China and their growing pile of gold

Recently, there has been increasing coverage of gold as an investment in the mainstream media.  While it usually makes me nervous when so-called experts start recommending specific investments that appear on the front page of the business section of newspapers, gold is one investment that should be used by investors as a hedge/insurance against catastrophe.  As I showed in this posting, during the Great Recession, gold stock prices dropped by a far greater percentage from their peaks in early 2008 when compared to the physical metal (it dropped about half as much as paper mining shares) and after the rebound, gold has regained all of its losses and now sits at 39 percent over its peak just before the great debacle of 2008 began while mining share prices are roughly even with their pre-debacle peaks.

On December 2nd, China's Shanghai Gold Exchange revealed that it had imported 209 tonnes of gold in the first 10 months of 2010 compared to 45 tonnes in all of 2009.  That amounts to a 500 percent increase so far this year.  China is rapidly becoming the world power when it comes to the world's gold market.

The Shanghai Gold Exchange (SGE) was founded by the People's Bank of China to provide services that allow gold transactions to take place, connect the international and domestic gold markets and generally supervise the gold business in China as stipulated by the People's Bank of China.  Its members are commercial banks and corporations that are authorized to produce, smelt, process, import and export precious metals and their products.

China first legalized personal investment in gold in 2004 and the SGE has allowed individual investors to trade tangible gold.  Here is the news release from SGE announcing the debut of small gold bars:

From the 5th Annual China Gold and Precious Metals Summit 2010 website, I have gleaned the following facts about China and their gold market:

•   China is the second largest consumer of gold after India with demand reaching 461.9 tonnes in 2009, an increase of 7 percent over 2008.

•   Gold consumption for jewellery reached 347.1 tonnes, approximately 20 percent of the world's demand.

•   retail investment in gold reached 80.5 tonnes, up 22 percent over 2008.

•   gold trading volume on the SGE reached 3174.54 tonnes for the first half of 2010 - this compares to 4710.8 tonnes for all of 2009 and 1828 tonnes for all of 2007. 

•   China's gold mine output reached 313.98 tonnes in 2009, up from 282 tonnes in 2008 and 270 tonnes in 2007, making them the world's largest gold producer.  By comparison, both the United States and Australia share second place with 215 tonnes, both 12 years off their peak production year back in 1998.

•   the total amount of platinum consumed for jewellery (world-wide) in 2009 reached 93.6 tonnes with China consuming 64.7 tonnes of that total.

From the Gold Demand Trends November 2010 report published by the World Gold Council, I have taken the following information.  Growing demand from both China and India, the world's two largest consumers of gold, is having a marked impact on the world's gold market.  With recent debt issues in the EU and the Federal Reserve's QE2 program, investors are looking for an investment safe haven.  Unlike North America where people are selling their gold jewellery for scrap as prices rise (jewellery tonnage in the United States was down 5 percent year-on-year), China's demand for gold jewellery rose 8 percent year-on-year and retail sales rose 18.3 percent in the first three quarters.  Hong Kong's gold jewellery demand was up 22 percent year-on-year.  It's obvious that residents of China regard high purity gold jewellery (18 karat) as a safe investment.  If we contrast that to the United States, retailers have been forced to reduce the gold content in their jewellery items as the price of gold rises and gold plated items are taking market share from 10 and 14 karat items.

Chinese investors are also purchasing gold bars and coins; demand reached a new record of 45.1 tonnes in the third quarter of  2010, up from the previous record of 39.6 tonnes in the first quarter of 2010.  In local currency, demand for gold bars and coins was up 64 percent year-on-year.  This compares to a demand of 24.8 tonnes in the United States and 48 tonnes for all of Europe.

If one takes all of these factors into consideration, it is apparent that demand for gold from China during 2010 has added fuel to the gold price fire.  My suspicion is that while world production of gold in the third quarter of 2010 was up 18 percent year-on-year to 1028 tonnes, the increase was mainly due to a 41 percent increase in the supply of recycled gold.  In fact, mine production was up by only 3 percent to 702 tonnes.  As consumers in the Far East increase their demand for gold in the form of high purity jewellery, coins and bars, demand will outstrip production and the price of gold will continue to rise.

As an aside, silver trading on the SGE reached 18073 tonnes for the first half of 2010.  This compares to 16248 tonnes for ALL of 2009.  As I'll explain in a future post, I think that silver is the "elephant in the room" when it comes to investing in precious metals.