Asia Trip Report: Positive Signals for Gold

I'm just back from nearly three weeks in Beijing, Shanghai, Hong Kong, Singapore, Malaysia and Vietnam, where I met with gold dealers, brokers, bankers, analysts and leading gold-industry officials.

Take-Home Message—Very Positive

The take-home message is very positive for gold: Virtually everyone I asked expects gold consumption across the region—both jewelry and investment—to continue rising for years to come.

And, there was also strong agreement that China's central bank, the People's Bank of China (the PBOC) would continue its own buying program well into the decade if not beyond.

Many analysts and market participants in the West have difficulty imagining gold sustaining past gains let alone registering significant price advances for years to come. But this is not the consensus view across much of Asia!

For gold investment demand and jewelry consumption to grow in China and elsewhere in the region to continue growing and to continue supporting a rising world gold price requires only moderate growth in economic activity and household income in China and neighboring countries. Inflation fears or financial market uncertainties are not required, although their presence (as in Vietnam) will only encourage more savings-related demand.

Eastern Worries

Here in the West, most gold analysts look to Europe's sovereign debt crisis and the decline of the euro to explain this year's sharp gold-price appreciation. But in the east Asian countries I visited, it was clear that people are much more worried about the U.S. dollar and America's own huge and growing sovereign debt—and this is one factor motivating China's private and central bank gold interest.

There was also much agreement that China's economy would continue growing at eight to 10% a year despite weakness in its U.S. and European export markets, propelled instead by the long-term secular trends of industrialization, technological advancement, rising consumer spending, and continued public-sector spending on major infrastructure projects such as railroads, highways, power generation, and rural development.

There was also agreement that China's exchange-rate would soon be allowed a slow upward appreciation—not under pressure from the West. . .but as a monetary-policy tool to cool domestic inflationary pressures and mitigate the uptrend in commodities prices.

Shifting to the Consumer

Western observers worry that rising inflation in China will provoke monetary restraint, much slower economic growth, and weaker demand for commodities—including oil and gold. But China's policy-makers are already engineering significant wage increases across the economy—and plan to continue doing so over the next few years—to keep consumers spending and the economy growing at an acceptable pace while big productivity gains, gradual yuan appreciation, and a good harvests from China's agricultural sector hold the inflation rate in check at under the 3% ceiling targeted by the central bank.

Pro-Gold Policies

This is a propitious economic scenario for gold. . .with rising personal incomes in China and across the region resulting in continuing growth in jewelry consumption and physical gold investment.

I also heard personally from one high-ranking gold industry official that China's pro-gold government policies will continue to encourage private gold investment just as the central bank itself continues to build its own gold reserves, buying month after month from China's domestic mine production.

The Chinese government legalized private gold investment only about three years ago, this after banning gold investment ever since the Communist revolution in 1949. To be sure, some Chinese (like their Indian and Vietnamese neighbors) purchased gold jewelry with an investment motive—but bar hoarding, per se, was proscribed.

Today, gold investment is not only legal in China—it is endorsed and encouraged. Physical bar and coin purchases this year will probably total 100 tons or more and could account for as much as 20%–25% of total annual demand. And, physical investment will continue to grow from year to year both in absolute terms and as a share of total consumption.

More than five decades of pent up and unrealized investment demand, the establishment of domestic spot and futures markets for gold, the introduction of a national gold-investment distribution system through banks and retail shops, the rise in personal income, a growing middle and upper classes and rise in wealth across the population, inflation anxieties, and the country's long cultural affinity to gold assures that China will have an increasingly important influence on global supply-demand trends—and a powerful positive influence on the metal's price for years to come.

And, this doesn't even take into account the continuing demand from China's central bank.

Official Buying to Continue

It's already old news that the PBOC announced last year that it had purchased some 454 tons of gold from domestic mine production during the prior six years beginning in 2003—but it did not report these purchases and count this gold as official reserves until April 2009.

It is widely believed that China's central bank continues to discretely purchase gold from domestic mine production but chooses to hold these acquisitions “off the books” so to speak, as announcements of PBOC purchases and inclusion of this metal in its published official reserves accounts would probably result in a higher world market price making subsequent official and private-sector purchases that much more expensive.

So while China's reported reserves have remained at 1054 tons since April of last year, actual gold reserves are probably already in the neighborhood of 1,200–1,300 tons. . .and growing.

Following last April's announcement, Hou Huimin, deputy secretary general of the China Gold Association, commented that China may want to hold a total of 5,000 tons of gold in its central bank reserves. This would put China squarely between the United States, which leads the world in official gold holdings at 8,134 tons, and Germany with 3,407 tons. While not an official target, this does suggest that current holdings remain well below the PBOC's long-term objective.

Moreover, as U.S. dollar and other foreign currency reserves pile up, the proportion of China's official reserves held in gold remains under 2%, despite the central bank's gold-buying program. In comparison, European central banks as a group hold nearly 60% of their official reserves in gold and the United States holds some 70% of its official reserves in gold.

In addition to Mr. Hu of the China Gold Association, other government and central bank officials have made pro-gold statements, supporting the view that China's goal is to gradually build its gold reserves over time. Wang Zhenying, deputy director-general for the PBOC's Shanghai office advocates the development of gold investment products that suit the needs of Chinese investors and savers. And Yi Gang, deputy governor of the PBOC and administrator of the State Administration of Foreign Exchange has talked about official buying from domestic sources gradually and persistently to minimize the positive effect on global gold-market prices.

Sovereign Wealth Goes for Gold

In another twist, the China Investment Corporation (the CIC), China's largest sovereign wealth fund, announced its own purchase of about 4.5 tons early this year via the NYSE-listed gold exchange-traded fund, the SPDR Gold Trust.

It is likely that this purchase had the blessing of the People's Bank of China and other government agencies. At the very least, even if a one-time purchase and not a big deal compared to total PBOC gold holdings, it further signals China's very positive pro-gold official attitude. . .and gives private investors greater confidence to by gold for their personal savings and investment programs.

Bottom Line—China Bullish for Gold

China promises to be a growing giant in the world of gold for years to come. Those who fail to recognize the pro-gold developments now occurring in China will greatly underestimate the potential long-term influence on world gold prices and will greatly underestimate the heights to which gold will rise over the next five to ten years.

Asia Trip Report: Positive Signals for Gold