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Renminbi Internationalization And China’s Gold Strategy

Here we go!

A seminar about gold supporting the internationalization of the renminbi and China’s financial strength was held in Beijing on 18 September 2015. One of the keynote speakers was Song Xin, President of the China Gold Association (CGA), Chairman of the Board of China International Resources Corporation, President of China National Gold Group Corporation and Party Secretary, who believes China’s economic power must be serviced by appropriate gold reserves to support the renminbi. An article written by Song published on Sina Finance in 2014 stated (translation by BullionStar):

For China the strategic mission of gold lies in the support of renminbi internationalization. Gold … forms the base for a currency moving up in the international arena.

If the renminbi wants to achieve international status, it must have popular acceptance and a stable value. To this end… it is very important to have enough gold as the foundation and raising the ‘gold content’ of the renminbi. Therefore, to China, the meaning and mission of gold is to support the renminbi to become an internationally accepted currency and make China an economic powerhouse.

That’s why, in order for gold to fulfill its destined mission, we must raise our gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.

President of the CGA before Song was Sun Zhaoxue, who shared many of the viewpoints of his successor. In 2012 a famous article from Sun was published in Qiushi magazine, the main academic journal of the Chinese Communist Party’s Central Committee, wherein he plead for stimulating the Chinese citizenry to buy gold next to increasing China’s official gold reserves (translation by BullionStar):

Currently, there are more and more people recognizing that the ‘gold is useless’ story contains too many lies. Gold now suffers from a ‘smokescreen’ designed by the US, which stores 74% of global official gold reserves, to put down other currencies and maintain the US Dollar hegemony. Effectively, the rise of the US dollar … and later the euro currency, from a single country currency to a global or regional currency was supported by their huge gold reserves.  

Individual investment demand is an important component of China’s gold reserve system, we should encourage individual investment demand for gold. Practice shows that gold possession by citizens is an effective supplement to national reserves and is very important to national financial security.

Regular readers of this blog will know what Sun wrote in 2012 regarding ‘individual gold investment’ is exactly what has unfolded; through the Shanghai Gold Exchange (SGE) we could see thousands of tonnes of gold moving into the mainland in recent years. According to my estimates Chinese privates gold holdings have reached 12,000 tonnes – next to the People’s Bank Of China’s (PBOC) gold buying program.

Since my last extensive blog post (20 May 2015) on PBOC gold purchases I’ve been able to collect more clues related to the amount of gold China’s central bank has harvested in exchange for its lopsided US dollar holdings. Last week I spoke to an insider with connections at Western bullion banks. This gentleman confirmed proxies of the PBOC purchase gold directly in the London OTC gold market that is shipped to Beijing. Implying much of the 1,750 tonnes that have mysteriously vanished from the London Bullion Market (left London without being disclosed in UK customs statistics) in between 2011 and early 2015 went to China. This supports the analysis the PBOC is buying at a pace of 500 tonnes a year in the international OTC market (not through the SGE) and owns approximately 4,000 tonnes by now.

Furthermore, it seems the writings from Song and Sun correspond with China’s real undertakings in the gold market, which influences our valuation of their words. There are no transcripts from the seminar in September, but I found an article (in Chinese) that summarizes what Song and others have said. Please read the gripping translation below.

CGA

Note, Song is the President of China National Gold Group Corporation, which started an alliance with Russian gold miner Polyus Gold to deepen ties in gold exploration. China and Russia aim to trade (newly mined) gold over the Shanghai International Gold Exchange in renminbi for international institutions and central banks as part of the Silk Road Gold Fund to attract the center of the international gold market towards the East.

Renminbi Internationalization and China’s Gold Strategy Seminar

Date: September 22, 2015. Source 

On 18 September 2015 the “Renminbi Internationalization and China’s Gold Strategy Seminar” was smoothly held in Beijing. The seminar was guided by the China Gold Association and jointly held by the Chinese Gold Research Center of Capital University of Economics and Business and Beijing Gold Economic Development Research Center. It was supported by Zhao Jin Futures, Shandong Zhaojin Investment Co., Ltd., Shenzhen Jinmingzhu Jewelry Co., Ltd. and Chifeng Jilong Mining Industry Co., Ltd.

Over 130 representatives from the governments, banks, gold mining industry, gold investment organizations, jewelry companies and educational institutions attended the seminar. Wang Wenju, Vice President of Capital University of Economics and Business announced to rename the Chinese Gold Market Research Center of Capital University of Economics and Business on the seminar site.

Wang Jiaqiong, President of Capital University of Economics and Business, Song Xin, President of Chinese Gold Association & General Manager and Secretary of the Party Committee of China National Gold Group Corporation, Wang Xiaomei, Deputy Party Secretary of China National Gold Group Corporation, Wei Benhua, Former Director of the State Administration of Foreign Exchange and Former General Representative of Chinese International Monetary Fund, and other leaders and representatives attended the seminar. 13 experts from China Gold Association, Shanghai Gold Exchange, Renmin University of China, Chinese Social Science, Capital University of Economics and Business, China Center for International Economic Exchanges, China Forex Investment Research Institute, Gold Economic Research Center, ICBC, China Construction Bank, Shandong Gold Group and Shandong Zhao Jin Group delivered splendid speeches.

Wang Jia Qiong
Wang Jiaqiong

President Wang Jiaqiong delivered a speech. In his speech, Wang Jiaqiong pointed out, RMB internationalization is a struggling process in need of strategic research. In the seminar, many experts, scholars and entrepreneurs were discussing renminbi internationalization and Chinese gold strategies. They would propose wise ideas and good policy suggestions after brainstorming, playing as a think tank in the development of China. The research team led by Professor Zhu Heliang from our university spent years studying Chinese gold strategy problems and some research results obtained the central affirmation and recognition. All of your arrival can better support our in-depth research on relevant topics and construction of related disciplines.

In the opening ceremony, Wang Wenju announced the renaming of the Chinese Gold Market Research Center of Capital University of Economics and Business, which focuses on the current gold market, to Chinese Gold Research Center of Capital University of Economics and Business with the purposes of better studying gold problems comprehensively, displaying the function of gold in national economy and society, boosting renminbi internationalization and keeping pace with the times. The school would offer vigorous support and hope that the new research center can strengthen team building and display think tank functions.

Song Xin rmb au
Song Xin

In his speech, Song Xin mentioned that the Chinese gold industry has achieved a great-leap-forward development since the new century. In 2014, Chinese gold yield had turned China into the biggest gold producing country in the world for eight consecutive years and the biggest gold consumption country again. Whether in the past, present or future, gold plays a crucial role in the development of human society. Renminbi internationalization has boosted China’s march towards an economic power from an economic giant. The new age has endowed gold with more important missions. Gold has shouldered a heavy responsibility of “increasing credit” for renminbi internationalization and increased the “gold content” for renminbi internationalization. 

Recently, the Central Bank announced to increase gold reserves to the public many times in succession. In fact, it’s the strategic layout and major move for laying the renminbi’s international credit foundation. We always suggest formulating and boosting national gold strategies in pace with national financial strategies positively, further improving the quantity and proportion of gold in national foreign exchange reserves, developing occupancy volume of gold production and increased gold resources. We further suggest perfecting the gold market, promoting foreign currency in individuals, boosting Chinese and western wealth flowing, improving our control power of global gold wealth flowing, accelerating renminbi internationalization, helping the renminbi enter special drawing rights currency basket, rebuilding international currency system, balancing American hegemony process, and positively displaying the due function of gold and the gold industry. Leaders from Capital University of Economics and Business have supported the research on gold problems for a long time. The team led by Professor Zhu Heliang has persistently pursued basic research on gold with outstanding viewpoints. They have obtained relevant departments’ high attention for long. I hope that Capital University of Economics and Business can further display its gathering advantages of majors and talents, and strengthen the cooperation with Chinese Gold Research Center, China National Gold Group Corporation and its subordinate companies.

In the seminar, experts thoroughly analyzed the essence and inherent laws of renminbi internationalization, new positioning and functions of gold in the non-gold standard currency system. They discussed the strategic significance of gold in renminbi internationalization from historical and actual perspectives and Chinese gold strategies in the new age. Experts unanimously regarded gold as playing an irreplaceable role in currency internationalization progress. The important element of gold shouldn’t be ignored during renminbi internationalization. The country should attach great importance to the development of the gold industry and market and increase gold reserve from a strategic height.

The seminar is the “prelude” of the first renminbi internationalization and Chinese Gold Strategy Research Project jointly carried out by Chinese Gold Research Center of Capital University of Economics and Business and Beijing Gold Economic Development Research Center. After the seminar, key viewpoints were to be collected and submitted to related departments. Chinese Gold News will set up a special column and publish solicited articles about “renminbi Internationalization and Chinese Gold Strategies”. Meanwhile, two organizations will organize special research teams, focus on the topic research of “renminbi internationalization and Chinese Gold Strategies”, and open the research results for publication. With national major strategy research as their own duty, the two organizations have formed a strategic alliance in terms of promoting renminbi internationalization and adjusted research directions of Chinese gold strategies in order to make effort and contribution to the prosperous cause of China.

German Central Bank Publishes Gold Bar List

The central bank of Germany, the Bundesbank, has published the bar list of all German official gold reserves stored in Frankfurt am Main, London, Paris and New York. The list contains the bar numbers, melt or inventory numbers, the gross and fine weight as well as the fineness of the gold. German official gold reserves account for 3,384 tonnes and is the second largest after the US.

In 2012 the Bundesbank initiated its first repatriation schedule to repatriate 150 tonnes of gold from the US in three years, ending in 2015. Before one bar was brought home, this schedule was revised in the beginning of 2013 to repatriate 300 tonnes from the US and 374 tonnes from France by end-2020, to eventually have at least 50 % of German official gold reserves at home. So after January 2013 two repatriation schedules co-existed. They were not mutually exclusive – most Germany expected to see back was 150 tonnes from the US by 2015, and ultimately 674 tonnes by 2020 from both the US and France.

But at the end of 2013 only 37 tonnes of gold had reached German grounds of which 5 tonnes came from the US, and all of the 5 tonnes from the US were recast into new bars. Germany decided in February 2014 to cease repatriation schedule Plan A, and continue Plan B. Basically the Bundesbank (BuBA) was giving the Federal Reserve Bank Of New York (FRBNY) more time to ship the gold to Germany, as there were clearly some logistical problems.

21 November, 2014: the central bank of the Netherlands (DNB) made public it had covertly repatriated 122.5 tonnes of gold from the FRBNY. Gold analysts were surprised how DNB could have repatriated 122.5 tonnes in a few months while BuBa needed seven year to ship home 300 tonnes from the US.

Although the German repatriation schedule accelerated in 2014 and by year end it had brought home 85 tonnes from the US and 35 tonnes from France, this time 50 tonnes of the 85 tonnes Germany received from the US had been recast into new bars and the mystery as to why it was taking so long to transport the German gold was not clarified.

The mystery grew when the FRBNY disclosed on 31 January 2015 it had been drained from 176.81 tonnes of physical gold out of the foreign deposit accounts in 2014. A drop from 6,195.60 tonnes to 6,018.79 tonnes over 12 months. Whilst, DNB and BuBa had claimed to have received 207.5 tonnes (122.5 tonnes by DNB and 85 tonnes by BuBa), which is 30.69 tonnes more than what the FRBNY said to have shipped out. The only explanations could be, (i) a fourth central bank had deposited 30.69 tonnes at the FRBNY in 2014, (ii) the FRBNY had swapped gold with a foreign central bank that was supplied to DNB or BuBa, or (iii) DNB or BuBa did not receive the amount of gold they stated.

Untitled

Although the German bar list is anything but complete (it misses the refiner brands, refinery bar numbers and year of manufacturing) it seems the Germans are increasing the pressure on the FRBNY by releasing the list of bars they have stored at the four locations (Frankfurt, Paris, London, New York). Leaving the FRBNY no other option than returning the exact bars that belong to Germany.

Year to date the FRBNY earmarked gold has dropped by 80 tonnes. This has likely all gone to Frankfurt as it’s not known any other countries are currently repatriating from New York.

FRBNY gold deposits

You can download the German gold bar list via this link.

China Aims For Official Gold Reserves At 8500t


2383
China should accumulate 8,500 tonnes in official gold reserves, more than the US, according to Song Xin, President of the China Gold Association, General Manager of the China National Gold Group Corporation and Party Secretary. He wrote this in an opinion editorial published on Sina Finance July 30, 2014. Gold is money par excellence in all circumstances and will help support the renminbi to become an international currency as “gold forms the very material basis for modern fiat currencies”, Song notes. In the short term the Chinese will not back the renminbi with gold (establish a fixed renminbi price for gold), but support it with gold so it has sufficient credibility for the world to accept it as a trade and reserve currency.

The previous President of the China Gold Association (CGA), Sun Zhaoxue, was also the General Manager of the China National Gold Group Corporation, these jobs are apparently connected. Song took over from Sun as CGA President and Manager of China National Gold in February 2014. Remarkably, when Sun was in office he wrote equally candid articles (in Chinese) about the importance of gold for China’s economy. Sun’s most renowned article is titled “Building A Strong Economic And Financial Security Barrier For China”, published on August 1, 2012, in Qiushi magazine, the main academic journal of the Chinese Communist Party’s Central Committee (click here for a translated version). From Sun:

The state will need to elevate gold to an equal strategic resource as oil.

Currently, there are more and more people recognizing that the ‘gold is useless’ story contains too many lies. Gold now suffers from a ‘smokescreen’ designed by the US, which stores 74% of global official gold reserves, to put down other currencies and maintain the US Dollar hegemony. Going to the source, the rise of the US dollar and British pound, and later the euro currency, from a single country currency to a global or regional currency was supported by their huge gold reserves. 

Individual investment demand is an important component of China’s gold reserve system, we should encourage individual investment demand for gold. Practice shows that gold possession by citizens is an effective supplement to national reserves and is very important to national financial security.

2386Song’s vision is in line with these statements which confirms the strategy of the Communist Party of China to aggressively accumulate official gold reserves and to stimulate individual gold investment in order to strengthen the Chinese economy and protect it from internal and external shocks.

Note, Song is the President of the CGA that for political reasons largely understates Chinese gold demand figures in order to conceal China’s true hunger. Though clearly expressing his point of view in the next article, he could not disclose deviant data regarding CGA demand numbers. Actual Chinese wholesale gold demand in 2013 was 2197 tonnes, as is confirmed numerous times.

Translated by LK, gold investor from Hong Kong.

Gold Will Support Renminbi As It Moves To Join World

By Song Xin, General Manager of the China National Gold Group Corporation, Party Secretary and President of the China Gold Association.

2014 edition 6

For China, the strategic mission of gold lies in the support of RMB internationalization, and so let China become a world economic power and make sure that the “China Dream” is realized. 

Gold is the only thing carrying the dual mantels of a commodity as well as a monetary substance. It’s both a very ‘honest’ asset and forms the very material basis for modern fiat currencies. Historically, gold has played an irreplaceable role in responses to financial crises and wars as it comes to protecting a country’s economic security. Because of this, gold carries with it an honored and divine-given strategic mission in the ascend of the Chinese people and the pursuit of the “China Dream”.

The Important Function Of Gold

Gold is the world’s only monetary asset that has no counter party risk, and is the only cross-nation, cross-language, cross-ethnicity, cross-religion and cross-culture globally recognized monetary asset. Gold is the last protection for a country’s economic security; it safeguards a nations sovereignty in times of crises. A textbook example happened in 1997 during the Asian financial crisis. To work through Korea’s severe debt problem, the IMF’s condition for a rescue package was to sell large enterprises. In the end, the Korean government had no choice but to call on its people to donate gold to settle the foreign debt, and it was only through this act that the chaebols at the center of the country’s economy and independence survived.

From our country’s point of view, gold has played an irreplaceable role in the development of our economic society. In the wars during the Revolution [1921-1937] gold provided strong support in the economic development of the liberated zones and achievements in reforms; in the three years of natural disasters, the nation used gold reserves to obtain information on living and production conditions and took actions to alleviate hardship. At the start of the great Reforms (1980’s), gold boosted our foreign reserve levels and helped the promising private sector and it advanced society. After 1989, we suffered economic sanctions from Western countries for a while and the PBOC used our gold reserves to enter into swap agreements to obtain needed foreign currencies. Right now, gold is still serving its functions to protect against economic risks; contributing in ever more important ways to our financial security. For the moment, although in general the international scene is peaceful, conflicts can develop in certain regions. If there should be a blockade or regional war, there could be only one method of payment left: gold.

The strategic Mission Of Gold

Since the 18th People Congress, general secretary Xi Jinping brought up the goal to revive our nation, to realize the “Chinese dream “. One important part of this dream is to have a strong economy. Though China is already the world’s second largest economy, there is still a long way to go to become an economic powerhouse. The most critical part to this is that we don’t have enough say in matters such as international finance and matters regarding the monetary system, the most obvious of which is the fact that the RMB hasn’t fully internationalized.

Gold is a monetary asset that transcends national sovereignty, is very powerful to settle obligations when everything else fails, hence it’s exactly the basis of a currency moving up in the international arena. When the British Pound and the USD became international currencies, their gold reserve as a share of total world gold reserves was 50% and 60% respectively; when the Euro was introduced, the combined gold reserves of the member countries was more than 10,000 tonnes, more than the US had. If the RMB wants to achieve international status, it must have popular acceptance and a stable value. To this end, other than having assurance from the issuing nation, it is very important to have enough gold as the foundation, raising the ‘gold content’ of the RMB. Therefore, to China, the meaning and mission of gold is to support the RMB to become an internationally accepted currency and make China an economic powerhouse.

In this view, our gold reserves are very low, both in terms of a nominal level as well as a percentage of official reserves. From the nominal level, the total official reserves of gold in the world stands at 30,000 tonnes, of which the USA has been occupying the first place at 8133.5 tonnes – 26 % of the world total. Germany has 3387.1 tonnes and Italy and France both hold more than 2,400 tonnes. Ours is 1054 tonnes at the sixths place – only 3.4% of the world total. As a percentage of a country’s total reserves, US gold reserves amount to 71.7 % and European nations have kept their levels between 40% to 70%. The average of the world is about 10%, but for us it’s only 1%.

That is why, in order for gold to fulfill its destined mission, we must raise our gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.

All-round, Multi-channel Increases In Gold Levels. Fulfill Our Part In Enabling Gold To Accomplish Its Strategic Mission.

How to achieve growth in our gold reserve? Apart from the PBOC directly buying in the open market, we should use also use the following strategies:

1. Relax gold import controls, grant large scale gold enterprises permits to import gold. In 2013, our gold consumption reached 1176.4 tonnes. Compared to the 426 tonnes of local production, there is a shortage of 750 tonnes. To meet this gap, we presently let the 12 commercial banks with gold-trading rights import standard gold ingots. But these banks lack the ability to refine and assay gold, they can only import standardized gold, missing the large amount of non-standardized gold and wasting the international resources that we could reach. By relaxing import controls, the large-scale gold companies can then obtain this gold and use their own technology to refine it into standard quality gold. This can help meet demand in the market, or turn gold into official reserves as required.

2. Establish a gold reserve building fund. This can be seeded using capital from the State Treasury, and open it for participation by private-sector capital in the public. It should be controlled by the State and used to target diverse off-shore gold resources, acquire mines and raw gold and in so doing, extend our reach beyond our borders and add a layer of opaque reserves to otherwise standard reserve numbers.

3. Establish a Gold bank. We need to establish our gold bank as soon as possible, and enable it to break the barrier between the commodity and monetary world. It can further help us acquire reserves and give us more say and control in the gold market. It may be guided under the PBOC and led by the China Gold Association, involving leading gold industry companies and commercial banks, and it’s business would include: gold pricing (fix), gold financing and leasing, gold-guaranteed payments, gold saving accounts, gold lending, gold production chain financing and issuance and trading of paper gold and other gold investments. This gold bank can then naturally use market-oriented methods to change commodity gold into monetary gold reserves, thus help us increase our strategic gold reserves.

Does The PBOC Purchase Gold Through The Shanghai Gold Exchange?

Nope – that’s my answer. It’s my assumption the People’s Bank Of China (PBOC) does not buy any gold through the Shanghai Gold Exchange (SGE), for a number of reasons. In previous posts I’ve speculated about these reasons, here’s a recap; from Koos Jansen (April 15, 2014):

The main objectives for the PBOC to accumulate gold are:

  • Supporting the renminbi for its internationalization (adding trust and credibility)
  • Owning hard currency as the cornerstone of capitalism.
  • Owning reserves that protect the Chinese economy from external/internal shocks and inflation.
  • Owning reserves that are not controlled by a foreign nation (the US).
  • Diversifying its excessively large USD reserves prior to an irrevocable USD devaluation.
  • Hedge their exorbitant USD reserves.

In my opinion the PBOC (or its proxies SAFE and CIC) does not purchase gold from domestic mines or from the SGE. The PBOC’s incentive is to exchange USD’s for gold, preferably buying undervalued gold with overvalued dollars. Hence the PBOC buys in utmost secrecy, not to affect the market.

It wouldn’t make sense for the PBOC to buy gold from domestic mines because they would have to pay in RMB. This wouldn’t fit all their objectives mentioned above. Additionally Chinese law dictates all domestic gold mining output is required to be sold through the SGE (page 15). All physical gold on the SGE is quoted in RMB, so its not likely the PBOC buys gold through the SGE . On top of that I have several sources in the mainland, including a teacher in ‘economics and the gold market’ at the Henan University of Economics and Law in Zhengzhou City, that all tell me the PBOC would never buy gold on the SGE.

My assumptions have just been strengthened as new evidence came out showing the gold sold at the SGE does not end up at the PBOC. At the LBMA Forum in Singapore the chairman of the SGE, Xu Luode, stated Chinese consumer demand hit 2,000 tonnes in 2013, and at another speech he stated 1540 tonnes was net imported that year. This net import figure disclosed by Xu is highly unlikely to include PBOC purchases (PBOC’s gold demand is China’s best kept secret).

Torgny Persson, chief executive officer of BullionStar.com who attended the LBMA Forum in Singapore, wrote me:

In the speech Mr. Xu mentioned and I quote the official translation in the headphones “..as the Chinese consumption demand of gold hit 2,000 tons in 2013.”

My interpretation is that consumption demand is non-government demand and excludes PBOC purchases. Xu came to this number, 2,000 tonnes, because he summed up Chinese net import (1540 tonnes) and domestic mining output (428 tonnes), as he stated in a speech at the Fourth Commercial Bank Gold Investment Forum. The China Gold Network reported

Xu pointed out that the current gold market, especially the physical gold market is actually in the East, mainly in China. Last year China’s own gold-enterprises produced 428 tons; at the same time China imported 1,540 tons of gold, adding up to nearly 2,000 tons.

At the Shanghai Finance Forum Xu mentioned the same numbers, according to the website Xinmin News 365.

SGE withdrawals accounted for 2197 tonnes in 2013, but because 229 tonnes of this was supplied from recycled gold Xu only mentioned the amount of gold that was net added to non-government reserves; net import was 1540 tonnes, plus domestic mining 428 tonnes, is 1968 tonnes. Recycling gold through the SGE doesn’t affect non-government reserves. The Chinese gold market, with the SGE at its core, is designed by the State Council to track the quantity and quality of gold added to Chinese non-government reserves. Through the SGE 1968 tonnes of gold was added to non-government reserves, hence Xu stated “Chinese consumption demand of gold hit 2,000 tonnes in 2013″.

To confirm Xu’s statement at the LBMA Forum in Singapore I called the SGE on monday June 30, 2014. The gentleman I spoke to was Jesse Yang, who had witnessed  Xu’s speech, as well as Torgny Persson. However, Yang didn’t listen to a interpreter on headphones, he could understand Xu’s speech in Chinese. This is a screen shot of the delegate list of the LBMA Forum in Singapore:

Shanghai Gold Exchange and ICBC precious metals department delegates at LBMA Forum Singapore 2104.

Shanghai Gold Exchange and ICBC precious metals department delegates at LBMA Forum Singapore 2104.

Over the phone Mr Yang told me:

What Xu stated was that in 2013 more than 2,000 tonnes was delivered into consumers hands and that could be interpreted as demand.

Again, this relates to non-government demand and these numbers exactly fit the volumes traded at the Shanghai Gold Exchange in 2013. The statements by Xu and Yang reaffirm the PBOC does not purchase any gold through the SGE.

LBMA Forum Singapore: SGE Chairman Confirms Chinese Gold Demand In 2013 Hit 2000 MT

I just received a very interesting email from Torgny Persson, chief executive officer of BullionStar.com, who is attending the LBMA forum in Singapore today.

Dear Koos,

Following up on our brief discussion before, I’ve continued to follow your excellent blog and have some breaking news for you. I’m writing to you from the lunch break at the LBMA forum in Singapore today.

Among the speakers were Xu Luode, Chairman of the Shanghai Gold Exchange, and Zhou Ming, General Manager of the precious metals department for ICBC.

Mr. Xu started his speech by referring to the official figure of demand for the Chinese gold market 1189 tons, as published by WGC, but mentioned twice that the figure for consumption is likely higher. Later in the speech Mr. Xu mentioned and I quote the official translation in the headphones “..as the Chinese consumption demand of gold hit 2000 tons in 2013”. There you have it. The chairman himself said it out straight.

Other key takeaways from the Chairman’s speech:

– The government and the government agencies are strongly supporting the gold market development in China generally and the Shanghai free trade zone specifically.
– There’s a London fix for gold, there should also be a fix in China.
– The free trade zone will open up the Chinese gold market internationally. Settlement will be in RMB but with the possibility to freely exchange to other currencies.

The chairman focused especially on the strategic opening up of the Chinese market internationally and China influencing the international gold market.

Mr. Zhou’s speech was equally interesting.

According to Mr. Zhou, the commercial bank retail volume including sale and repurchasing in China was 500 tons in 2013, up 165 % compared to 2012. Of this ICBC stands for 200 tons. The four largest banks have 80% of the market.

Mr. Zhou also mentioned that the transaction increase for paper gold was up 27 % in 2013 i.e. much less than the physical demand. The volume of the OTC gold derivates market in China in 2013 was 550 tons according to Mr. Zhou and the market for interbank borrowing and leasing was 1300 tons in 2013 up 160% compared to 2012.

ICBC has over the last years restructured their precious metals department with a speciality branch in Shanghai. ICBC has more than 300 dedicated warehouses for gold in 36 provinces and more than 20 million gold clients!

The customers buy for ‘personal use’. It’s rare that anyone sells back.

Mr Zhou also interestingly mentioned that ICBC “can not meet the demand of the market” and that we will see “the price of derivatives delinking from the (physical) spot price”. He said that fluctuations will affect the pricing system in gold but that the market will retreat to the fundamental analysis of gold supply and demand to rebuild the current market structure (my comment: obviously hinting that the physical Chinese market will take over the current derivative markets flawed price setting mechanism). He was talking about the shift of trading distribution and price transmission mechanism in the light of this.

To summarize, I was stunned about the frank and straightforward remarks by both of the above gentlemen and just wanted to share with you as I know many in the industry including big media is reading your blog.

See attached pictures of Mr. Xu and Mr. Zhou from the LBMA forum one hour ago.

Kind Regards

Torgny

LBMA Singapore 2014 Xu Luode
LBMA Singapore 2014 Xu Luode
LBMA Singapore 2014 Zhou Ming
LBMA Singapore 2014 Zhou Ming

SGE Chairman: China Should Become First Class International Gold Market

Below is the full translation of a Chinese article I’ve used in a previous post on the Shanghai Gold Exchange international board. The article is about a speech from SGE chairman Xu Luodo at the Fourth Commercial Bank Gold Investment Forum where he spoke about the SGE international board.

It’s a must read because Xu clearly states he is developing the SGE from a domestic to an international gold exchange for China to have a stronger voice in gold pricing – and stimulate the internationalization of the renminbi. Xu Luode has long been engaged in the practice of financial reform and development, he has a wealth of experience and deep theoretical knowledge. A short biography:

1983, Xu Luode graduated in economics at the Hunan University (the oldest institution in Chinese history, founded in 976 AD).

1983 to 1996, Xu worked at the China Banknote Printing and Minting Corporation, that carries out the minting of all renminbi coins and printing of renminbi banknotes for the People’s Republic of China.

1996 to 2003, Xu served as general director at the People’s Bank of China (PBOC).

2003 to 2007, Xu served at the People’s Bank of China Payment and Settlement Division.

2007 to 2013, Xu was president of China UnionPay, a bankcard association established under the approval of the State Council and the People’s Bank of China, where he gained experience to internationalize a Chinese financial institution. China UnionPay is one of the world leaders in payment services, reaching 3.5 billion people in over 30 countries.

October 2013, Xu was appointed as the chairman of the SGE and vice president of the China Gold Association. In December 2013 he announced the SGE international board.

According to this article Xu also currently holds a position at the China Society For Finance And Banking, China Numismatic Society and the Payment And Clearing Association of China.

Very important about this translation is the part where Xu points out that in 2013 Chinese mines produced 428 tonnes of gold and China net imported 1540 tonnes, adding up to nearly 2000 tonnes. This is exactly in line with the amount of total supply (/demand) at the SGE that year: 2197 tonnes. The 229 tonnes gap has been filled by scrap supply. With this statement Xu confirms that SGE withdrawals equal wholesale demand. (read this for a full analysis of the Chinese gold market)

Dai op SGE
December 2013. Left: Dai Xianglong, PBOC governor from 1995 until 2002, the man who initiated the reform of the Chinese gold market during the tenth five year plan. Right: Xu Luode, SGE chairman.

Translated by Soh Tiong Hum:

Xu Luode: China Should Become First Class International Gold Market

2014/5/16

Author: Lilin Xu | Source: China Gold Network

May 15 , Speaking at the “Fourth Commercial Bank Gold Investment Forum” in Hangzhou, Xu Luode, Chairman of the Shanghai Gold Exchange said the Chinese gold market is an important force, a positive energy in the international gold market but its influence does not correspond to its mass and scale. Therefore to accelerate the development of China’s gold market, he proposed building China’s “Shanghai Gold”.

Commenting on China’s voice in the international gold market, Xu Luode said that the right to price gold now lies in the West, namely New York and London. New York prices gold through bidding whereas gold price is fixed by five banks in London. However the London gold fixing price is now being questioned since these five banks are price-fixers while at the same time they are also the market’s most important participants.

Xu pointed out that the current gold market, especially the physical gold market is actually in the East, mainly in China. Last year China’s own gold-enterprises produced 428 tons; at the same time China imported 1,540 tons of gold, adding up to nearly 2,000 tons. China’s import volume is significant but China’s influence in the gold price is very small. Although influence was visible last year, real influence still lies in the West. Data such as Non-farm payroll, even a speech could impact the gold market in a big way. In this sense, the mass and scale of China’s gold market and its voice and influence in the international gold market do not match, so it should speed up the development of China’s gold market.

Xu pointed out that the development of China’s gold market should not be limited to an increase in scale, it also needs market development, product improvement, system development and risk prevention. Marketing, pricing mechanisms and international standards are all very important building blocks so every aspect of China’s gold market should join forces to speed up development.

Touching on the Shanghai Gold Exchange, Xu said the exchange has nearly 8,000 institutional investors and nearly 5 million individual investors.

As for Shanghai Gold Exchange’s future direction and potential, Xu said that there should be more and more investors to participate in the Shanghai Gold Exchange platform. Along with China’s economic development and growing personal wealth, the rising middle class wants to invest in capital markets, make financial investments, attend to wealth planning and also want to invest in the gold market. This is a judgment based on the general trend. Therefore the Shanghai Gold Exchange must grow to accommodate more domestic investors participating in the gold market, for example growing from the current 5 million investors to 6 million, 7 million, 8 million or even more. Key issues are marketing, sales, sufficient investor education and plentiful products.

Xu suggested that a platform such as the Shanghai Gold Exchange should be internationalized. Compared to international exchanges, the number of domestic exchanges is relatively few so the emergence of the Shanghai Gold Exchange was well received from all quarters; approved by the regulatory body, supported by the industry and acknowledged by society.

Xu said the Shanghai Gold Exchange is actively preparing for internationalization this year. Of course, the specific meaning of internationalization is to allow overseas investors to invest through the Shanghai Gold Exchange platform and to trade gold quoted in RMB.

Xu said that other currencies can be used as margin for transactions. Shanghai Gold Exchange will become an international platform with global investors. This will raise the standard of product assortment, ability to prevent risk, information technology and support market promotion and regulation.

Xu believes that China’s gold market should be the first class in the international gold market. China is fully qualified and may become the world gold market’s most important player.

When talking about the Shanghai Gold Exchange international board, Xu said that early interaction is very good with very good momentum. Many commercial banks, industrial enterprises and investment institutions all expressed interest in the international board.

The World Gold Council’s New Clothes

On this blog I’ve repeatedly questioned the Chinese gold demand figures from the World Gold Council, or “the global authority on gold” as they call themselves (which is weird when you think about it, how can any institution be the global authority on gold?). In 2013 Chinese wholesale gold demand was 2197 tonnes, though the World Gold Council claims demand was 1066 tonnes. All their arguments that should explain the difference appeared to have been untenable after researching them.

Most people on this planet who have an interest in gold simply copy the demand numbers from the WGC. The consequences of the world being misinformed on this subject is hard to comprehend.

The World Gold Council, who we are

It’s my belief the WGC continues to spread erroneous information, therefor I will continue to share where I disagree. Let’s begin with what happened in the first quarter of this year. In the WGC’s quarterly report covering Q1 2014 they state Chinese gold demand was 278.1 metric tonnes. However, in Q1 Hong Kong net exported 287.2 tonnes to the mainland and Switzerland 74.9 tonnes, on top of this Chinese domestic mining was 96.5 tonnes. This adds up to 458.6 tonnes. Domestic mining and net import from only two countries was 458.6 tonnes, yet demand as disclosed by the WGC was only 278.1 tonnes. Again there is a disparity (of at least 180.5 tonnes).

The way how I measure Chinese (wholesale) demand is by looking at Shanghai Gold Exchange (SGE) withdrawals. Because in China all imported and mined gold is required to be sold through the SGE first and the bars that leave the SGE vaults are not allowed to return to these vaults, SGE withdrawals equal Chinese wholesale demand (and thus; total supply equals SGE withdrawals equals total demand). In Q1 2014 withdrawals accounted for 564.2 tonnes, which means 105.6 tonnes (564.2  minus 458.6 ) was supplied by additional import and scrap. From this end the numbers always make sense.

Back to the WGC. In their Gold Demand Trends Q1 2014, they come up with several arguments that should validate their figures on Chinese gold demand. Confirming they have some explaining to do on the discrepancy between the huge amount of apparent supply and their demand figures, just like in their prior report China’s Gold Market: Progress and Prospects (published April 15, 2014). However, the more arguments they present the more contradiction, confusion and misinformation is being communicated. I’ll go through all the arguments the WGC presents in both reports and share my point of view, as concise as I can.

Gold Trade Flows

From page 14, Gold Demand Trends Q1 2014:

Trade flows: illustrated last year when gold flowed out of western ETFs, through refineries in Switzerland and to consumers in the East, official trade data can provide insights into global gold flows. Global Trade International Services provide access to a wide range of countries’ trade data and we also monitor individual countries’ trade data, particularly from the Hong Kong Census and Statistics Department. However, looking purely at trade data can be misleading. It can include scrap, doré and concentrates, which would be captured in supply rather than demand. Nuances such as ‘round-tripping’ can affect the data too. So, while trade data plays a valued role in informing a view on global gold flows, it is an imperfect measure of gold demand.

Sure, trade data can be misleading, but it helps if we look at right numbers. The Hong Kong Census and Statistics Department makes a clear distinction between scrap and gold in other forms. They categorize commodities according to SITC Rev. 4 (Standard International Trade Classification, Rev. 4). The 287.2 tonnes Hong Kong net exported to the mainland in Q1 2014 did not contain scrap.

SITC 97103 gold scrap
SITC code and description for gold scrap
97101 SITC
SITC code and description for gold

Is it possible net gold export from Hong Kong to the mainland contains doré and concentrates? It’s possible, but it can’t explain the difference we’re after. The WGC stated in China’s Gold Market: Progress and Prospects, on page 49:

Only banks with PBOC-issued import licenses can import gold. They can only import LBMA good delivery bars and these must be traded through the SGE.

This statement is incorrect, it should be: “Only banks with PBOC-issued import licenses can import gold. They can import gold bars made by LBMA-approved refiners that meet SGE specifications and these bars must be traded first through the SGE”. Gold bar import into China is conducted by 12 commercial banks that hold a PBOC license, though anew approval has to be granted for every shipment. The general manager of Malca-Amit Precious Metals, a global gold vaulting and transportation company that has many bullion bank clients, said the following in November 2013 (1:40):

Currently gold being transported to China is imported only by local banks. A lot of the times the gold is being parked out of China, and only transported and shipped into China when needed.

Gold bullion is being parked into Hong Kong. After the banks get approval from the PBOC it’s imported into the mainland. Most of the 400 ounce London Good Delivery bars that since 2013 were exported from the UK to Switzerland, where it was remelted into 1 Kg 9999 barswere at first shipped to and parked in Hong Kong before entering the mainland. Hong Kong serving as a depot. Hence my supposition Hong Kong primarily exports gold bars to the mainland. I can’t think of a reason why doré and concentrates, from Chinese owned overseas mines, would be imported into the mainland via Hong Kong.

The gold Switzerland net exported to the mainland in Q1 2014 is even less likely to be doré or concentrates. Switzerland is well known for its refining capacity, not for its gold mines. Everything that comes out of Switzerland is bullion. The Swiss categorize commodities according to HS 2007 (Harmonized System, click to compare HS to SITC), which is more specific than SITC. We can read from their trade reports the gold does not contain powder. In general gold bullion is traded under HS code 7108 globally.

Swiss gold trade Q1 2014
Screen shot from Swiss precious metals trade excel sheet Q1 2014

The WGC also mentions round ripping as a cause that distorts trade numbers, which should explain the difference we’re after. This is false, I’ve written two extensive posts (#1, #2) on why round tripping has got nothing to do with the Chinese domestic gold market, Chinese gold demand or SGE withdrawals.

In China’s Gold Market: Progress and Prospects, page 56, the WGC wrote:

Moreover, because nearly all gold flowing into China goes through the SGE, round-tripping can inflate the SGE delivery figures.

 

This is simply not true, please read my previous posts on this subject. The WGC even admitted round tripping has got nothing to do with Chinese demand in email correspondence.

In the Gold Demand Trends report they stated on page 14:

At a country level, we monitor figures released by official institutions and trade bodies which can give an insight into local gold demand. For example, we examine the Shanghai Gold Exchange withdrawal figures and China Gold Association demand figures…

The WGC mentions SGE deliveries and withdrawals in two separate reports. (i) I hope they know the difference. (ii) If they watch SGE withdrawals why not publish these numbers and inform the world on the significance of these numbers. This is essential information regarding the Chinese gold market. Why is the WGC reluctant to cover these essentials?  

Gold Stock Changes

From the WGC, Gold Demand Trends, page 14:

The number denoted as OTC investment and stock flows encompasses a number of elements, including: gold deposit accounts; stock changes that have yet to be identified; transactions in the relatively opaque OTC market; spot and forward products; as well as any statistical residual.

Chinese spot and froward products are traded in the Chinese domestic gold market. It doesn’t make the amount of supply any less. Stock increases could absorb some supply that doesn’t meet retail demand. However, the accumulative difference between wholesale and retail demand (2007 – 2013) was 2000 tonnes. Why would any jeweler or the mint add anymore stock in Q1 2014 when supposedly they already have this much in stock? And why doesn’t the WGC count gold purchased by an individual investor through a gold deposit account as demand. These are popular investment products in China. Just have a look on the website of China’s largest bank ICBC.

SGE withdrawals vs WGC Chinese gold demnad

PBOC Gold Purchases

In China’s Gold Market: Progress and Prospects the WGC speculates apparent supply (net import, domestic mining) may have been purchased by the PBOC. According to my analysis “all net import we can see” is not being bought by the PBOC. The trade reports from the Hong Kong customs (and the UK and Switzerland) are very clear in describing the gold that is being exported as NON-MONETARY. The PBOC has a strong incentive hiding their purchases, that is not to affect the market. Why would the PBOC insist their purchases to be declared by any customs department around the world while they can easily import gold without anyone seeing it?

Chinese law dictates domestically mined gold is required to be sold first through the SGE, where all gold is quoted in renminbi. I don’t think the PBOC does gold purchases on the SGE while it can exchange their surplus US dollars overseas for gold, killing two birds with one stone; getting rid of some of their exorbitant US dollars reserves and purchase physical gold for all the obvious reasons.

The chairman of the SGE, Xu Luodo, said on May 15, 2014, at the Fourth Commercial Bank Gold Investment Forum, that China net imported 1540 tonnes in 2013 and his exchange has nearly 8000 institutional investors and 5 million individual investors. Institutional investors can include pension funds and alike, this explains very well where all the SGE withdrawals end up and the difference we’re after. I haven’t come across any Western mainstream media outlet that reported on these statements from Xu, though numerous Chinese media have covered it, to date you can only read it in English on this blog.

Shanghai Gold Exchange International Board Another Blow To US Dollar

As we can see power shifting from West to East on a daily basis at the current time of writing, in the fourth quarter of this year the Shanghai Gold Exchange (SGE) will launch an international board in the Shanghai Free Trade Zone (FTZ) for investors worldwide to trade gold spot contracts denominated in renminbi. The purpose being is becoming not only the world’s primary physical gold market but also increase pricing power and internationalize the renminbi.

Shortlist of recent developments regarding the rising powers in the East:

Russia’s central bank bought 28 metric tonnes of gold in April

Russia set up a Euarsian Economic union with Belarus and Kazakhstan

Russia dumps record amounts of US treasuries

Russia closes an energy deal with China worth $400 billion (amongst 40 other business contracts)

Putin says Russia and China need to secure their gold and currency reserves

China openly calls for de-Americanization of the world

China, Russia, Iran and 21 other countries bolster cooperation to promote peace, security and stability in Asia

China is buying assets all over the globe and investing in infrastructure in Africa and West Asia

China is importing unprecedented amounts of physical gold

The SGE international board will be another blow to the US dollar hegemony, as more people around the world will hold renminbi, use the renminbi for trading gold and China wil have more power in pricing gold, though the international board’s pricing power can only be wholly exploited when the renminbi is fully convertible.

A Provisional Introduction To The Shanghai Gold Exchange International Board

Currently I don’t have any official documentation on the launch of the SGE international board, but by reading media (one, two) and from a source in the mainland, this is what I understand of it at this point: China’s central bank, the Peoples Bank Of China, has given approval to the SGE to set up a subsidiary company called the Shanghai International Gold Trading Center to operate the international board. The SGE is currently working on member recruiting, including commercial banks, gold producing companies and investment funds. Allegedly HSBC, ANZ, Standard Bank, Standard Chartered and Bank of Nova Scotia are to take part in the global trading platform.

Imported gold into the FTZ can be deposited in a brand new 1000 tonnes vault, after contracts are settled the gold can be delivered in this vault and withdrawn to be re-exported. Shanghai to become an international warehouse center. At first only spot contracts will be traded on the SGE international board, down the line derivatives will be launched. From Chinese state TV network CCTV:

The Shanghai FTZ can be considered as a Customs Specially Supervised Area, which I have written about extensively on these pages. Gold imported into the FTZ is not allowed to enter the Chinese marketplace without a PBOC permit. A Chinese trader in the mainland can not sell its physical gold to an international trader, for which it would be exported out of the mainland. To export gold out of the mainland there is a PBOC permit required. From what I’ve read, The structure of the Chinese domestic physical gold market will remain in tact after the launch of the SGE international board. Source

A free trade zone (FTZ), also called foreign-trade zone, formerly free port is an area within which goods may be landed, handled, manufactured or reconfigured, and re-exported without the intervention of the customs authorities. Only when the goods are moved to consumers within the country in which the zone is located do they become subject to the prevailing customs duties.

 

SGE Chairman to Lead The Way

The chairman of the SGE is Xu Luode, who is former President of China Unionpay, a bankcard association established under the approval of the State Council and the People’s Bank of China. Xu already gained experience at Unionpay to lead a financial institution overseas. In 2010 Xu delivered a speech on how Chinese financial institutions can go global at the Lujiazui Forum, an important Chinese forum for policy makers on the rapid expansion of China’s financial market and China’s growing influence on the global economy. Now Xu will use his experience to open up the SGE to the world. From China Unionpay in 2010:

On June 26, Xu Luode, President of China Unionpay, was invited to attend the “Lujiazui Forum 2010,” …President Xu Luode delivered a speech on How Chinese Financial Institutions Can Go Global during the Post-crisis Era. New changes in the international economic pattern, especially the financial pattern, provided significant opportunities for Chinese financial institutions to go global, while the challenges were also formidable. Chinese institutions need strategy and holistic knowledge to promote globalization strategy prudently and steadily and successfully grow to be international corporations, expressed President Xu Luode in his speech.

President Xu Luode emphasized in his speech that the internationalization of an enterprise was not only the business behaviour of the enterprise itself, but should be also closely linked with national strategy and strategies of relevant enterprises. Since 2004, CUP’s internationalization has closely coordinated with the “reaching out” strategy of the country, and at the same time cooperates and interacts with the expanding of Chinese financial institutions and the internationalization of the Chinese Renminbi, thus achieving relatively rapid development.

Was Xu appointed as SGE chairman in October 2013 to launch the SGE international board? Who knows

Heraeus Precious Metals Sales Director Kevin Crisp visits SGE Chairman Xu Luode, 2014
One of the largest gold refineries Heraeus Precious Metals’ sales director Kevin Crisp visits SGE Chairman Xu Luode, February 18, 2014

On may 15, 2014, Xu attended the fourth Commercial Bank Gold Investment Forum in Hangzhou. Based on three sources mentioned above (translated by Soh Tiong Hum) he made the following statements:

The Chinese gold market is an important force, a positive energy in the international gold market but its influence does not correspond to its mass and scale. Last year China’s domestic gold mines produced 428 tonnes; at the same time China imported 1540 tonnes of gold, adding up to nearly 2000 tonnes. China’s import volume is significant but China’s influence on the price of gold is very small. Real influence still lies in the West. Data such as Non-farm payroll, or even a speech could impact the gold market in a big way. In this sense, the mass and scale of China’s gold market and its influence in the international gold market does not match. Through the SGE international board Chinese pricing power will increase.

Foreign investors can directly use offshore yuan to trade gold on the SGE international board, which is promoting the internationalization of the renminbi. The international board will form a yuan-denominated gold price index system named “Shanghai Gold”. Shanghai Gold will change the current gold market “consumption in the East priced in the West” situation. When China will have a right to speak in the international gold market, pricing will get revealed. New York prices gold through bidding whereas the gold price is fixed by five banks in London. However the London gold fixing price is now being questioned since these five banks are price-fixers while at the same time they are also the market’s most important participants.

The development of China’s gold market is not limited to an increase in scale but a series of moves including market development, product improvement, system development and risk prevention. Marketing, pricing mechanisms and international standards are all very important building blocks so every aspect of China’s gold market should join forces to speed up development.

The Shanghai Gold Exchange has nearly 8,000 institutional investors and nearly 5 million individual investors.

The International board will be a platform with global investors. This will raise the standard of product assortment, ability to prevent risk, information technology and support, market promotion and regulation. China is fully qualified and may become the world gold market’s very important first class player.

Regional commercial banks should seize the trends and opportunities in the development of China’s gold market, and become actively involved in the market.

As you may remember Malca-Amit opened a 2000 tonnes gold vault, their biggest vault on the planet, in the Shanghai Free Trade Zone in November 2013. Of course they knew Shanghai was to become to center of the global gold market (why else build such a big vault?). I think Malca-Amit has a lot of market intelligence as many bullion banks and other market participants are their clients. If a part of the Malca-Amit vault in Shanghai is designated to the SGE I don’t know at this moment. The following video is from November 2013:

Though we’ll have to wait for the details on how the SGE international board will exactly operate in a few months, it’s influence on the global gold market will be significant and this will further deteriorate the status of the US dollar hegemony.

SGE foreign exchange gold system

Mainstream Media Exaggerated Chinese Commodity Financing Deals

In the beginning of May I wrote an extensive post on why round tripping, also referred to as a Chinese Commodity Financing Deal, does not influence the amount of gold withdrawn from the vaults of the Shanghai Gold Exchange, which equals Chinese wholesale demand. Round tripping merely inflates the import and export of gold between a Customs Specially Supervised Area in the mainland, usually Shenzhen, and foreign countries, usually Hong Kong.

What I didn’t cover in that post was the amount of physical gold tied up in round tripping. Though this does not have anything to do with domestic Chinese gold demand, it can be important because when these financing deals are unwound the gold is released as physical supply. So how much gold is there tied up in round tripping? In the latest report on the Chinese gold market from the World Gold Council, China’s Gold Market: Progress and Prospectswe can read:

Imported commodities are used in China for financing purposes – most notably copper but also, increasingly, gold. Restrictions on finance and lending have boosted this market.

…No statistics are available on the outstanding amount of gold tied up in financial operations linked to shadow banking, but Precious Metals Insights believes it is feasible that by the end of 2013 this could have reached a cumulative 1,000 tonnes, equal to a nominal value of nearly $40 billion.

In this context the WGC used the term financial operations with regard to round tripping and not another type of commodity financing deal. But did they mean 1000 tonnes of physical gold is tied up in round tripping, or a much smaller amount that cumulative inflated trade numbers by 1000 tonnes – over a few years? I’ve sent an email to the World Gold Council (WGC) and got a very clear answer.

In their reply they stated the amount of physical gold tied up in round tripping is far less than 1000 tonnes and that in theory it can’t be more than gross export from China mainland to Hong Kong. This was 337 tonnes in 2013. However, these exports definitely contain jewelry fabricated in Shenzhen to be sold in Hong Kong or other nations; genuine processing trade. Also, the gold tied up in round tripping is likely to make more than one round. If so, every round would make the Hong Kong Census and Statistics Department count the same gold as additional import. For example, if 50 tonnes is round tripped three times, that would show up as 150 tonnes of gross export from the mainland to Hong kong. Though I don’t know either how much gold is tied up in round tripping, I think the amount is far less significant than what mainstream media have presented. Just guessing 20 – 100 tonnes.

To my surprise the WGC added in their email that the amount of gold tied up in round tripping should not be conflated with Chinese demand, as it merely inflates trade statistics. Although I agree, this is contradictory with what they wrote in their report:

…This is the practice commonly referred to as ‘round-tripping’. Moreover, because nearly all gold flowing into China goes through the SGE, round-tripping can inflate the SGE delivery figures. 

As I’ve explained in my prior post, SGE deliveries (or withdrawals they should say) can only be supplied by gold that is imported by one of the twelve commercial banks that have a PBOC import license for general trade. These banks are not engaged in round tripping, which only occurs in processing trade for which no PBOC license is required. SGE withdrawals, that supply the Chinese domestic gold market, are therefor not influenced by round tripping, and neither is Chinese demand.

Chinese gold trade laws

When I was doing research for this post I was quite shocked when I read the articles from Reuters and the Financial Times regarding round tripping again. Reuters stated Chinese firms could have locked up as much as 1,000 tonnes of gold in financing deals“, Izabella Kaminski from the Financial Times seemed happy to go with this number:

China Gold Collateral Financing Shock

This Reuters story about China having up to 1,000 tonnes of gold tied up in financing deals is doing the rounds, courtesy of information out of the WGC.

But it’s hardly a revelation.

We’ve known that China has been using gold (and almost everything else under the sun) for financing purposes for ages.

 Goldman even blessed us with a more recent update about the shenanigans in March…

…A key consequence of such an unwinding could be a commodity shock.

…this is why we’ve always been sceptical of those using rampant Chinese consumption of gold as an indication of an imminent rebound in the gold price.

Many people have been mislead about this subject as the WGC has published incomplete and contradictory information and the major news outlets have misinterpreted the WGC.

The Round Tripping Myth And Why It Doesn’t Hurt Chinese Gold Demand

Much has been written lately about the influence of Chinese commodity financing deals (CCFD) on Chinese gold demand. An often perceived analysis is that CCFD have been inflating Chinese demand/import figures and thus balance the surplus of physical gold supply in China.

In 2013 the mainland net imported 1,158 metric tonnes through Hong Kong – the Chinese do not disclose total net gold import – and domestic mining output was 428 tonnes. Without counting scrap supply and net gold import through other ports than Hong Kong, total supply was 1,581 tonnes (according to me total supply was 2,197 tonnes, as Shanghai Gold Exchange withdrawals equal total supply and demand, more on that later). Most institutions, like the World Gold Council (WGC), the China Gold Association (CGA), and GFMS state Chinese demand was lower than 1,581 tonnes in 2013, forcing themselves to explain where the rest of the supply ended up. I disagree with their explanations that are often based on CCFD. CCFD can be either done through round tripping or gold leasing. This post is solely on round tripping.

Many reports I read on CCFD simply don’t take into account Chinese laws on gold trade and the structure of the Chinese gold market. These are a few of the pieces I stumbled upon regarding this matter, from:

Goldman Sachs
Zero Hedge
Monetary Metals
The World Gold Council
Reuters
FT Alphaville

What are Chinese commodity financing deals?

Simply put Chinese commodity financing deals are trades to acquire low cost capital using a commodity as collateral. There can be many ways to do this, but for now we will focus on round tripping as I would like to demonstrate this does not influence Chinese net gold import or demand. Let’s walk through the reports linked to above and get an understanding of such deals with regard to gold in comparison to other commodities. Goldman Sachs stated a few important facts:

While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:

– the volume of physical inventories that is involved

– commodity prices

– the number of circulations

Our understanding is that the commodities that are involved in the financing deals include gold, copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil and rubber.

…Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China, so it is not shown in trade data published by China customs. In detail, Chinese gold financing deals includes four steps:

1. Onshore gold manufacturers pay LCs to offshore subsidiaries and import gold from Hong Kong to mainland China – inflating import numbers

2. offshore subsidiaries borrow USD from offshore banks via collaterizing LCs received

3. onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products – inflating export numbers

4. repeat step 1-3

Making a clear distinction between gold and copper round tripping is very important. Though Goldman Sachs mentions the difference – gold needs to be physically round tripped, copper not – they desist to explain what’s causing this difference. The reason is that the trade laws for gold are different than for every other commodity (because the Chinese government has chosen gold to be a part of China’s economic backbone and likes to have firm grip on this metal). A quote from myself from a post I wrote a few weeks ago:

A very long and complicated story short: In the mainland there are two types of trade; general trade and processing trade. General trade can be considered as normal trade. If gold is imported in general trade this is required to be sold through the Shanghai Gold Exchange. Only 12 banks have general trade licenses for gold from the PBOC (though for every shipment they need anew approval).

1. Industrial and Commercial Bank of China
2. Shenzhen Development Bank / Ping An Bank
3. Agricultural Bank of China
4. China Construction Bank
5. Bank of Communications
6. China Minsheng Bank
7. Bank of Shanghai
8. Industrial Bank
9. Bank of China
10. Everbright
11. HSBC
12. ANZ

It’s not likely the PBOC would approve bullion gold to be exported in general trade.

Additionally there are a few jewelry companies that have PBOC licenses, but these also have to ask for permission for every trade they conduct. The PBOC has a very firm grip on gold trade.

Processing trade is something else. In this trade form raw materials from abroad are imported, processed into products and then these products are required to be exported again. This processing is usually done (there can be exceptions) in Customs Specially Supervised Areas, or CSSA (or Free Trade Zones). Processing trade doesn’t require a permit from the PBOC, as the gold that is imported will be exported after being processed. To export gold from a CSSA to a non-CSSA (that’s the rest of the mainland) a PBOC license is required.

Pocessing trade

An example for a processing trade would be; gold from Hong Kong is exported to Shenzhen (a CSSA just across the border from Hong Kong and well known for its vast jewelry fabrication industry; 4000 manufacturers), then the gold is fabricated into jewelry and imported back into Hong Kong. This trade would show up in Hong Kong’s customs report, but it would not affect Hong Kong net export to the mainland.

Chinese gold trade laws
The rest of the world can trade in the same manner with China mainland as Hong Kong.

Copper trade in China is also done through general or processing trade, the difference being that for copper general trade there is no PBOC license required and imported copper is not required to be sold through the Shanghai Gold Exchange (SGE), or any other exchange. This explains the difference in copper and gold round tripping.

Now let’s jump to what the World Gold Council had to say in it’s latest report China gold market progress and prospects on round tripping. In my opinion they made some conflicting statements, not only regarding CCFD:

Imported gold is being used via gold loans and letters of credit to raise low cost funds for business investment and speculation.

Most of this has been built up since 2011, when gold has been increasingly used as the basis for a variety of financial operations [CCFD] in China that have required the importation of very large quantities of physical bullion. … , there is the use of gold for financial arbitrage operations that will also be based upon gold loans or LCs. In most cases the gold is quickly re-exported to Hong Kong, often as very crude jewellery or ornaments to get round tight controls on bullion exports. (This is the practise commonly referred to as ‘round-tripping’. Moreover, because nearly all gold flowing into China goes through the SGE, round-tripping can inflate the SGE delivery figures.)

In theory only jewellery manufacturers or others active in the gold trade can take out gold loans, although it appears that the rules can be circumvented either by setting up a ‘gold enterprise’ or by using the services of an existing company in the gold trade. …

Gold loans or LCs used to import gold therefore offer wealthy individuals and companies a form of cheap short-term financing either for business or speculation.

The WGC is correct when it states the CCFD are conducted by gold enterprises (and wealthy individuals). These are allowed in processing trade to import gold (in a CSSA), later to be exported. But then they claim this round tripping inflates SGE deliveries, which is false!

First of all the term they should use is SGE withdrawals, that is the amount of gold leaving the SGE vaults entering the Chinese market place, whereas deliveries merely relate to the settlement between longs and shorts after a trading day, that is the amount of physical gold changing ownership in the SGE vaults. Second, although they got the term wrong it’s quite remarkable they don’t spent any more attention to SGE withdrawals; they don’t even disclose withdrawal numbers. How can it be it’s common knowledge in China what the significance is of SGE withdrawals, yet the WGC refrains from discussing this topic? Last but not least, only the 12 banks mentioned above can import gold in general trade, which is required to be sold through the SGE (supply) and subsequently can influence withdrawal numbers (demand). These banks are not involved in round tripping, they don’t need round tripping because they have direct access to the cheapest funding in the world. Gold enterprises are not involved in SGE withdrawals, as gold enterprises can only import gold in processing trade that doesn’t flow through the SGE.

For me there was also some great information in the WGC report, but when it comes to supply and demand I found numerous errors. One other example:

Only banks with PBOC-issued import licenses can import gold. They can only import LBMA good delivery bars and these must be traded through the SGE.

This is true except for the part that they can only import LBMA good delivery bars. The specifications for LBMA good delivery bars is that the weight must be in between 10.9 and 13.4 Kg, while PBOC license holders have imported at least 1,100 metric tonnes in 1 Kg bars in 2013. The correct statement should be: Only banks with PBOC-issued import licenses can import gold. They can import gold bars made by LBMA-approved refiners that meet SGE specifications and these bars must be traded through the SGE”.

Next, GFMS:

Looking at demand by country China tops the list for the first time (based on our data series) as Indian consumption struggled under the government’s import restrictions, higher taxes, a weak rupee and subsequent high domestic premium. Indeed, China consumed 1,283 tonnes of gold in 2013, 28.2% of global physical demand and substantially higher than India at 987 tonnes and 21.7% of global demand. Chinese imports of gold, and deliveries from the Shanghai Gold Exchange (SGE) were also considerably higher than this owing to growth in pipeline stock, increased holdings by commercial banks to back paper products (a legal requirement in China) and some double counting of gold that was involved in round-tripping to Hong Kong ….

Also GFMS briefly mentions SGE deliveries (withdrawals) and acknowledges physical supply transcended demand, which they inter alia explain by “double counting of gold that was involved in round-tripping to Hong Kong”. Though, round tripping has no effect on Chinese net gold import (read the Goldman Sachs quote above) or SGE Withdrawals. Round tripping is only done by Chinese gold enterprises that import gold into a CSSA and soon after export the gold.

The problem these institutions (WGC, GFMS, etc.) have is this:

SGE withdrawals vs WGC Chinese gold demnad

There has been so much gold flowing into the mainland since 2007 of which they don’t know were it ended up (the accumulative difference 2007-2013 was 1,989 metric tonnes in total).

When I called the SGE a few months ago to ask where the difference as shown in the chart above was going, they told me these are withdrawals from individual SGE account holders. If these individuals are secretly jewelers trying to avoid VAT rules or institutional buyers I don’t know. I do know these 1,989 metric tonnes haven’t been used for stock increases at jewelers or banks. In 2012 the accumulative difference accounted for 983 tonnes. With so much gold “in stock” why would they add another 1051 tonnes in 2013?

Another argument by GFMS is that, “holdings increased by commercial banks to back paper products (a legal requirement in China)”. Ok, so that has got nothing to do with demand? That gold is just brought into a vault, laying there soon to be obsolete? No, they’re referring to Chinese buying gold on paper that oddly enough has to backed by physical gold in China – I know, it’s unbelievable. According to me all arguments GFMS presents to explain the large amount of SGE withdrawals, of which they refuse to disclose the numbers, are untenable.    

Reuters disclosed a very important quote in their article:

“I do not think there is large scale gold trade-financing deals like in copper,” said Jiang Shu, an analyst with Industrial Bank, one of the few gold-importing banks in China. Import quotas and a limited number of banks allowed to import meant gold would not be a popular choice for commodity financing deals, he added.

This gentleman can know because he works at one of the banks that is allowed to import gold in general trade and it’s very likely he knows a thing or two about the Chinese gold market.

From Goldman Sachs:

…However, we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.

Yes, the number of circulations can be in between 1 and X. But, for sure these circulations do not influence Chinese net gold import or SGE withdrawals.

SGE Withdrawals Equal Chinese Gold Demand, Part 3

On April 4, 2014 Alasdair Macleod published an extensive analysis on the Chinese gold market. I felt obligated to respond to it by sharing my point of view and explain where I disagree with his analysis. I think his estimates are largely overstated because he double counts certain demand categories. He states Chinese gold demand in 2013 was 4843 metric tonnes, according to me it was 2197 metric tonnes (my estimate excludes some hidden demand and PBOC purchases on which I have no hard numbers). Setting out our differences was incidentally a good occasion for me to write another in-depth analysis on the Chinese gold market.

I highly respect Macleod, who was probably working in finance when I was in diapers, and I’m very grateful he has been using my findings about SGE withdrawals and the structure of the Chinese gold market. I see very little commentators stepping into this realm, though it’s truly the most important economic event happening in our time. Having said that, my concern is the accuracy of the data being spread. I present my analysis:

For all clarity please note I make a clear distinction between deliveries and withdrawals since a couple of months, as they do not relate to the same data. The SGE uses the term deliveries inconsistently which has caused for confusion.

Let’s go through the aspects of the Chinese gold market in random order; PBOC demand, the SGE, domestic mining, mainland net import and Hong Kong trade.

PBOC Gold Purchases

Macleod states all Chinese domestic mine supply is soaked up by the PBOC, according to my analysis this is not likely to be the case.

The main objectives for the PBOC to accumulate gold are:

– Supporting the renminbi for its internationalization (adding trust and credibility)

– Owning hard currency as the cornerstone of capitalism.

– Owning reserves that protect the Chinese economy from external/internal shocks and inflation.

– Owning reserves that are not controlled by a foreign nation (the US).

– Diversifying its excessively large USD reserves prior to an irrevocable USD devaluation.

– Hedge their exorbitant USD reserves.

In my opinion the PBOC (or its proxies SAFE and CIC) does not purchase gold from domestic mines or from the SGE. The PBOC’s incentive is to exchange USD’s for gold, preferably buying undervalued gold with overvalued dollars. Hence the PBOC buys in utmost secrecy, not to affect the market.

It wouldn’t make sense for the PBOC to buy gold from domestic mines because they would have to pay in RMB. This wouldn’t fit all their objectives mentioned above. Additionally Chinese law dictates all domestic gold mining output is required to be sold through the SGE (page 15). Last, I personally have never come across any evidence the PBOC has bought domestic mine supply in recent years.

Before the liberalization of the Chinese gold market in 2002 the PBOC did buy all domestic mine supply because the PBOC had the monopoly in the Chinese gold market; the PBOC was the Chinese gold market. A brief history lesson from SGE president Wang Zhe in 2004:

In April 2001, the governor of the PBOC announced the abolishment of the gold monopoly with a planning management system. In June of that year, the weekly quotation system for the gold price officially came into operation, which adjusted the domestic gold price in accordance with the price on the international market. The Shanghai Gold Exchange (SGE) officially opened on 30 October 2002, representing an important breakpoint in the revolution of China’s gold system, and reflected the great progress being made.

From chairman of the SGE board, Shen Xiangrong, in 2004:

After the PBOC abolished the monopoly on gold allocation and management, the SGE assumed the basic role of allocation and management of gold resources, stipulating the healthy and orderly development for gold production, circulation and consumption.

When the SGE was launched in 2002, the gold market wasn’t liberalized overnight, as one can imagine. It took a couple of years before the market functioned as the PBOC had intended. The intensions were, inter alia, to let the free market set prices and all imported and mined gold was required to be sold first through the SGE. The reason to channel fresh gold (import and mine supply) through one exchange is to keep track of the gold added to non-government reserves (jewelry, bar hoarding, institutional buying, etc). By requiring all fresh gold to flow through the SGE the PBOC can efficiently supervise the quality and quantity of the gold that enters the Chinese market place. The PBOC wants to know exactly how many grains of fine gold are being held among the people. Additionally scrap gold is allowed to be sold through the SGE, but because this type of supply doesn’t affect reserves, it isn’t required to be sold through the SGE (it doesn’t have to be monitored).

The structure of Chinese physical gold market with the Shanghai Gold Exchange at its core entails SGE withdrawals equal Chinese wholesale demand. This has been published by the SGE Annual Reports, China Gold Market Reports and CGA Gold Yearbooks 2007-2011 (I’ve written and extensive analysis on this theorem which you can read here). Unfortunately only a fraction of all these reports is publically available; if you study the rest and gather all bits and pieces you can make an informed analysis.

Through analysing data from 2002 to 2011, after 2011 the Chinese were reluctant to publish reports as this information became too sensitive, we can clearly see how the SGE and the Chinese gold market have developed.

The next table is from the China Gold Association (CGA) Gold Yearbook 2006.

Exhibit 1. The number circled in yellow is a typo (see exhibit 2).
Exhibit 1. The number circled in yellow is a typo (see exhibit 2).

I made a translated version:

Exhibit 2. I corrected the typo.
Exhibit 2. I corrected the typo.

Whilst we can see that SGE withdrawals grew from 2002 to 2006, moreover the table exposes SGE withdrawals grew relative to total supply.

The next table shows SGE withdrawals compared to total demand; the top row shows SGE withdrawals, note another typo, the bottom row is SGE withdrawals relative to (%) total demand. These tables illustrate the PBOC’s intention to match supply, SGE withdrawals and demand. Although they didn’t immediately succeed in 2002 when the gold market started to liberalize, in 2007 the CGA reported for the first time SGE withdrawals equalled demand for 100 %. As mentioned before, in the years after 2007 this continued to match (as I have demonstrated here)

Exhibit 3. The number circled in yellow I know for sure is a typo because I cross-checked the number with two other reports.
Exhibit 3. The number circled in yellow I know for sure is a typo because I cross-checked the number with two other reports.

From the CGA Gold Yearbook 2007:

2007年,上海黄金交易所黄金出库量363.194 吨,即我国当年的黄金需求量,比2006年增长了48.02%,低于供给增长率8.82个百分点。

In 2007, the amount of gold withdrawn from the vaults of the Shanghai Gold Exchange, gold demand of that year, was 363.194 tonnes of gold, compared to 2006 increased by 48.02 percent, 8.82 percentage points lower than the growth rate of supply.

Regular readers of my research are familiar with the equation:

Import + Mine + Scrap = Total Supply = SGE Withdrawals = Wholesale Demand

In this post I will show/repeat two examples to proof this equation. Example one; this is a quote from the China Gold Market Report 2008:

Exhibit 4.
Exhibit 4.

For the sake of simplicity I left stock carry-over out of my equation. Second example; this is a screen shot from the China Gold Market Report 2010:

Exhibit 5.
Exhibit 5.

It states domestic mining output in 2010 was 340.88 metric tonnes, 40.72 % of total supply, net import (others) was 240 tonnes and total supply was 837.20.

Now let’s have a look at SGE withdrawals in 2010. From The SGE Annual Report 2010:

Exhibit 6.
Exhibit 6.

Exactly 837.2 metric tonnes. Last but not least, total demand as disclosed by the China Gold Market Report 2010:

Exhibit 7.
Exhibit 7.

Also 837.2 metric tonnes! We know this 100 % match has occurred from 2007 to 2011 by reading the reports from those years. There are no signs SGE withdrawals stopped matching total supply and demand ever since. In 2013 total SGE withdrawals accounted for 2197 metric tonnes (boxed in red, Kg – 本年累计交割量)

Exhibit 8
Exhibit 8

My point being, I think all this clearly exposes Chinese domestic mine supply is being sold through the SGE, not to the PBOC. Does the PBOC purchase gold on the SGE? I don’t think so because all physical gold on the SGE is quoted in RMB and, again, it wouldn’t fit the PBOC’s objectives mentioned above to exchange RMB for gold. On top of that I have several sources in the mainland, including a teacher in economics and the gold market at the Henan University of Economics and Law in Zhengzhou City, that all tell me the PBOC would never buy gold on the SGE.

Commercial banks like ICBC do offer a few trading products in USD, but these do not incorporate physical delivery/withdrawal. These products merely offer Chinese citizens and businesses more trading flexibility.

Exhibit 9. From the ICBC website about USD precious metals account.
Exhibit 9. From the ICBC website about USD precious metals account.

The PBOC (or SAFE) is more likely to make gold purchases overseas in exchange for USD; this way they can fulfill all their objectives. It’s not hard for the PBOC to do this without the shipments showing up in global trade data.

UK customs (HMRC) recently wrote:

Exhibit 10.
Exhibit 10.

The UK net exported 1425 metric tonnes in 2013, most of which ended up in China. When looking at UK trade we should bear in mind these enormous amounts of gold exclude monetary gold.

Exhibit 11.
Exhibit 11.

All data I gather from the SGE, UK customs, Switzerland customs and Hong Kong customs do not relate to any PBOC purchases (click here to see how much gold was exported from the UK, through Switzerland, through Hong Kong to the mainland in 2013). The amount of gold bought by Chinese consumers, investors and institutions I can make fairly good estimates for (it simply equals SGE withdrawals).

Exhibit 12.
Exhibit 12.

My estimates on PBOC official gold holdings are pure guessing, based on common sense and anecdotal stuff (though it doesn’t take a rocket scientist to know the PBOC has increased it gold holdings since 2009, when it was last updated to 1054 metric tonnes). More on that later.

SGE Vaults

In Macleod’s article there is much emphasis on SGE vaulting, though to my knowledge this amount is currently unknown. This is how the SGE works: SGE members make gold deposits, they sell this gold and the buyers have the option to withdraw the gold from the vaults. From the data I have we know yearly SGE deposits and withdrawals have been approximately the same from 2007 to 2011. Deposits can transcend withdrawals as some SGE account holders purchase Au (T+D) deferred contracts, perhaps later withdrawing the gold. Withdrawals can transcend deposits because there can be stock carry-over from previous years (see exhibit 4).

Exhibit 12.
Exhibit 12.
Exhibit 13.
Exhibit 13.

The SGE does not own its own vaults. There are merely SGE designated vaults owned by, for example, commercial banks. Needless to say, SGE withdrawal data relates to physical gold that leaves SGE designated vaults.

The next table is from Macleod’s article.

Exhibit 14. Screen shot from Macleod’s article. Coloured boxes have been added by me.
Exhibit 14. Screen shot from Macleod’s article. Coloured boxes have been added by me.

First of all he mixes deposit and withdrawal numbers and presents these as vaulted gold numbers (blue boxed numbers are deposits, orange boxed numbers withdrawals). Compare the numbers in the top row with exhibit 13 (and 4, 6, 8, 12 and this). In 2013 the 2197 tonnes were not vaulted, they were withdrawn! One more exhibit from the China Gold Market Report 2008:

Exhibit 15. At the end of 2008 SGE inventory was increased by 8 metric tonnes.
Exhibit 15. At the end of 2008 SGE inventory was increased by 8 metric tonnes.

According to my analysis Macleod’s vaulted numbers are false and thereby his vaulted gold increase numbers, as presented as demand in the following table I took from his article.

Exhibit 16. Screen shot taken from Macleod’s article.
Exhibit 16. Screen shot taken from Macleod’s article.

Additionally he adds vaulted scrap and mine supply to Chinese demand, while this is already included in SGE withdrawals (Exhibit 5, 6, 7, and this). This is double counting.

Hong Kong And Mainland Gold Trade

Exhibit 17.
Exhibit 17.

The amount of net exports from Hong Kong to the mainland is clear. Very little of the gold imported by Hong Kong from the mainland was bullion withdrawn from the SGE vaults.

A very long and complicated story short: In the mainland there are two types of trade; general trade and processing trade. General trade can be considered as normal trade. If gold is imported in general trade this is required to be sold through the Shanghai Gold Exchange. Only 12 banks have general trade licenses from the PBOC, though for every shipment they need anew approval.

1. Industrial and Commercial Bank of China
2. Shenzhen Development Bank / Ping An Bank
3. Agricultural Bank of China
4. China Construction Bank
5. Bank of Communications
6. China Minsheng Bank
7. Bank of Shanghai
8. Industrial Bank
9. Bank of China
10. Everbright
11. HSBC
12. ANZ

It’s not likely the PBOC would approve bullion gold to be exported in general trade. Additionally there are a few jewelry companies that have PBOC licenses, but these also have to ask for permission for every trade they conduct. The PBOC has a very firm grip on gold trade.

Processing trade is something else. In this trade form raw materials from abroad are imported, processed into products and then these products are required to be exported again. This processing is usually done (there can be exceptions) in Customs Specially Supervised Areas, or CSSAs. Processing trade doesn’t require a permit from the PBOC, as the gold that is imported will be exported after being processed. To export gold from a CSSA to a non-CSSA (that’s the rest of the mainland) a PBOC license is required. An example for a processing trade would be; gold from Hong Kong is exported to Shenzhen (a CSSA just across the border from Hong Kong and well known for its vast jewelry fabrication industry), then the gold is fabricated into jewelry and imported back into Hong Kong. This trade would show up in Hong Kong’s customs report, but it would not affect Hong Kong net export to the mainland.

Exhibit 18.
Exhibit 18.

Processing trade explains the Hong Kong imports from the mainland. Most of the gold Hong Kong imports from the mainland is balanced by Hong Kong exports or re-exports to the mainland, as the PBOC is not likely to allow the mainland to export gold in general trade.

Macleod states correctly that Hong Kong gold re-exports to the mainland, gold that is virtually not processed in Hong Kong, are all 1 Kg bars refined overseas imported into Hong Kong and sent forward to the mainland. Regarding Hong Kong exports to the mainland, gold that is processed in Hong Kong, he states this refers mainly to jewelry fabricated in Hong Kong which is shipped to the mainland and sold directly without going through the SGE. I disagree:

1) There is no evidence for this. Just because the gold is declared in Hong Kong as export doesn’t say anything about its shape or form. There are many refineries in Hong Kong, all capable of casting 1 kg bars to export to the mainland. Hong Kong gold export to the mainland can also be 1 Kg bars destined for the SGE.

2) In China mainland there is a 22 % tax on jewelry (17 % VAT and 5 % consumption tax), these costs are added to the bullion and fabrication costs of the jewelry. This makes a 24 carat bracelet (most aunties buy 24 carat for investment purposes) of 100 grams much more expensive than the spot price of 100 grams of bullion on the SGE, which is free of VAT and consumption tax. Why would a Chinese jeweler fabricate its products in Hong Kong where wages are at least twice as high and then import them into the mainland? Assuming this company has a PBOC import license. It’s more likely Chinese jewelers buy bullion on the SGE in the mainland, the SGE has no vaults in Hong Kong, fabricate the jewelry and then sell it, all in the mainland.

Macleod adds Hong Kong gold exports to the mainland (211 metric tonnes in 2013) to Chinese demand, I don’t. Additionally he adds total Hong Kong net gold import (597 tonnes in 2013) to Chinese demand. I don’t.

Exhibit 19.
Exhibit 19.
Exhibit 20.
Exhibit 20.

We know some of the gold Hong Kong net imported in 2013 ended up in the hands of mainland citizens. Because in Hong Kong there is zero tax on jewelry, there are many mainland citizens making trips to Hong Kong to purchase jewlery and walk back across the border without being bothered by customs. It’s estimated half of the jewelry sold in Hong Kong is bought by mainland tourists.

Exhibit 21.
Exhibit 21.

There are also mainland citizen that purchase gold in Hong Kong and store it locally in safety deposit boxes at banks or private vaults. Unfortunately I don’t have any hard numbers on this hidden Chinese gold demand (yet). One could take half of the jewelry sales numbers from Hong Kong reported by the World Gold Council, but I have my reasons not to trust those numbers.

Hong Kong net imports can also be explained by the fact many gold brokers in the world offer vaulting services in Hong Kong (GoldSilver, GoldMoney, etc). In 2013 Malca-Amit Global Ltd opened a vault in Hong kong, with a capacity of 1000 metric tonnes, which can be used by investors worldwide. This is why Hong Kong net import isn’t solely Chinese demand.

My Estimate On Chinese Total Gold Reserves Held In The Mainland

Let’s put together some data and try to work out how much gold the Chinese people and the central bank have been accumulating in the past decades. In exhibit 5 we found a clue suggesting China has probably been a net importer since the nineties.

Exhibit 22.
Exhibit 22.

This means we don’t know how much of the gold China domestically mined prior to that period has been exported, but after, lets say, 1995 all domestic mining did not leave the mainland. My best estimate of how much gold was being held among the Chinese population in 1995 is 2500 tonnes, according to Albert Cheng from the World Gold Council (page 55). Starting from that year I will try to make a conservative estimate on how much gold the Chinese have been accumulating.

According to the PBOC their official reserves in 1995 accounted for 394 tonnes, Chinese mines produced 108 tonnes that year; our starting point is 3002 tonnes (2500 + 394 + 108) in 1995. Subsequently I added yearly domestic mining, cumulative, as the Chinese didn’t net export any gold since that year. In 2001 The PBOC announced their official reserves had increased to 500 tonnes and in 2003 they announced having 600 tonnes. Because the gold market wasn’t fully liberalized in those years I have subtracted these gains from cumulative domestic mining. Just to be on the conservative side, also because I have zero trade data from 1995-2001.

The official subsequent update to 1054 tonnes by the PBOC was in 2009, when the gold market was fully liberalized. This gain I didn’t subtract from cumulative domestic mining, as I believe this was imported monetary gold. The increase in PBOC holdings from here on is pure guessing, though I feel comfortable raising their holdings to 3500 tonnes in 2013.

Import I have calculated using Hong Kong net exports to the mainland (my data begins in 2001), net gold imports numbers disclosed by Chinese gold reports (2007-2011) and analysing SGE withdrawals (2007-2013), using the equation:

mine + scrap + import = SGE withdrawals

import = SGE withdrawals – scrap – mine

The end result is this:

Exhibit 23.
Exhibit 23.

The chart above I think is conservative as it excludes hidden demand on which I have no hard numbers (yet):

– Mainland tourist buying jewelry in Hong Kong and storing it locally or bringing it home.

– Potential gold smuggling via tunnels from Hong Kong into the mainland.

– Undeclared gold import by affluent Chinese circumventing all authorities (customs, SGE).

Taking this into account it’s safe to say there is now more than 14000 metric tonnes of gold in China mainland. Divided by 1.3 billion people that’s 10.7 grams of gold per capita.

In Gold We Trust

Interview Jim Rickards On The Death Of Money

I had the privilege to meet with Jim Rickards, while he was in The Netherlands for one day, to do an interview about his new book “The Death Of Money“. Accompanied by friend (and author of the book the The Big Reset) Willem Middelkoop we met at the hotel were Jim was staying and for one and a half hours we fired questions at him. Below you can read the highlights of the conversation.

March 12, 2014

Koos Jansen: Do you think there will be a collapse in the worldwide monetary system, including chaos, social unrest and bank failures because all policy makers will do too little too late?

Jim Rickards: My new book, The Death Of Money, is about the demise of the dollar. A world wide monetary collapse and the collapse of the dollar are the same thing. The dollar is the keystone of the system today, if the world loses confidence in the dollar the whole system collapses. Could there be disruptions, social unrest and other problems before the monetary system collapses? I think we’re seeing them already, in the Ukraine, in the Crimea and the Chinese navy sending vessels to these islands they are in disputes with near Japan. US monetary policy was also a contributing factor to protests in the Arab Spring’s early stages. We’re seeing signs happening already and that will continue.

I do expect that policy makers will continue to pursue the wrong policies, they won’t make the structural adjustments that are needed; unemployment remains high, growth remains weak and deflation continues to have us in its grip. These are all things that will lead to social instability, income and wealth inequality and we could see a lot of stresses before the collapse of the monetary system.

Central banks and governments have made it clear that the big banks can’t fail. That’s what they stated, all these too big to fail banks will not be allowed to fail. Now what are the consequences once they’ve said that? It invites reckless, parasitic and exploitative behaviour on behalf of the bankers. This allows them to grow too large which destabilizes the system. I don’t think we’ll see big bank failures along the way, but big banks will fail as part of the collapse. It’s the policy of too big to fail that leads to the dysfunction of the system that will lead to the collapse.

Jim Rickards Koos Jansen

Koos Jansen: Will the coming collapse of the monetary system be more severe than any prior one?

Jim Rickards: The point I’m making in the book is that the international monetary system has collapsed three times in the last one hundred year. In 1914, 1939 and 1971.  So it does happen, it’s not that unusual. When it happens it not the end of the world. What it means is that the major trading powers, the financial powers, come together and reset the system. There is actually a name for this, it’s “the rules of the game”. That’s not a phrase I made up, it goes back one hundred years. So the major powers will rewrite the rules of the game, but here’s the problem. The last crisis we had the Fed reliquify the world. There were tens of trillions of dollars in swap lines with the ECB, they guaranteed all the bank deposits in the US and they guaranteed all the money market funds in the US. It did prevent things from getting worse, but the problem is the Fed raised their own balance from $800 billion to $4 trillion after the liquidity crisis. We had a liquidity crisis in late 2008, but we haven’t had one in the last five years. So now what happens if we have a liquidity crisis tomorrow? They’ve got no more dry powder; they can’t go to $12 trillion.

The next crisis will be bigger than the last one, and it will be bigger than the Fed because they already trashed their own balance sheet. Then the only balance sheet left is the IMF’s.

Koos Jansen: Do you consider it a possibility the SDR will be the new world reserve currency backed by gold, like mentioned in Willem’s book The Big Reset? And following up on that, could it be all national currencies will be floating around such an SDR?

Jim Rickards: Yes, there is a probability the SDR will be the new global reserve currency. Gold and oil would be then be priced in SDR’s. It will be used for some of the balance of payments between countries, the creation of reserves and probably the financial accounts of the world’s largest corporations. So Siemens, General Electric and IBM will produce their financial statements in SDR’s, because they’re global corporations.

Koos Jansen: But will this SDR be backed by gold at a fixed parity?

Jim Rickards: It might be, this is where it gets interesting. That is not what our global leaders want. What they want is a paper SDR to replace the paper dollar. The question is, will people go along with that? Our global leaders may have to go back to gold not because they want to but because they need to restore confidence. It can go either way. The SDR project that will replace the dollar is already in the works. If the elites get enough time, they need about ten years, they will roll out a paper SDR. If the collapse comes sooner than that they’ll have to gold, or, if they insist on a paper SDR, they’ll have to go with martial law and neo-fascism.

Koos Jansen: Are you familiar with concept of freegold?

Jim Rickards: I’ve heard of it, I’m not really an expert on it.

Koos Jansen: Do you believe in Austrian economics?

Jim Rickards: My view is that Austrian economics has a lot to offer, but it is not a complete explanation of dynamics in capital markets. I consider myself a complexity theorist and I am one of those applying complexity theory to capital markets. Complexity theory is only about 55 years old as a science, but it is highly complementary to Austrian theory because it agrees with Hayek that the economic system has far too many autonomous agents of highly diverse views ever to be efficiently planned. If von Mises had been born 40 years later, he would have warmly embraced complexity theory.

Koos Jansen: If you were the president of the world, what would you implement as the most stable monetary system.

Jim Rickards: I favour what I call the King dollar. I’m a bit of an old school American. I don’t necessarily want the gold standard, and I don’t want the SDR’s, I want the dollar as the dominant currency in the world. I think America has the potential for a force for good in the world and therefore the American dollar as a global monetary standard to me would be a good thing. The problem is, the US government doesn’t agree. They don’t want a strong dollar, they want a weak dollar.

Willem Middelkoop: Is that the reason you began writing books? because you’re fed up with how the dollar is managed.

Jim Rickards: Absolutely.

Koos Jansen: Isn’t it always unsustainable if a national currency is used as the world reserve currency?

Jim Rickards: That doesn’t have to be, it can be. This is Triffin’s dilemma. What Triffin said in the sixties was that if one country issues the global reserve currency they need to run a persistent current account deficit because that’s the only way for the rest of the world to get enough money to finance world trade. But if you run deficits long enough you go broke. Now after 50 years the US is going broke.

There is another solution, which is real growth without money printing. What’s wrong with price stability, real price stability, why do we have to have inflation? Let people earn their dollars, or let the US maintain the value of it’s dollar with education, innovation, growth, productivity, good public policy, low taxes and a good business climate. These are the ways you drive growth, not by money printing. The answer is real growth.

Death of money, Jim Rickards, Koos Jansen, Willem Middelkoop

Koos Jansen: If the world starts to lose confidence in the dollar, will Yellen be forced to raise interest rates like Volcker did in the early eighties?

Jim Rickards: The problem is how do you raise interest rates when 50 million Americans are on food stamps, 26 million Americans unemployed or underemployed, 11 million Americans have disability, with all due respect to people with genuine disability, a lot of the disability is abused. My point being, given an extremely weak economy, given deflationary trends, given high unemployment and declining labour force participation how on earth do you raise interest rates? However, the market will raise interest rates in a way the Fed won’t be able to control. That’s when you may see… who knows? Debt restructuring of the treasury market…

Koos Jansen: More QE?

Jim Rickards: More QE and the Fed may use more financial repression. Why haven’t interest rates gone up already? Because of financial repression.

If there is a loss of confidence and the market wants to push rates higher, the Fed will respond by trying to suppress rates by printing money, which will lead to more loss in confidence. This will show up the foreign exchange market, it will show up in the price of gold and it will show up in some interest rates.

A lot of this will happen really quickly, it wouldn’t play out in one day, but we will see gold making moves of a hundred dollars in one day. People will say it’s a bubble, of course it’s not a bubble it’s a sign of panic. Then we’ll see gold moving five hundred dollars a day.

What I look at is the price of gold; to me gold is a constant. The price of gold is just the inverse of the value of the dollar. If gold goes up, what is actually happing is that the dollar goes down. When you see the price of gold jumping up what that tells you is that the dollar is collapsing. Even if the Fed is repressing interest rates, gold will tell you when the dollar is done.

Willem Middelkoop: That’s why the price of gold has to be controlled.

Jim Rickards: Yes, but a couple of thing on that. The Fed right now wants the price of gold to be higher. The Fed’s problem today is not inflation it’s deflation. The Fed wants controlled inflation and they can’t get it. So how do you get inflation? You have to change expectations. So allowing the price of gold to go up helps to increase inflationary expectations. It can’t go too far too fast, it can’t do what we just described. But the Fed wouldn’t mind if the price of gold would go to $1400, $1500, $1600 dollars because that would get people into an inflationary mindset; trying to get them spending more dollars, borrowing more etc. That’s what the Fed wants. Where the Fed is wrong is to think that they can just dial it up or down. They did do that in 2011 when gold went to $1900, the Fed was very fearful gold would go to $2000, a big psychological threshold, so they had to push it down. Right now I don’t think the Fed is doing anything to hold price of gold down, China might be.

Koos Jansen: Was it China behind the drop in the price of gold In April 2013, or was it maybe a collaboration between the US and China? A scenario could have been: China would support the dollar and in return could buy physical gold at extremely low prices.

Jim Rickards: Look, I’ll tell you what I know and what I don’t know.

When you’re a detective and you have a dead body and are looking for the killer, you’re looking for a motive. So who benefitted from the drop in the price of gold? China – they’re the most likely party. I know for a fact that SAFE, which is a Sovereign Wealth Fund that manages the foreign exchanges reserves of the People’s Bank Of China, bought 600 tons of physical gold through June and July 2013. I know this from the Perth Mint and Chinese dealers. At this moment the gold is on the balance sheet of SAFE but this can be flipped to the PBOC’s sheet like it happened in 2009.     

Whether the Chinese caused the drop price I can’t be sure, though I suspect it, but I know for sure they took advantage of it.

China right now has an interest in keeping the price low because they want to buy more. But at some point, if there will be inflation in the US, they want the price to go higher because that’s their hedge. That’s the reason they’re buying gold. All this talk about China backing the renminbi with gold is nonsense.

China has got $4 trillion dollars in reserves, their preference is a stable dollar. If the US devalues the dollar by 10 %, that’s a wealth transfer of $400 billion from China to the US. China’s hedge is gold, if the dollar would go down gold goes up.

Koos Jansen: China knows the US will need to devalue the dollar?

Jim Rickards: Correct.

Koos Jansen: Does SAFE buy it’s gold through the Shanghai Gold Exchange?

Jim Rickards: They have various ways.

Koos Jansen: How will the power be distributed in Asia after the monetary reset?

Jim Rickards: It will be based on gold.

A lot of analysts look at gold as a percentage of foreign exchange reserves, I think that’s meaningless. In the US gold represents 70 % of reserves, but the US can print dollars and they don’t need euros or Swiss francs. A better way of thinking about it is the amount of gold relative to the size of an economy in terms of GDP. Russia is on par with the US. China needs to have at least 4500 tons to get on par with the US.

In Chapter 6 of my book I write about the Shanghai Cooperation Organization, it’s not a treaty but a mutual cooperation organization between primarily Asian and central Asian powers. This is the primary forum for Russia and China to cooperate and stand up against the US. Eventually there will be two empires in Asia. Russia will have an empire comprised of Russia, eastern Europe and central Asia. China will have an empire comprised of the mainland, its immediate periphery and east Asia.

Koos Jansen: All the physical gold that’s exported to China is in 1 Kg 9999 bars. Gulf nations are remelting their 400 ounce London Good Delivery bars into 1 Kg 9999 bars through Switzerland. What’s your take on that?

Jim Rickards: In my view the 1 Kg 9999 bars will be the new Good Delivery standard. We’ll look back in a couple of years and wonder why we ever messed around in 400 ounce bars. The history of 400 ounce bars is interesting. They were intentionally made very large so people couldn’t have them – they were for central banks only or very wealthy individuals. In 1910 people used gold coins to pay for goods and services, then little by little central banks wanted to get rid of the gold coins, they wanted people to use paper certificates, which gave central banks more flexibility.

Koos Jansen: Will the Bundesbank get its gold back from the US?

Jim Rickards:  What a lot of people don’t understand is that the Bundesbank doesn’t want it’s gold back. The reason the Germans want to have it in New York is because they want to able to engage in price suppression. New York and London are markets for leasing, Frankfurt isn’t. For every ton of gold you remove from New York, there is 10 tons of paper gold that needs to be unwound. That’s why they’re taking eight years and that’s why they’re doing it in tranches.

There’s not such a leasing market in China either. Central banks are able to suppress the price of gold through the leasing market in New York. For example SAFE, a subsidiary of the PBOC, could call JP Morgan in New York and ask to actively lease their gold, which is partially stored in New York, and JP Morgan would do it.

Koos Jansen: Is the NSA Involved in financial warfare?

Jim Rickards: No, not to my knowledge. 

Willem Middelkoop: I know wealthy Americans taking measures like getting a second passport and moving their money offshore. Do you see this happening in your surroundings?

Jim Rickards: Yes, I see it all the time. There are billionaires who build vaults in their own houses because they don’t trust Brinks.

Willem Middelkoop: What does that tell you?

Jim Rickards: It tells me that they see what I see, in some ways, but their not willing to talk about it. They’re ready for the collapse but want to milk the system in the meantime.

Willem Middelkoop: Which part of all your activities do you like most?

Jim Rickards: Writing. That’s why I’ve done two books, and now I will start a new book project sooner than later. It will hopefully be a four book series. I have some sketches.

Koos Jansen: We’ll be looking forward to reading more of your books. For now, thank you very much for your time Jim.

Death of Money - Dust Jacket_150x150_p1

In Gold We Trust

New York Federal Reserve Lying About Gold Storage?

There is about 6700 metric tonnes of gold stored 80 feet below street level on the bedrock of Manhattan, in the vaults of the New York Federal Reserve. None of this gold is owned by the New York Federal reserve, they are merely the custodians for the US treasury (that holds approximately 400 metic tonnes in NY), 60 sovereign countries and the IMF; completely free of charge! From the NY Fed website:

The New York Fed charges account holders a handling fee for gold transactions, including when gold enters or leaves the vault or ownership transfers (moves between compartments), but otherwise does not charge fees for gold storage.

NY Fed

 

What would be the NY Fed’s incentive to provide this free service? My local gold storing company charges me more than 1 % per annum for the safekeeping of my bullion (lucky me gold is dirt cheap at the moment). If we subtract the 400 metric tonnes, which the NY Fed stores for the US treasury, from the 6700 it stores in total, the outcome is 6300 metric tonnes. At current market value 1 % of 6300 metric tonnes is more than $2.5 billion. I’m sure sure the big guys can store gold at lower prices, it’s still very kind the NY Fed doesn’t charge its depositors one dime.

But let me get to the point. The NY Fed also states on its website:

All bars brought into the vault for deposit are carefully weighed, and the refiner and fineness (purity) markings on the bars are inspected to ensure they agree with the depositor instructions and recorded in the New York Fed’s records. This step is vital because the New York Fed returns the exact bars deposited by the account holder upon withdrawal—gold deposits are not considered fungible.

This is where it might wring. For one, the Bundesbank succeeded to repatriate 5 mt from the NY Fed in 2013 (although they wanted to withdraw 37.5 mt that year to repatriate 300 mt before 2020). Did they get back the exact same bars they once deposited? No, the bars were remelted. This is only logic as we know New York has a big gold leasing market which is largely facilitated by gold from the NY Fed vaults. No, gold leasing is not a conspiracy, it’s just part of the gold market. (Note, it’s also possible the BuBa leased out their gold themselves.)

The Netherlands have 300 mt of gold stored in New York. The Dutch gold is managed by De Nederlandse Bank (DNB, The Dutch Central Bank). Senior policy maker financial markets at DNB Jan Lamers wrote an essay in 2006 named “Gold Policy Of The Dutch Central Bank“.  I translated a few snippets that explains a bit about central bank gold leasing:

From the beginning of the eighties of the last century there has been a gold leasing market of some size. DNB also participated in it. Because gold leasing is often seen as something magical, I will explain that this is just a normal activity that is part of responsible management of the official gold reserves.
…The lease market made it possible for central banks to lend gold with interest. In a gold loan the gold is physically delivered to the counter-party, the lender gets a claim denominated in gold on the counter-party. When DNB therefore lends 1000 kilograms, it gets a claim of 1000 kilograms of gold on the counter-party. When the loan is repaid the gold bars that are returned are not the same as the ones loaned out, but they meet the same quality standards. Such a transaction is similar to the lending of € 1000 in the form of banknotes. …The debt does not have to be paid back with the same notes, as long as the banknotes are legal tender. If we look at it this this way there is really nothing magical about a gold loan.

…In the eighties of the last century gold producers were looking for a tool to to secure revenues from future mining production and bring down high interest rates for borrowing money. Moreover, it was difficult to attract equity capital to finance mining. As a solution was to borrow gold on a large scale from specialized banks, who in turn borrowed gold from central banks. The borrowed gold was sold in the spot market and with the proceeds the miners financed the production of gold. In later years the mining output could pay of the gold loan. This process serviced mines relatively cheap financing and also they covered the price risks.

…The supply of gold loans is mainly from central banks around the world, only a fraction is being supplied by private gold owners.

 

Although not every gold lease requires a movement of physical gold, it can also be a a book entry, the statement from the NY Fed they grant to return the exact same bars deposited by the account holder upon withdrawal is hard to swallow. As we have have seen by the repatriation of some German gold from the NY Fed.

China’s Road To Secret Gold Accumulation

In august 2013 I published a translation from an article written by a Chinese gold commentator called Zhang Jie. In the article Zhang described how not only the US but also other western countries have been involved in manipulating the price of gold to control the international monetary system for decades. I suggest to read the full article – here are a few snippets:

…Gold leasing is an important innovation in the gold settlement system. Through continuous gold leasing the gold in the market can be circulated and produce derivatives, creating more and more paper gold. This is very significant for the United States. Gold leasing is a major tool for the Federal Reserve and other central banks in the West to secretly control and regulate the gold market, creating gold credit derivatives and global credit conflict.

…The purpose of gold leasing is not just to receive a rent, but it also provides the ability to short-sell gold, which allows central banks to interfere in the currency market.

…If the Fed’s large gold reserves are used in gold leasing, there will be a serious problem. Germany therefore will threaten the Fed’s dominant position by demanding their gold back; the Fed subsequently needs to withdraw the leased gold and thus could destabilize the market. This is a new credit game of international capital.

…The Fed probably has agendas aimed at preventing Germany to inspect its gold or to ship it back to Germany.

I recently came across another article by Zhang that I also found worth sharing. First you can read the article, then I will provide some comment. This article is dated 16-04-2013, but it must be a repost as the data in the text shows it had to be written Jan/Feb 2013. Everything in between [brackets] is written by Koos Jansen.

Translated By Soh Tiong Hum!

Zhang Jie: China’s Road To Secret Accumulation

2013-04-16  Author: Zhang Jie

Zhang Jie


Core hint: China may gradually acquire gold on the international gold market through non-central bank financial entities, the newly acquired gold shipped back to China to be converted into central bank gold reserves. Credit in various forms including gold reserves will support China’s Renminbi and its internationalization.

Unless military confrontation or economic sanctions take place between China and US, there should be little question about the safety of China’s gold reserves stored at the US Federal Reserve. The question of China’s gold is not its safety but rather to possess the ability to use it for market intervention, and to boost creditworthiness of the Renminbi.

 

Difficult To Bring Back Gold

Risk of losing China’s gold stored at the US Federal Reserve can be temporarily set aside because in comparison to China’s foreign exchange reserves, the risk to China’s foreign exchange reserves is larger than the risk of gold deposited at the Federal Reserve! Regardless of buying sovereign debt or depositing in the US financial system, there is risk of a mass default. A mass failure to fulfill obligation by Western countries should no longer be called a default but a crisis. Cash deposited inside the financial system has even more danger. Western banks can go bankrupt, even large corporations like Lehman. Therefore risk has to be looked at in relative terms, not just absolute ones. The gold question should be looked at from the angle of the global currency system. Whether gold should be stored in China has to be considered for the level of creditworthiness.

The PBOC operates on a ‘pool’ concept, which also needs gold. Considering the global credit game, it is highly necessary for China to develop her own gold reserves and must do so with a better strategy than Germany.

The US has already demonized China’s rise so if China were to ask to bring back her gold, it would surely lead to a tremendous confrontation. When China first shipped her gold to the US, it was meant for reform, opening up and removing US economic sanctions. To ask for the gold back now would be a political signal. China can wait to look at Germany’s outcome before considering to repatriate it’s own gold from the Federal Reserve. China does not yet have to pull her chestnuts out of the fire. If China were to make a fuzz about their gold, Western countries will point their fingers at China, but not to Germany because of their close relation.

pboc

Accumulating Gold To Convert FX Reserves

China can use its increasing foreign exchange reserves to buy gold continuously. When the US and European central banks are continuously leasing and short selling gold, China can buy this gold and take possession, adding them to domestic reserves.

It’s best to let domestic financial entities acquire gold rather than the PBOC, to create multiple positions in the domestic gold futures market, to create the impression of forced buying by private hands so as to shut off international opinion. 
Purchased gold is withdrawn from the futures market, stored with reserves held in core financial entities then moved to the PBOC for domestic safekeeping. Just like Western central banks use gold leasing and short sell gold, China also needs to employ deception to secretly accumulate gold in a timely manner.

It is a good time for China to use surplus foreign exchange reserves to purchase gold when central banks around the world are secretly leasing gold and short selling gold to prop up currency printing. During the 10 years after gold leasing was born [early eighties] the world sold gold short, while during the gold bull market short sellers in the gold leasing business covered their shorts. International gold price fluctuations after 2008 was when gold short selling commenced again, especially at the time when gold fell from USD 1900 and US and Western countries were running endless quantitative easing. With the gold price is running contrary to quantitative easing, it is highly probable that Western central banks or major institutions were short selling gold. With China acquiring gold till a currency crisis erupts and short sellers need to cover their position, international gold price will certainly rally, possibly resembling eighties like fluctuations. It is therefore a tremendous opportunity for China to buy gold now to hedge against risk from a global currency crisis.

China in possession of large amounts of gold, China has secretly accumulated more gold, is a way to fight developed countries that are depreciating their currencies with quantitative easing; China’s gold accumulation gives them caution about short selling gold and currency printing. This is the most effective means to protect China’s foreign exchange reserve wealth from the threat of the Western financial hegemony.

Great Wall of China

China’s GDP and foreign exchange reserves already exceed Germany’s. Therefore China must possess effective control over gold volume not less than Germany’s gold reserves. At the current price of USD 1700 per ounce, one ton of gold is worth USD 50 million. When gold rises to USD 2500 per ounce, one ton of gold is worth USD 75 million. If China brings in 10,000 tons, foreign reserve spending is merely USD 800 billion but this volume is roughly 30% of gold in global circulation [he means global official reserves!] and is going to be pole position in global markets. Spending such a small expense to swallow such a massive gold position is only possible when the world is short selling. Otherwise price will go sky-high when you buy 10,000 tons! Buying US government debt with China’s current foreign exchange reserves at USD 3.3 trillion yields less than the 0.25% Fed Funds Rate. With this very low yield, buying gold is a good deal.

More than 80% of the PBOC’s currency in circulation is foreign exchange. Depreciation by foreign currencies such as US Dollar forces Renminbi to lose its purchasing power and increases turbulence. This was the reason why China imported inflation years ago. If China buys gold in large amount now, she can choose to support the value of Renminbi with gold in future. Purchased gold will support Renminbi creditworthiness. At the moment, Renminbi’s creditworthiness is supported by the central bank’s foreign exchange reserves but the creditworthiness of foreign exchange in its possession is a function of the issuing country, not China. Supporting China’s creditworthiness is not just about buying gold but also buying China’s sovereign debt, government debt, core industry debt, Chinese real estate, Chinese rare earth, tungsten, antimony and so on. However, besides foreign exchange gold and precious metals are the most appropriate for use overseas to support Renminbi’s export and international policy.

The foreign exchange standard has more problems than a gold standard. The Renminbi wants to be internationalized and China wants to be wealthy and strong. If the Renminbi issuance remains linked to the US Dollar, then the Renminbi will just resemble many so-called international currencies, becoming merely a proxy of the US Dollar, unable to match the creditworthiness of the US Dollar. Internationalization of a pegged-Renminbi is a make-believe internationalization, just like the Hong Kong Dollar, freely changeable but confined to linked rates.

______________________________________________________________________________________________________

Though he’s not a politician Zhang provides us with interesting insights about China’s monetary policy.

My thoughts:

Zhang writes; “there should be little question about the safety of China’s gold reserves stored at the US Federal Reserve” (I asked my interpreter if this is really what he wrote, he really did..), while he clearly states these reserves held by the Fed are leased out and are thus NOT save. A few sentences later he writes; “Risk of losing China’s gold stored at the US Federal Reserve…”. In fact the rest of the article is about the importance of the PBOC holding official gold reserves in the mainland to strengthen the Renminbi. I don’t understand why he wrote the gold is safe in the US in the beginning.

“When China first shipped her gold to the US, it was meant for reform, opening up and removing US economic sanctions.” This underlines the dirty game the US is playing. It demands countries to store a part of their official gold reserves at the New York Federal Reserve so ultimately only the US controls the global currency market. According to this article, written in January 2013 by Liu Zhongbo from Agricultural Bank of China, at least 600 tons of Chinese official reserves are stored at the Fed.

“It’s best to let domestic financial entities acquire gold rather than the PBOC, to create multiple positions in the domestic gold futures market, to create the impression of forced buying by private hands so as to shut off international opinion. Purchased gold is withdrawn from the futures market, stored with reserves held in core financial entities then moved to the PBOC for domestic safekeeping.” I fully understand the PBOC is buying gold through proxies, however all my sources in the mainland ensure me the PBOC would never (indirectly) buy at the Shanghai Gold Exchange, which is the only domestic futures/deferred market where significant amounts of gold are being withdrawn from the vaults. On the Shanghai Futures Exchange withdrawals are neglectable. Maybe Zhang’s approach is wrong here.

The PBOC wants to diversify it’s FX reserves (USD) in gold, all gold on the SGE is quoted in RMB. It would make more sense for the PBOC to buy gold abroad in exchange for dollars, this would also circumvent SGE premiums. On the Chinese Foreign Exchange Reserves of the People’s Republic of China wikipedia page (not on the English page) it states:

中国大陆外汇储备作为国家资产,由中国国家外汇管理局及中国人民银行管理,实际业务操作由中国银行进行。

The FX reserves of the Chinese mainland are State-owned assets and managed by SAFE and the PBOC. The real operations are done by the Bank of China.

The Bank Of China is a commercial state-owned bank and LBMA member, just like ICBC. It’s more likely the PBOC would make purchases through these channels.

The World Gold Council Clueless on Chinese Gold Demand?

February 18, 2014 the World Gold Council released the Gold Demand Trends for 2013. According to this report total 2013 Chinese consumer demand was 1,065.8 tons. In my opinion this number is highly disputable.

Chinese Gold Market Essentials

The Chinese gold market is completely structured top down. The main physical (spot and deferred) exchange in China is the Shanghai Gold Exchange (SGE), that serves as the entrance point for imported and mined gold to the Chinese marketplace. Additionally the SGE is supplied by recycled gold. The Shanghai Futures Exchange (SHFE) facilitates the trading of gold futures contracts (to compete with the pricing power of Western markets).

The reason the PBOC requires imported gold to be sold first through the SGE (mined and recycled gold are stimulated to be sold through the SGE by tax incentives) is to keep track of how much gold is added to non-government reserves (jewelry, bar hoarding, etc). The setup is quite simple; to channel import and mine supply through one exchange the PBOC can efficiently supervise the quality and quantity of the gold that enters the Chinese market place. The PBOC likes to knows how many grains of fine gold are being held among the people.

Before gold is allowed to enter the vaults of the SGE it’s assayed by the National Quality Supervision and Inspection Center for Bullion & Its Products that grants a minimum fineness of 99.95. Gold withdrawn from the SGE vaults can only re-enter as recycled gold. After being remelted, by one of the associated refineries (see the list on page 40), and an assaying process the gold can move back into the SGE vaults. Just to make sure on SGE level gold of the highest purity is traded.

SGE

The consequence/purpose of the structure of the Chinese gold market is that SGE withdrawals equal wholesale demand. Confirmed by the fact that total demand reported by the China Gold Market Reports 2007 – 2011 exactly equal SGE withdrawals for the corresponding years. For an extensive analysis read this.

The Great Disparity

In 2013 SGE withdrawals accounted for 2197 tons. The next screen dump is from the last SGE report of 2013, the second number from the right (red – 本年累计交割量) is the total amount of gold withdrawn from the SGE vaults in Kg.

SGE total withdrawals 2013

The World Gold Council (WGC) claims to report on ALL sorts of demand; consumer, investment, industrial and central bank demand. This is from their February 18, 2014 press release:

Global consumer demand for gold at unprecedented levels in 2013 China the world’s largest gold market in 2013 

Consumers around the world bought gold in record amounts in 2013, led by demand in China and India, with China becoming the world’s biggest gold market, according to the latest World Gold Council Gold Demand Trends report. …

In 2013 the gold market saw 21% growth in demand from consumers which contrasted with outflows of 881t from ETFs. The net result was that global gold demand in 2013 was 15% lower than in 2012, with a full year total of 3,756t. …

Central banks

Although down 32% on 2012 they continued to be strong buyers of gold, a trend which began in 2009. 2013 saw net purchases in all four quarters, totalling 369t, meaning 12 consecutive quarters of net inflows. …

Technology

Demand reached 405t in 2013, virtually unchanged from the figure of 407t in 2012.

We can see the WGC tracks consumer (jewelry, bar and coin), ETF (and thus investment funds), central bank and industrial demand. Logic, if one wants to thoroughly analyze the gold market all facets of supply and demand must be taken into account.

So how come there is such a big difference between Chinese demand reported by the WGC, 1066 tons, and wholesale demand, 2197 tons? Why is the WGC missing 1132 tons? One reason is because the Chinese are hiding it. Since 2008 the Chinese have great interest to hoard in the dark in order to diversify their US dollar reserves, strengthen their economy and protect it from external shocks. The China Gold Association (CGA) changed the way they measure demand and all other Chinese gold institutions ceased publishing reports on demand since 2011. The only valuable information they continue to publish are SGE withdrawals. Not often, but sometimes the facts seep through the Chinese press:

China’s explosion in demand for physical gold in 2013 left a deep impression on international investors. The Shanghai Gold Exchange withdrawals for the year up till 27 December 2013 exceeded 2180 tons. Considering the exchange’s position as a hub for domestic gold circulation, in conjunction with a system that forbids withdrawn gold from re-entering inventory, to a large extent the withdrawals number can be treated as the best benchmark for physical gold demand in the Chinese market.  Not to mention that the entire 2013 global mined gold production does not exceed 2700 tons. China’s massive demand has to a large extent remade the world’s gold circulation system. Newly mined and stocked gold is moving through trade links in London – Switzerland – Hong Kong – into China in a large scale orientation towards the East. The impact of China’s demand on international gold price will inevitably increase.

Why consumer demand as presented to the world has been understated since 2008 is because the China Gold Association is manipulating the demand category net investment to suppress other categories like jewelry and bar.  This is an overview from the China Gold Market Report 2010.

Chinese gold demand 2010

According to the China Gold Market Report 2007 net investment was 18 tons. Thomson Reuters GFMS (which is the sole data provider for the WGC), assumed this was gold added to the stocks of banks, jewelers and the mint, as it was withdrawn from the SGE vaults but wasn’t sold on retail level. In 2007 this was probably true. But when Lehman fell the world changed, the Chinese began to overstate net investment to hide true demand. Up until today GFMS states net investment is stock movement changeLet’s have a look at how much net investment was in recent years. Note, in the chart below the “Difference” is approximately net investment, calculated as SGE withdrawals minus WGC consumer demand minus industrial demand.

SGE withdrawals vs WGC

Actual net investment published by the China Gold Market Reports: 2007 – 18 tons, 2008 – 129 tons, 2009 – 147 tons, 2010 – 266 tons, 2011 – 285 tons.

From 2007 – 2013 net investment was roughly 2000 tons. This definitely can not have been stock movement change at banks, jewelers and the mint. According to my analysis this gold was bought at the SGE by investment funds, individual investors and jewelers pretending to be individual investors. In the mainland there is 17 % VAT on jewelry, plus an additional 5 % consumption tax – you do the math.

WGC gold

I contacted the WGC and got in touch with one of their experts based in China. When I asked him what net investment was we had a brief debate after which he had to admit he was clueless on where this gold was going. He told me the Chinese will never disclose this information. I asked him if he would like to collaborate with me to research net investment. I got no response. A week later I asked him if he would grant me permission to publish our email correspondence. He responded to not publish our correspondence as it was meant to be private.

gfms

In the meantime I was emailing a precious metals analyst from Thomson Reuters GFMS about the Turkish gold market. This gentleman was extremely kind and helpful and explained to me in detail how GFMS measures Turkish gold coin production. Very valuable information for me! When I asked him what his take was on Chinese net investment, I got no response.

CPM Group

Jeff Christian from CPM Group did respond after I wrote him an open letter regarding SGE withdrawals. You can read our debate in the comment section of this post. Not surprisingly we couldn’t agree. What was interesting about our conversation was that he said total Chinese net gold import in 2013 was 1411 tons.

CGA

Of course I’ve written a million emails to the CGA, in English and Chinese, no response whatsoever. I called them speaking English, no luck. My friend in the mainland has called them numerous times, they always say the gentleman who wrote the China Gold Market Reports is on holiday. The message is clear…

The mainland officially net imported 1158 tons of gold from Hong Kong in 2013. Total net import according to Jeffrey Christian was 1411 tons (according to me it was 2000 tons), let’s take his number for an example. How can China import 1411 tons and mine 428 tons (that’s 1839 tons) but only demand 1066 tons? Did they import gold without asking for it? Did someone secretly pushed it across the border and now the Chinese are stuck with it? Or is there a lot of demand the WGC doesn’t disclose?

Anyway, I think 1066 tons Chinese consumer demand as reported by the WGC is highly underestimated. To be continued…