BENONI (Gold Forecaster) – We heard that China’s economy was going to be the same size as the U.S. economy by 2016. This is considerably faster than U.S. economists thought would be the case just two years ago. At the speed China is growing it will dwarf the U.S. by 2020.
The encouragement the Chinese government has given to the development of the gold market there and the direct incitement to buy gold tells us that this is a long-term policy. It also tells us that the Chinese would not favor a significant rise in the exchange rate of the Yuan, particularly against the dollar, because this would lower the gold price in the Yuan. So what will the Chinese gold market look like in 2020?
With the clear move of currencies away from providing definable values for goods and services it is becoming increasingly likely that there will be a rise in global retail demand for gold with the objective of protecting wealth, alongside a rising demand from global central banks adding to their reserves of gold.
The various currency crises affecting both sides of the Atlantic are reinforcing a trend set in 2007 [When the French Finance Minister suggested that the euro be sold to push its exchange rate down to protect its exports] where the U.S. to China and virtually all national currencies in between, now use their exchange rates solely as a currency to benefit its trade positions and not for the assessment of the value of goods and services.
This left a large gap in the monetary system which has to be filled.
On the retail as well as the official front, demand is showing that gold is filling that gap. This trend is unlikely to change as the restoration of stable values to currencies is a thing of the past.
Consequently there will continue to be global demand for gold in the months and years to come. This sets the stage against which the Chinese gold market will develop.
Even in China demand from both the retail and the official sectors will grow in the years ahead. It is well known that the People’s Bank of China has an agency that is acquiring gold on its behalf. This is not publicized with the exception of an announcement once every five years [or when it suits the government] when this agency delivers the gold it has bought over the previous five years to the People’s Bank of China. It is thought that this gold comes from local production and constitutes the entire gold production of China.
Three years ago, when the last announcement was made it was clear that the 454 tonnes delivered matched the local production of the previous five years. Since then local production has grown to reach 430 tonnes last year. We would not be surprised if the next announcement in two or so years covered the delivery of over 1,000 tonnes.
Where does this leave local retail demand? The Chinese government has encouraged its citizens, nationwide, to buy gold as an investment for the long-term. The gold distribution system has been developed quickly by the leading Chinese banks to cover all the main cities where new customers can be found. Import licenses for gold have been dramatically increased to facilitate gold imports.
As the almost exponential expansion of the Chinese middle classes continues gold demand is rising fast. In a nation of 1.3 billion people of whom most are climbing out of poverty right now, the bulk of that population become potential gold investors from tiny amounts of a few grams to much larger amounts.
This trend is not simply going to parallel the expansion of the middles classes, but find that most of these people will become repeat buyers. All of that demand has to find its gold overseas, not from local production.
We fully expect Chinese demand, together with Indian demand to completely dominate global retail demand and so set the price and the trend of the gold markets of the world by 2020.
THE GOLD FIXING
Banks like HSBC [The Hong Kong and Shanghai Banking Corporation] will likely feed the bulk of that demand. HSBC is a member of the London gold Fixing with one of five seats on that panel. It is also the Custodian of the World Gold Council’s gold Exchange Traded Funds in the U.S. and the U.K. So its hold on global supplies is stronger than other banks. The refineries supply HSBC, who then offers it at the Gold Fixing in London twice a day, alongside other suppliers and buyers. The price is agreed by the banks at the Fixing, each of which has a telephone line direct to their largest clients [who, in turn, are linked to their largest clients at the same time]. When a balance between demand and supply has been reached and a price agreed, all transactions are done at that one price. A bank like HSBC will have been notified by their Hong Kong branch, after receiving orders from their Chinese outlets, to deliver regular amounts of gold for onward sale all over China.
At the moment the average per capita ownership of gold in China is way below the 5grams in most other countries in the world. We do expect demand to keep rising to perhaps overtake that amount, in time [it will take more than 9 years to achieve that average, we believe].
One of the main differences to the developed world ‘gold’ markets is that the physical gold market of Asia, just as we see in India today, is primarily a physical gold market. The smaller Asian investor is not convinced by gold derivatives, such as options or futures. He buys the physical gold.
Yes, in China there is a futures and options exchange, but these are for the professional investors seeking profits. The average Chinese investor buys gold he can hold for his financial security. He is not keen to let someone also hold it for him. This makes the Asian market an even more significant player in the establishment of the gold price. With this in mind it is easy to see how the Asian gold market will dominate the global physical gold market in the not too distant future.
By 2020 the demand from China may well be far greater than from the amount the developed world buys at present. It is most likely that there will be an equivalent market to the gold Fixing in London but based in Hong Kong, where there already exists a very large bullion vault, next to their huge Airport. It may even be that the London Fixing will then represent a much smaller market than the 90% of physical demand it represents currently or work in conjunction with London [three or four Fixes a day?].
We do expect the Chinese gold market, in time, to dwarf the London gold Fixing, if only because of the size of total Asian demand.
Even Indian demand may well be channeled through Hong Kong. What is unlikely to change will be the current membership of the London gold Fixing. The membership may well have grown by then with leading Chinese banks as additional members, so the number of members will rise up from five.
WILL THE DEVELOPED WORLD GOLD MARKET DECLINE?
Just as we see now in the developed world so-called, gold markets are often just financial derivatives of the gold market. Gold mining company shares, Options and any instrument linked to the gold price do not directly affect the gold price. Only 5% of the gold market on COMEX involves the physical movement of gold.
While investment companies do invest in gold through gold Exchange Traded Funds, only some invest directly in physical gold that they hold for themselves [like the Texas fund that sold these shares and holds allocated gold in their bank’s warehouse]. This number is expected to rise but not to the extent that it changes the developed world’s perspective on the gold market [primarily profit orientated]. So the size and variety of these so-called gold markets will not change that much we believe. But the physical gold markets in the developed world will rely less on that demand and become global in that they will incorporate Asian demand in a 24-hour market then.
Compare the physical gold market of the developed world to the potential gold markets of Asia [mainly India and China] and it is easy to see just how fast Asia will dominate the gold market completely.
So will the developed world gold market decline? We doubt it very much. That’s because we believe that while the developed world will see a good quantity of its wealth move to the east, it will not lose its ability to buy and use gold. Global wealth as a total will increase with the rise of Asia, not stay a fixed amount. But certainly Asia’s gold market will completely overshadow the developed worlds.
Julian Phillips is a long time specialist analyst of the gold and silver markets and is the principal contributor to the Gold Forecaster – www.goldforecaster.com – and Silver Forecaster- www.silverforecaster.com – websites and newsletters