grams of gold per capita per year, compared to an average of more than 20 grams a year worldwide. There is certainly room for further marketing of gold products to individuals. And if gold accumulation becomes a part of national policy, whether to aid the internationalization of the currency or to diversify forex reserves, then the momentum will be considerable.