Chinese view gold as real money and demand is exploding

Chinese demand is behaving as we predicted. If you look at the recent history of Chinese gold demand, you start in 2003 when gold ownership was made acceptable, having been banned from 1945 until then. This occurred at a time when the agency for the People's Bank of China began buying gold for their reserves. Prior to that, HSBC tried to persuade China to buy gold, but the time was not quite right for them. Now it is very right for China to buy gold. What has happened since 2003 and during 2010?

THE GROWTH OF THE CHINESE GOLD MARKETS

Once allowable, gold ownership was, hesitatingly, encouraged. But first, as with so many areas of finance in China, the embracing of the western financial system had to be tempered with the development of skills and structures to handle the changes. In gold's case, the Shanghai gold market had to be instituted, the banking system's gold distribution had to be established, all of which has taken since 20003 to bring a sufficiently capable system to their gold markets.

In the past year, we have seen the Chinese government issue permits to import gold into the country by a much larger number of banks and importers. The Chinese gold distribution system has still a long way to go, in line with the development of the country overall. Gradually, the distribution system for gold was slowly developed, first in the main centers for the newly wealthy, then through the select top five Chinese banks and their main central outlets. All the banks are now allowed to distribute gold and slowly, it will reach the western outer reaches of China as the country develops.

GROWTH OUT OF THE GROWTH OF CHINA ITSELF

China's development, as we all know, began with the export of cheap parts sub-contracted out of the developed world, then moved onto exports of their own. The south-east and mid-east benefited first with infrastructural development fanning out from there.

Now infrastructural development is reaching into all other parts of the nation at break-neck speed. With this development comes a new middle class of hard working people earning small proportions of what they could in the developed world, but saving up to 40 % of their income.

Now this middle class is growing explosively alongside the overall development of the nation. Until recently they held their savings in bank deposits, which is why when interest rates go up, Chinese middle class disposable income rises with them.

For good reasons, the government has realized that China, as a whole, will benefit from its citizens owning gold as well as the central bank, the People's Bank of China. Hence, they are actively encouraging the Chinese people to buy gold, as are the banks. The Chinese have memories of how gold is real money. They are buying it because it is seen as true wealth in all seasons. They don't buy it simply as a hedge against inflation, but because it will weather all sorts of financial ails.

CHINESE CENTRAL BANK GOLD BUYING

In addition, the government published two years ago that the People's Bank of China had added 400 tonnes to its reserves. It became clear that another government agency was acquiring this gold over the previous five year period for the central bank. We are of the opinion that the same agency continues to acquire gold for the central bank. This will only be disclosed when [likely in another three years - every five years] it suits the government to disclose it. However, we now realize that it may well be a mistake to think that the 400 tonnes acquired over the five years prior to 2008 was acquired at an even rate. This amount could well have been the buying of rising local production over those years. After all, as the Chinese themselves have said, buying on the international market can be difficult without forcing the gold prices up [it can be done on a ‘limit' order basis, accepting offers only, without chasing prices]. It makes far more sense to buy local production from local producers ‘off' market.

We are aware that the government is still buying in the international market as well as local production but it is impossible to discern what amounts, without the government supplying that information. More than that, it is very difficult to discern what the government is buying and what the Chinese jewelry and investment trade is taking. With local production of 340 tonnes this year and imports set to be around 280 tonnes for the year, with an unknown amount perhaps stored in Hong Kong vaults for the government agency, we do know that China is taking at least 620 tonnes in total in 2010. But what will happen in the Chinese gold market in 2011 and beyond and what will that do to the gold price?