China’s 2010 Gold Rush

Owning gold is more often the aim of accumulation, not the means, in China today...

THE COLLAPSE of Indian gold demand since the global financial crisis broke in 2007 might seem good reason to question the fundamental strength of gold buying worldwide today.

After all, if the world's No.1 gold buyers can't keep up with record-high Gold Prices, who can...?

But the plain fact, as BullionVault first forecast in spring 2009, is that China has overtaken India as the number one private gold buyer this year. The typical Chinese New Year gold rush has already begun (thanks in part to 3% discounts at major retailers), and robust demand looks likely to continue through 2010 if not beyond.

Full-year 2009 private demand in mainland China could outstrip India, the former No.1 buyer, by one quarter if not one third. Short of a (very unlikely) collapse in Q4 demand, full-year private gold buying – including jewelry and retail investment – is set to have grown 10% from 2008's record in volume terms, rising 26% by value to equal $13.5 billion or more.

On recent trends, that would equate to more than 2.0% of China's famously massive household savings (up from 1.0% ten years ago) and account for almost one ounce in every eight sold worldwide.

Basis the GFMS consultancy's data (published by the World Gold Council), physical gold purchases by mainland Chinese households in 2009 was already running 19% ahead of India's private demand for Q1-Q3.

Given China's continued economic growth (certain to hit Beijing's 8% target according to the Chinese Academy of Social Sciences) – let alone the surge in money-supply and credit growth over and above GDP (put at 23 and 27 percentage points respectively by Deutsche Bank) – private gold consumption in Q4 most likely remained very robust. Whereas India's private gold off-take during Oct-Dec. continued to shrink in the face of record-high prices. Indian bank and wholesale dealers have reported below-market bids from their clients throughout the autumn. Comments from the Bombay Bullion Association put Q4 imports 54% lower from 2008's already disastrous finish.

Fourth-quarter Chinese consumption should be in the range of 116 tonnes (if it adds 37% to Q1-Q3 volume, as per the 5-year average) to 128 tonnes or more (if Q4 tops Q3 by volume, as it has each year since 2004). Running total to end-Sept. was 315 tonnes. Likely to finish full-year at 431-443 tonnes.

India's private demand, in contrast, ran 45% below 2008 levels during the first 9 months of the year, most notably depressed during Q1 (down 83% from Q1 08, with Indian investors becoming physical dis-hoarders on GFMS's data; overall, India was a net exporter of gold for the first time since the Depression according to market historian Timothy Green). Applying the 5-year average ratio of Q4 demand to Q1-Q3 figures (27% added to 264 tonnes), full-year private off-take would come in at 336 tonnes, the lowest total since at least 1991 on GFMS's data.

India's full-year imports (it has virtually no domestic mining output) are forecast at 370-380 tonnes says the Bombay Bullion Association. They have not been below 400 tonnes per year since at least 1997 according to the Indian Bullion Market Association.

It is impossible to predict the outlook for gold-buying in mainland China next year, but this decade's drivers for Western gold investment – credit excess and miserable returns to cash – also apply in China, with bells on.

The People's Bank cut its benchmark rate from 7.5% to 5.3% in Dec. 2008, and has left it there since. Inflation in the cost of living was officially reported at minus 1.1% across the first 3 quarters, but real rates were negative in H2 2004 and again in at the turn of 2007-8. Some analysts are forecasting 4.0% inflation for 2010, and either way, commercial rates have been so attractive this year that new credit growth was CNY295 billion in Nov., equal to $43 billion. That was down from 2009's monthly average of $130bn, but took full-year credit growth to the equivalent of $1.35 trillion, equal to 27% of GDP.

Pitched against this rampant credit excess, gold's quasi-religious and auspicious appeal in Chinese culture – as a solid, tangible, intrinsically valuable store of wealth – will only have grown. Most significantly, and in sharp contrast to Indian demand, private Chinese buying has grown as the price has risen (gold has than tripled against the Yuan since retail price controls were lifted in 2001).

That might suggest gold is just another bull-market asset for China's increasingly wealthy and capital-rich middle classes. But owning the metal is most often viewed more as an end-in-itself than as an investment vehicle; it's the aim of accumulation, not the means.

Given this last decade's average 15% annual gains for US-Dollar investors – plus the outlook for sub-zero real interest rates, struggling equity dividends, and the danger of sharply higher bond yields (i.e. falling bond prices) as the Treasury attempts to finance a new record deficit – might the Chinese approach to Gold Investment start to take hold in the West...?

Please Note: A version of this article first appeared in the Financial Times' China Confidential

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“Get Exposure to Rising Gold”

The CPM consultancy's outlook for Gold Prices in 2010

WHAT'S THE OUTLOOK for Gold Prices going into 2010...?

Here Carlos Sanchez, associate director of research at New York's CPM Group speaks to Hard Assets Investor...

HAI: You guys are very much involved in metals – gold, precious metals – and gold has been on a tear. We had one of your colleagues here several months ago, Jeff Christian, at the time when gold was probably more or less around $900 an ounce. He was not that bullish at the time, looking at fundamentals such as actual physical demand, mine output, etc. Yet we have broken through; we've seen gold vault up above the $1100 figure. How high do you think it could go?

Sanchez: Well back then, we didn't expect prices to perhaps rally as high as it did so quickly. We had expected prices to move higher, but over the course of later this year and into the first quarter of next year.

Gold Investment demand has been the main driver behind prices over the past couple of years, and more so over the past several months. I think investors continue to be concerned over financial markets, economic conditions and political conditions as well. So I think with weak economic growth, with high unemployment, with what's going on in Afghanistan, Iran, etc., you have increased concern. And investors continue to rush to safe-haven assets such as gold.

HAI: Are investors coming up with new bullish-for-gold arguments, and bearish on the general economy, even though we're starting to see things improve?

Sanchez: Even despite the recent stabilization and the pickup in stock markets over the past several months, I think there's concern that stock markets remain vulnerable, not only in the US, but around the world. You also have increased concern over the economic conditions. There have been signs of stabilization, but they still remain vulnerable. Economic growth has not been as it was over the past several years

HAI: What about some of these extreme forecasts? I've heard people say, "We're going to $5,000. We're going to $10,000...$20,000..." Are those realistic?

Sanchez: I don't think they're realistic now. I think we'll have to wait to see what happens over the next several months. But I think $1,400, $1,500 is definitely a possibility, perhaps early next year. As far as $2,200, I think economic conditions will probably have to deteriorate from here going forward for us to see that price level.

HAI: Now if they don't deteriorate, if we continue to see the stock market improve and maybe even start to see some job creation at some point...don't forget, back in 2003, I remember very well the so-called jobless recovery turned into a recovery that actually created jobs. Can we have a scenario where gold continues to appreciate even though real economic conditions improve?

Sanchez: You know, if economic conditions do improve and you see a steady decline in unemployment, a stabilization in economic conditions and financial markets, you may see Gold Price gains capped. But at the same time, they will be supported. Because it will take several years for unemployment to move back to levels where it was prior to this recent financial calamity.

HAI: So from your perspective, there's no element of excess speculation or sort of a bubble environment right now when we talk about gold?

Sanchez: I think investors have helped push prices higher. They've been chasing prices higher, and that's helped sort of continue that cycle of rising prices. Perhaps once investors see that their price targets have been hit, there will be a pullback in prices. But at the same time, that pullback may not be as sharp as some expect. I think the pullback, as we've seen over the past several months, has been $30 to $40. But at the same time, the investors have been willing to Buy Gold at increasingly higher levels.

HAI: All right. So just quickly, would you say the new floor, what price level is that? $700, $800?

Sanchez: On a short-term basis, I think that price level is $1,100. If prices do fall below that, I think you could see increased buying. There's potential for prices to fall perhaps $40 to $50 lower. But that would, I think, pick up investor attitudes, and there could be some increased buying there. But next year the floor may be $1,000 if not $900.

HAI: What about silver? Silver looks like it's kind of lagging, both in terms of its nominal prices and inflation-adjusted price, way below the level it was in 1980...

Sanchez: I think silver prices have always really been much more volatile than, perhaps, Gold Prices. Some expect silver prices to head much higher just because it's much lower than its record high it hit in 1980, which was around $50.

HAI: The silver/gold ratio right now is probably a little bit more than 50 to 1?

Sanchez: Right...

HAI: Historically, what has been the range?

Sanchez: Well, the range has been from 40 to 70. But at the same time, that's dependent...you know, many investors look at the ratio, but you have to look at the underlying fundamentals behind the silver market as well. So I wouldn't really focus too much on that ratio.

HAI: Silver then is more driven or governed by economic factors. It's much more, you would say, an industrial metal. Many people say gold is money.

Sanchez: Right...

HAI: So it's a sort of a currency in some people's minds. I don't know if I would buy into that. But for many people, that's how they look at it, whereas silver, what you're saying I think, is that there's more of an economic fundamental driver behind that.

Sanchez: Silver's seen as a hybrid sort of commodity. It has its financial roles similar to what gold is, but also an industrial metal. And what's been driving prices higher has been strong investor interest. But at the same time, what's been capping prices is weak industrial demand, weak fabrication demand for silver.

HAI: All right, what about some of the other precious metals? Let's talk about platinum, let's talk about palladium. How do those look? Still sort of a bullish outlook for those metals?

Sanchez: We're pretty bullish on all of those metals. For silver, we're expecting prices to, perhaps, top $20 later this year; platinum's already topped $1,400, and perhaps will test $1,500. And palladium, possibly $400.

HAI: Now some of those metals – platinum of course, palladium – are very tied into the automobile industry. It's used in the manufacture of certain components in vehicles. Automobile output has been weak because of general economic conditions. If we start to see that come back, that would be a supportive factor then I would guess.

Sanchez: Yes, that would definitely be supportive. And auto production and sales are expected to come back. They are strong in developing economies. In developed economies, they've come off from prior years. But once the economy does begin to pick up, you should see demand increase as well.

HAI: Let's get back to gold for a second, because there have been some interesting new developments in the fact that we are starting to see some major central banks purchasing gold. Now historically, traditionally, central banks have been sellers of gold. Now they're buying it. You have India; people say China could be next. You know, it was sort of a contrarian indicator when they were all selling heavily down when it was about $250 an ounce. You don't take it as any kind of a contrarian indicator when they're buying it at $1,100, $1,200?

Sanchez: Well, you know, central banks aren't really in the market to hedge or to speculate or to profit. They work more on a mechanical basis. So when they feel that they need to increase or decrease their amount of gold that they hold, according to, perhaps, the amount of foreign exchange holdings that they have, they'll do that. They won't look at the price, because that's not what they do.

HAI: But it has been a bullish story in the sense that investors, when they see that, they sort of extrapolate, and say, "Well, you get one central bank doing it, you're going to get all of them or many of them, anyway, coming in." And their ability to purchase in vast quantity, that's a real ability.

Sanchez: Right. I think it definitely solidifies the view that there is strong demand for gold, that, "Hey, look, if central banks want more gold, so should we." But I think it definitely does support prices.

HAI: What would happen if the Fed starts raising interest rates?

Sanchez: At some point, central banks are going to have to increase interest rates. But that may be farther off than some expect. In the US, the Federal Reserve is expected to increase rates later in 2010. But at the same time, it's going to be a slow process. And that liquidity is going to be drained from the market very slowly to ensure that economic growth continues. So it may help cap Gold Prices, but at the same time, you're still going to have these underlying financial/economic concerns that will support them as well.

HAI: For an investor now who's thinking about getting into this, what's the best way to do it? Should you go via the Gold ETF route? Should you buy mining stocks? Should you buy physical gold bars, gold coins? What would you say to somebody?

Sanchez: I think it depends on the investor, but I would definitely get some exposure to rising Gold Prices. Now depending on what your preference or what your ease of use is, as long as you have some exposure to the rising Gold Prices, that would be good.

HAI: All right, there you have it: You've got to get some exposure to rising Gold Prices. That's it for now, folks. Thank you for joining me. Thanks to Carlos for coming by here.

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