At MoneyNews: Understanding China’s Insatiable Gold Demand

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Chinese demand for gold will remain strong for the foreseeable future, driven by longtime cultural affinity for gold, growing affluence among more citizens and government encouragement.

While China became the top producer of gold in 2007, in 2013, China surpassed India to become the top consumer of gold in the world. In total, 1,132 metric tons of gold were purchased, setting a global historic record. That accounted for approximately 26 percent of the total private sector demand in the world and there seems to be little sign of demand waning.

The primary driver of Chinese gold demand is their longtime cultural affinity for gold. Dating back millennia, the Chinese have given gold as a traditional gift for weddings, births and to celebrate the Lunar New Year. More recently, Mother’s Day and Valentine’s Day have joined the roster of gold-gifting holidays. Because gold is also viewed as money, giving gold not only makes the recipient more prosperous, but also shows off the wealth and prestige of the giver.

While the Chinese buy both bars and Panda bullion coins made by the Chinese government (it is illegal to import other governments’ bullion coins), the majority of gold purchased by consumers is 24 karat gold jewelry. The Chinese prefer the purest gold because the its deeper yellow color, perhaps dating back 5,000 years to the first ancestors: the legend of Huang Di, the Yellow Emperor, and the Yan Di, the Fiery Emperor. They prefer cheaply made jewelry because they do not want to pay a large mark up over spot gold prices like for bullion coins. Also, jewelry has the advantages of being portable and wearable and therefore an opportunity to show off your wealth.

One of my most treasured possessions is the 24 karat gold necklace and bracelet that my mom gave me when she passed. It was given to her as a wedding gift from her father-in-law. Around the necklace and bracelet were $2.50 and $5 U.S. gold coins. Not only did he want to celebrate the newlyweds, but also he wanted to make sure that if she ever needed to flee danger at a moment’s notice, there would be enough wealth on her to ensure the continuation of the Moy family line.

Just in his lifetime, he survived the fall of imperial rule, the rise and fall of the warlords, the rise and fall of the Nationalist government, two world wars and a Japanese invasion, the Korean War, multiple failures of their currency and banking systems, rampant inflation and the rise of the Communists. That is enough instability for anyone to want to make sure they have a portable survival fund.

A secondary driver of Chinese gold demand is the growing affluence among more citizens. China’s GDP growth rate of 7+ percent and rising wages have created hundreds of millions of new urban middle class from poor rural citizens and is expected to add 200 million more in the next five years. Chinese in general are some of the biggest savers in the world and the new middle class is anxious to diversify their savings from yuan to gold.

However, for cultural reasons, they are keen on physical gold and less interested in paper gold like gold exchange-traded funds (ETFs). There are also limited investment alternatives. For example, the Chinese stock market has much less transparency than the U.S. market does and therefore is less trusted. In addition to preserving their new affluence (and showing it off), they plan on passing down their gold holdings to ensure the continuation of their family name, just like my grandfather.

The third driver of Chinese gold demand is government encouragement. The government promotes gold ownership by its citizens by slowly liberalizing their gold market. Starting with the People’s Bank of China allowing the sale of bars and coins to individual investors in 2004, the Bank has encouraged the development of Gold Accumulation Plans for individual savers at member banks and the formation of the Shanghai Gold Exchange, both making it easier to purchase physical gold for investment purposes. The Chinese government believes that the more citizens who own gold, the more prosperous China will be as a country.

The consequences to U.S. investors are many. Each time the gold price drops, the Chinese view it as a buying opportunity. Not only is it a relative bargain, Chinese investors subscribe to the worldview that American monetary policy will ultimately devalue the dollar and drive up gold prices. China also believes that U.S. economic power is on the wane and China’s is on the rise.

And as U.S. institutional and individual investors abandon gold ETFs, the Chinese are buying the excess ETF gold. Many Chinese hoard gold and it is unlikely that they will sell it for a profit, but instead pass it down to family, resulting in shrinking worldwide supply.

While there will be many ups and downs in China’s gold appetite, you can count on continued high demand for physical gold in the foreseeable future.

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