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PBOC Gold Purchases: Separating Facts from Speculation

This post is part of the Chinese Gold Market essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated late 2017. 

In this post we will analyze everything there is to learn about PBOC gold purchases. Grasping the exact size of their official gold reserves is unfortunately impossible, assuming they have more than what is publicly disclosed (roughly 1,840 tonnes as of 2017), but there are many clues signalling they’ve covertly bought hundreds if not thousands of tonnes of gold since 2009.

The purpose of this post is to get an overview of all clues and data in order to separate the facts from speculation regarding PBOC purchases. Subsequently, we’ll estimate how much above ground gold is held in China mainland – official (PBOC) and private reserves.

I have been writing for a long time the PBOC does not buy any gold trough the SGE, and therefor PBOC purchases must be seen in addition to the flows of gold going through the famous bourse in Shanghai. Though, it’s necessary to expand on this subject in great detail.

We have a fairly good view on how much gold is going through the SGE and thus how much non-monetary gold is net imported into China from countries like the UK, Switzerland, Hong Kong and Australia (after which it’s not allowed to be exported and thus is accumulated in the mainland). If we add domestic mine supply to imported gold, we can estimate how much gold is held in reserves by the Chinese. But, are any of these visible gold flows bought by the PBOC? Not according to my investigation.

Why The PBOC Does Not Buy Gold Through The SGE

Below are the reasons why I think the PBOC does not buy gold through the SGE.

1) The PBOC prefers to buy gold with US dollars, while all physical gold on the SGE is quoted in yuan.

To get a better grip on this subject it helps if we understand why the PBOC would buy gold in the first place, so let’s sum up all possible incentives. The main objectives for the PBOC to accumulate physical gold are:

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

After reading this list it should be clear the PBOC rather buys gold with their foreign exchange reserves than with renminbi – China’s FX reserves are worth about $3.0 trillion (2017) and mostly held in USD. The amount of gold currently on the PBOC’s balance sheet (roughly 1,800 tonnes) is disproportionate to the amount of USD held. Hence, the PBOC would prefer to exchange USD for gold. All gold on the SGE is quoted in yuan, meaning the PBOC can’t exchange USD for gold through the SGE. Therefor, the PBOC is more likely to buy gold abroad and these purchases should be added to the visible gold flows we see entering the mainland through the SGE.

2) The PBOC would prefer to buy gold in large 12.5 Kg bars, which are relativly more cheaper. 12.5 Kg bars have almost never traded over the SGE.

It should be said the SGE is a subsidiary of the PBOC. In 2002 China’s central bank erected the SGE to develop the domestic Chinese gold market; for the people to trade gold in yuan. The gold bar sizes available on the SGE are 50 gram, 100 gram, 1 Kg, 3 Kg and 12.5 Kg. Though, the volume of 12.5 Kg contracts (Au99.5 and iAu99.5) ever traded on the SGE is close to nil.

Weekly Volume 12.5 Kg Bars Traded On SGE:SGEI (counted unilaterally)

Only the 50g, 100g, 1 Kg and 3 Kg bars are traded, which are consumer sizes. This is a sign the PBOC is not buying gold through the SGE. Gold in large 12.5 Kg bars is relatively cheaper and more attractive for central banks. All central banks, that I know of, hold large bars.     

3) The PBOC would prefer to hide its gold purchases. The reason we don’t know how much Chinese official gold reserves are is because this is the best kept secret in China. The PBOC buys gold in utmost secret or it would influence the market and geo-politics. If we think from the PBOC’s point of view, why would they leave a single trace when buying gold? Why would the PBOC buy any gold through the SGE for the world to see? I think they wouldn’t.

4) The PBOC would prefer to import monetary gold which is exempt from being disclosed in customs reports. Let me explain. All bullion gold trade on this planet that is visible  (that shows up in customs reports) is classified as non-monetary. Monetary gold is exempt from being published in customs reports according to the guidelines in the International Merchandise Trade Statistics 2010 (IMTS) drafted by the United Nations. This is perfect for the PBOC to covertly ship gold to China.

The PBOC, having an incentive to exchange its superfluous USD in the international OTC market for gold, is actually obliged to monetize the gold it buys abroad. And when these purchases are transferred to China they will not be disclosed in foreign customs statistics. Subsequently, monetary gold imported into China does not go through the SGE, as only the non-monetary small gold bars go through the SGE.

All visible gold exports to China, traded over the SGE, are not PBOC purchases.

For more information on global trade rules for monetary and non-monetary gold, please read my blog post The London Bullion Market And International Gold Trade.

5) The PBOC would prefer to buy gold in an OTC market, not over an exchange like the SGE. The majority of global gold trade is done through the London Bullion Market; the most liquid market there is. This is not a central exchange like the COMEX, but an Over The Counter (OTC) market where buyers and sellers connect (electronically) one on one to trade gold without nosy analysts taking notes. The gold traded can be Loco London – located in London – or elsewhere. The London Bullion Market is ideal for the PBOC, as opposed to the SGE.

6) Another reason for the PBOC to buy abroad would be because it’s cheaper. Gold on the SGE often attracts a significant premium over London spot. Why would the PBOC pay that premium? Especially if it’s buying large quantities.

7) There is anecdotal evidence the PBOC covertly imports gold. Gold industry expert Jim Rickards has written in The Death Of Money (2014):

A senior manager of G4S, one of the world’s leading secure logistics firms, recently revealed to a gold industry executive that he had personally transported gold into China by land through central Asian mountain passes at the head of a column of People’s Liberation Army tanks and armored transport vehicles. This gold was in the form of the 400- ounce “good delivery” bars favored by central banks rather than the smaller one- kilo bars imported through regular channels and favored by retail investors.

This is very interesting. Not only because it demonstrates the PBOC prefers 400 ounce (12.5 Kg) bars over 1 Kg bars, but more so because it confirms the PBOC does not import gold through visible channels. This strengthens my analysis the PBOC does not buy any gold through the SGE. Again, all visible import (in general trade) is required to be sold through the SGE in China.

For information on how monetary gold might be imported into China by the military please read my post China’s Gold Army.

8) Early 2017 Jim Rickards was in a meeting with the three heads of precious metals trading desks of large Chinese bullion banks. These gold dealers told Rickards that indeed the PBOC does not buy any gold through the SGE. Jim stated in the Gold Chronicles podcast published January 17, 2017 (at 25:00)[brackets added by Koos Jansen]:

What I [Jim Rickards] don’t know is about the Shanghai Gold Exchange sales, they’re pretty transparent, how much of that is private and how much of that is the government [PBOC]. And I was sort of guessing 50/50, 70/30, whatever. What they told me, and these guys are the dealers [the three heads of the largest bullion banks in China], it’s 100 % private. Meaning, the government operates through completely separate channels. The government does not operate through the Shanghai Gold Exchange. … None of what’s going on on the Shanghai Gold Exchange is going to the People’s Bank Of China.

9) The SGE chairman has stated only consumers buy gold over his exchange. On the LBMA Forum in Singapore on June 25, 2014, a speech was delivered by Xu Luode, then Chairman of the Shanghai Gold Exchange. Below is a snippet from Xu:

Last year, China imported 1,540 tonnes of gold. Such imports, together with the 430 tonnes of gold we produced ourselves, means that we have, in effect, supplied approximately 2,000 tonnes of gold last year.

The 2,000 tonnes of gold were consumed by consumers in China. Of course, we all know that the Chinese ‘dama’ [middle-aged women] accounts for a significant proportion in purchasing gold. So last year, our gold exchange’s inventory reduced by nearly 2,200 tonnes, of which 200 tonnes was recycled gold.

Xu mentions the amount of gold imported into China mainland in 2013 (1,540 tonnes). Would Xu be allowed to break China’s best kept secret on an LBMA forum? Would any of these imports end up at the PBOC? I don’t think so. Moreover, Xu explicitly says all imports and mine output (and scrap supply) has been sold through the SGE system to consumers, not the PBOC.

10) SGE withdrawals are elevated when consumer buying is strong. When examining SGE gold purchases by withdrawals from SGE designated vaults, we can depict a seasonal trend of strong demand around New Year (and in April 2013 and mid 2015). The Chinese people typically buy gold in this period as gifts for each other. Does this trend look like PBOC activity? No.

Shanghai Gold Exchange SGE weekly withdrawals

11) The World Gold Council assumes the PBOC doesn’t buy gold through the SGE. From Understanding China’s gold market, July 2014:

China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. But there are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBoC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.

12) All reliable sources I have regarding the Chinese gold market tell me the PBOC does not buy gold through the SGE. One of these gentlemen, with ties to bullion banks worldwide, confirmed to me proxies of the PBOC purchase gold directly in the London OTC gold market that is shipped to Beijing with “own airplanes” (possibly by the Chinese gold army). In addition, a Chinese banker told me the PBOC buys gold “in the OTC market”, and, “PBOC proxies can deal directly with refineries in Switzerland and Africa, such as Rand and MKS“.

13) The SGE President of the Transaction Department confirmed to Na Liu from CNC Asset Management Ltd. the PBOC does not buy gold through the SGE. Na Liu wrote in a report about 2013 SGE withdrawals:

…none of the 2,200 tonnes of gold was bought by the Chinese central bank. The President said: “The PBOC does not buy gold through the SGE.”

14) The head of a global operations company in security transport leaked in 2013 that 12.5 Kg bars were covertly imported into China for the PBOCWhen I interviewed Alex Stanczyk, currently Managing Director of Physical Gold Fund SP, on 9 September 2013 he told me [brackets added by Koos Jansen]:

One of our partners had lunch in the recent past with the head of the largest global operations company in security transport. He said there is a lot of gold that they’re moving into China that’s not going through exchanges [SGE]. If the gold is for the government they don’t have to declare where it’s going. They don’t have to declare where it’s going in, or where it’s heading.

…We talked to the head of the largest refinery in Switzerland and he told us directly that all that metal that’s coming out of London (904 tons YTD) is being refined into kilo bars and send to China, as well as metal that’s coming in from other areas in the world, that’s all going to China. It’s way more than is being reported or moved through the exchanges. All the kilo bars go to the Chinese people but the PBOC is likely only buying good delivery.

With ‘good delivery’ Alex means the 12.5 Kg large bars that are not being sold through the SGE, but are imported as monetary gold into China without showing up in any country’s customs reports. The quote very clearly indicates that 12.5 Kg bars are imported into China for the PBOC without moving through the SGE. 

I shall rest here. The purpose of the listed arguments is to provide you with as much information about the Chinese gold market and PBOC purchases as possible.

In short: according to my analysis the PBOC does not buy gold through the SGE!

How Much Gold Does The PBOC Hold?

What do we know about how much the PBOC has bought? Allow me to present a few clues:

1) From a study by Zhang Bingnan, Vice President of the China Gold Association, we can read the PBOC buys approximately 500 tonnes a year (August 2012):

Forecast the optimal gold reserve capacity in the next 20 years. The conclusion is: 2020, China’s gold optimal reserves should be 5,787 tonnes – 6,750 tonnes. 2030 should be 8,995 tonnes – 10,532 tonnes.

Estimated PBOC gold reserves growth (by Zhang)

2) Yi Gang, deputy Chinese central bank governor, stated the PBOC is able to buy approximately 500 tonnes a year (March 2013):

We will always keep gold in mind as an option in reserve assets and investments. We are able to import 500-600 tons a year, or more, but we will also take into consideration a stable gold market. If the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers. We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small.

3) Song Xin, President of the China Gold Association, wrote on July 2014 the PBOC should first aim to reach the 4,000 tonnes mark [brackets added by Koos Jansen]:

That is why, in order for gold to fulfill its destined mission, we must raise our [official] 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.

4) According to Deutsche Bank Markets Research the PBOC buys 500 tonnes a year (November 2014):

In another example, the Chinese government’s open market purchases of roughly 500 tonnes per year have not prevented the gold price from plummeting in recent years.

5) Numerous Chinese analyst suggest the PBOC aims to hold 5,000 tonnes in official gold reserves. Roland Wang, World Gold Council China Managing Director, said (March 26, 2015):

China currently holds about 1.6 percent of its foreign exchange reserves in gold, which is relatively low compared with developed countries and some developing countries, WGC China managing director Roland Wang said.

“The ideal amount should be at least 5 percent of its total forex reserves,” Wang told Reuters in an interview in Hong Kong.

Remarkably, the exact same day Reuters published Wang’s statement Chinese newswire Caixin published a story on gold written by Hedge Fund manager Li Sheng (March 26, 2015):

Gold accounts for only 1.6 percent of China’s forex reserves. This is only a fraction of the figure in the United States and many other developed countries. If China ever increased the level to 5 percent, it would have an enormous impact on global demand for gold.

Li mentions the exact same numbers as Wang from the World Gold Council on the same day: 1.6 % and 5 % of total FX reserves. If China would announce they hold 5 % of total reserves in gold, this would translate into roughly 5,000 tonnes.

If the PBOC would have more than 5,000 tonnes of official gold reserves their ‘gold to GDP ratio‘ would be roughly on par with to the US, Europe and Russia. One of the theories about our current international monetary system – that was detached from gold in 1971 – is that it can shift to a new gold anchored system when all power blocks have equalized the chips (Jim Rickards). In other words, if the US, Europe, Russia and China all have an equal ratio of official gold reserves to their GDP, the international monetary system could make a transition towards gold.

Global Official Gold Reserves vs GDP (December 31, 2016)

6) Jeremy East, Managing Director Global Head, Metals Trading, Standard Chartered Bank, stated the PBOC is planning to support the renminbi with gold for internationalization (June 25, 2014):

I was at the Shanghai Derivatives Forum at the end of May and one of the speakers was a representative of the [China] Gold Association. He gave us quite an interesting insight into the flavor of what is going on in China from a strategic perspective. Some of the things he talked about included that China planned to change the landscape of world gold markets. He talked about having a strong currency and about having that currency backed by gold, like the US dollar. He also talked about people holding more gold and encouraging more people to hold gold. That is not just individuals, but also the central bank. …

(By the way, China is not planning to “back” their currency with gold in my opinion, they’re more likely to “support” their currency with gold at no fixed parity.)

7) The PBOC could have bought as much as 1,750 tonnes of gold in London in between 2011 and 2015. Although, it’s virtually impossible to track monetary gold flows around the world, as these are exempt from international merchandise trade statistics, the least we can do is try. In September 2015 Ronan Manly and Nick Laird conducted an investigation with respect to how much monetary and non-monetary gold was present in the UK. Luckily, the London Bullion Market Association (LBMA) had published a few estimates in recent years about the total amount of physical gold in London (monetary and non-monetary). In 2011, there were 9,000 tonnes in London. In 2015, there were 6,256 tonnes in London – likely all in 12.5 Kg Good Delivery (GD) bars. These estimates from the LBMA combined with Manly and Laird their investigation have resulted in the next charts (conceived by Nick Laird, Sharelynx):

LBMAHoldingsAU01

LBMAHoldingsAU05

For a better understanding of physical gold located in London you can read this post by Ronan, this post by Nick or have a look at the next illustration conceived by Jesse from Cafe Americain:

LondonGold11

Remarkably, according to estimates by the LBMA the total amount of gold in London decreased by roughly 2,750 tonnes in the period from 2011 until early 2015, while UK’s customs department discloses only 1,000 tonnes were net exported as non-monetary gold during this period. Implying, 1,750 tonnes have been (covertly) exported as monetary gold.

For more information please read my post The London Float And PBOC Gold Purchases.

UK Gold Trade 2011 - June 2015

8) Dutch newspaper NRC Handelsblad published an article in 1993 about a 400 tonnes gold sale from the Dutch central bank that was partially bought by the PBOC (you can read a translation of the article here). From NRC:

“With 99 percent certainty we know that the People’s Bank of China has been one of the buyers of the Dutch gold”, said Philip Klapwijk from Goldfields Mining Services, an institute in London affiliated with the South African gold mines that specializes in research into the gold market. Also other London bullion dealers have a strong suspicion that China was involved in the gold sales of DNB. “We have noted that the Chinese central bank has bought gold in recent months”, said John Coley of the London bullion dealer Sharp Pixley and spokesman of the London Bullion Market Association.

I should add, in the nineties the PBOC was the primary (monopoly) dealer in the Chinese domestic gold market and in theory could have sold the gold to Chinese jewelry fabricators.

Facts And Speculation

Let’s chew on some numbers. In the first chart below I’ve plotted a conservative estimate of the total above ground gold reserves in China mainland in June 2017. This conservative estimate is based on the assumption the PBOC owned 1,842 tonnes in June 2015 (this is what the PBOC officially discloses), and the rest of imports and mining were added to private holdings.

Estimated Total Chinese Gold Reserves low june 2017

What about the amount of private reserves displayed in the chart? Let me explain my calculations from the starting point in 1994. Precious Metals Insights (PMI) has estimated that 2,500 tonnes of gold where held by population in the mainland in 1994, that’s the dark grey jewelry base you can see in the chart. The PBOC official reserves in 1994 accounted for 394 tonnes. In addition, Chinese domestic mining was 90 tonnes in 1994. Below is a chart showing historic Chinese domestic mining output.

Yearly Gold Mine Production China Mainland

China is said to be a gold “importer since the 1990s”, suggesting domestically mined gold was not exported after 1994. In the next screen shot from the China Gold Market Report 2010 we can read “China has been a gold importer since the 1990s”.

Screen Shot 2015-05-17 at 11.48.53 PM
Courtesy China Gold Market Report 2010

Furthermore, China began importing (non-monetary) gold a few years ago, have a look the next chart that shows historic gold trade between Hong Kong and China. Net imports ramp up in 2010. Other countries than Hong Kong, such as Switzerland, also started to visibly export to China after 2010.

Hong Kong - China gold trade historic

So, the starting point in the first chart on Estimated Total Gold Reserves in 1994 in China mainland is computed as:

2,500 (jewelry base) + 394 (official reserves) + 90 (mining) = 2,984 tonnes

Subsequently, I’ve added annually domestic mining output – as the Chinese didn’t net export any gold since 1994 – and net imports every succeeding year in the chart. I’ve subtracted all PBOC official reserves gains before 2007 from cumulative domestic mining, the gains after 2007 have I have not subtracted from cumulative domestic mining. Why? Two reasons:

  1. The Chinese domestic gold market (SGE) was fully liberalized in 2007 after which I think the PBOC stopped taking in any gold from domestic mines. (Prior to the liberalisation of the Chinese domestic gold market the PBOC was the primary dealer.)
  2. According to my calculations, from 2003 until 2009 total Chinese gold supply (scrap + mine + import from Hong Kong) wasn’t sufficient to meet total consumer demand and 454 tonnes in PBOC purchases over that period. Although the PBOC claims all purchases before 2009 were done from domestic mines and scrap, I don’t think that’s possible. Hence, I think the PBOC started invisible import somewhere in between 2003 and 2009. And therefor, anything the PBOC added to its official gold reserves after 2007 I did not subtract from cumulative domestic mining.

Lead by the aforementioned calculations, the PBOC had accumulated 1,843 tonnes and the Chinese private sector 16,193 tonnes in June 2017 2016 (in total 18,036 tonnes). This does not capture gold in the black market, that thrived before 2002, neither any assets from wealthy Chinese families. It’s the most conservative estimate I can make using all data I could find.

However, in my opinion the PBOC has bought a lot more gold in recent years. What all the clues mentioned above have in common, is that the PBOC has bought roughly 500 tonnes of gold per year since 2009. Let’s make a new more speculative chart:

Estimated Total Chinese Gold Reserves high June 2017

The above chart is a copy of the previous conservative estimate, supplemented by 500 tonnes per year since 2009 in PBOC purchases, which I have not subtracted from cumulative domestic mining or cumulative import, as my assumption is this gold has invisibly been imported and not bought through the SGE. (I stopped adding 500 tonnes per year after 2015 because evidence is lacking.)

Speculating: the PBOC has accumulated at least 4,000 tonnes and the Chinese private sector 16,193 tonnes as of late June 2017 (in total 20,193 tonnes).

Addendum

Above you could read clues from Song Xin (China Gold Association, July, 2014) and Jeremy East (June 25, 2014) about China working on a ‘new monetary system’ that will include gold. Something similar was said by Zhou Ming, General Manager of the Precious Metals Department at ICBC, when Jeremy East asked him at the LBMA forum in Singapore (June, 2014) if the statement “Western gold moves East” was true:

With the status of the US dollar as the international reserve currency is shaky, a new global currency setup is being conceived. Uncertain changes will happen to gold’s traditional dollar-pricing so the US dollar’s influence on gold pricing needs to be re-evaluated.

But, of course, this could also relate to Ming bragging about renminbi internationalisation.

Why SGE Withdrawals Equal Chinese Gold Demand And Why Not – The Argument List

This post is part of the Chinese Gold Market Essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated in 2017. 

The difference between SGE withdrawals and Chinese consumer gold demand as disclosed by GFMS has aggregated to a staggering 6,032 tonnes from 2007 until 2016 (the period this article will focus on). To explain the difference, GFMS and other Western consultancy firms have presented several arguments in publications and lectures at conferences throughout the years, though none of them can really explain the difference in full. This post is an overview of all such arguments – supplemented by my own arguments.

Chinese Gold Supply & Demand sge gfms
Exhibit 1.

The reason I tend to compare SGE withdrawals to Chinese gold demand as disclosed by  GFMS, and not Metals Focus or CPM Group, is because the GFMS is globally the easiest (free) accessible data source for investors (next to the World Gold Council). Usually investors and news agencies worldwide consult GFMS (or WGC) for supply and demand statistics, which make this the most important firm to test for accurate numbers. Below we’ll examine to what degree the arguments can or cannot have caused the difference.

This is the argument list (by GFMS, WGC and CPM Group) in chronological order:

  1. Industrial demand (August 2013)
  2. Stock movement change (August 2013)
  3. Round tripping (April 2014)
  4. Leasing (April 2014)
  5. Official purchases (April 2014)
  6. Recycled distortion (November 2014, February 2015, March 2016)
  7. Export (May 2015)
  8. Chinese commercial banks’ balance sheets 
  9. Financial statement window dressing (March 2016)
  10. Retailers selling unsold inventories directly to refiners (March 2016)

These are my arguments:

  1. The Shanghai International Gold Exchange
  2. Smuggling

In 2014 the World Gold Council (WGC) came out with two special reports about the Chinese gold market that for the first time ‘should have’ shine a light on the difference (China’s Gold Market: Progress And Prospects from April 2014, and Understanding China’s Gold Market from August 2014). However, these reports contained many false statements and the segments on the difference failed miserably. As I’ve pointed out in several posts (one, two, three, four, five, six, seven, eight).

Surprisingly, after the reports were published and I had debunked the arguments in it, the WGC and GFMS swiftly came up with brand new arguments. Note this shift in arguments; when the old ones failed, the firms impudently moved on and came up with new ones. The fact the argument list is constantly changing confirms the weakness of all arguments it holds, and the apparent ‘ignorance’ of Western consultancy firms regarding the Chinese gold market. (By the way, eventually in late 2016 I found out why Western consultancy firms lie about Chinese gold demand, which is explained in my post The Great Physical Gold Supply & Demand Illusion.)

First, let’s go through all the arguments to investigate which ones make any sense. At the end of the post we’ll do some number crunching.

1) INDUSTRIAL DEMAND. The first argument ever presented to me came from the WGC. In August 2013 I’ve asked the Council what their explanation was for the difference between their Chinese gold demand numbers and demand as disclosed in the CGA Gold Yearbooks co-written by the PBOC – the latter exactly equals SGE withdrawals. They replied to me by email:

The data that we publish in Gold Demand Trends are collected for us by Thomson Reuters GFMS. Our data represent jewelry and bar & coin demand and do not incorporate any industrial demand or fabrication, which is included in the PBoC figures. As I am sure you will appreciate, data collection of this sort relies on a number of proprietary sources and these will not necessarily be the same for both GFMS and PBOC. It is, therefore, perhaps not surprising that the estimates of demand differ somewhat.

The WGC identified a gap of, at that point, 2,000 tonnes of gold with industrial demand. Not very credible. Additionally, in Q1 2015 the WGC started including industrial demand (technology) in its data, and as far as I know GFMS has always included industrial demand in its data. So, for our comparison of SGE withdrawals versus GFMS demand this argument is irrelevant.

2) STOCK MOVEMENT CHANGE. When I asked GFMS in August 2013 about net investment – which is how the difference was titled in the CGA Gold Yearbooks – they wrote me by email:

We have checked with our Data Specialist and confirmed that we use a different methodology. Total Chinese demand used by Thomson Reuters GFMS only includes jewelry, physical bullion bars/coins and all industrial demand. Any stock movement change (which is essentially the item 6 net investment) will not be included as underlying demand.

Me:

So according to you category six is “stock movement change”? This would be gold added to the stocks from jewelers, the mint, industrial companies, etc? (this is a few hundred tons each year!)

GFMS:

That’s correct based on the resolution provided by our data specialist.

Because SGE withdrawals capture wholesale demand the difference is partially what jewelry companies, refineries, industrial companies and the mint have purchased at the SGE, but not yet sold in retail. And so, stock movement change is a legitimate argument, though the amount of gold in stock can never explain the full difference of 6,032 tonnes.

According to an estimate by the WGC as much as 125 tonnes of gold can have been absorbed as inventory in the Chinese domestic gold market from 2009 until 2013:

… It is, however, indicative that as jewelers expanded, so too did their inventory levels and it is our judgment that across the industry between 75t to 125t may have been absorbed in the supply chain since 2009.

Stock movement change is a legitimate argument and its volume, 125 tonnes, will be taken into account for our calculation of true Chinese gold demand at the end of this post. I will stick to the number 125 because in my opinion the jewelry and coin industry in China hasn’t grown since 2013 (meaning inventory stayed flat).

3) ROUND TRIPPING. In April 2014 the WGC published a report titled China’s Gold Market: Progress and Prospects. It certainly was not the first WGC report on China – in 2010 China Gold Report was released – but it was the first time the Council elaborated on the structure of the Chinese gold market, the Shanghai Gold Exchange and the “supply surplus” in the Chinese gold market. Logically, the Council had some explaining to do, as it was clear China imported substantially more gold than what they disclosed as demand.

For the first time Chinese Commodity Financing Deals (CCFD) were introduced to the Council’s wide reader base. This type of financing is pursued to acquire cheap funds. It can be done trough round tripping or gold leasing. The Council wrote:

These operations fall into two broad categories, although there is some overlap between the two. Firstly, there is the use of gold via loans and through letters of credit (LCs) as a form of financing. Secondly, 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 other cases the metal is stockpiled in vaults in China or Hong Kong.  

In particular the part in bold is not true, as we could read in my previous posts Chinese Cross-Border Gold Trade Rules and The Chinese Gold Lease Market And Chinese Commodity Financing Deals Explained. Basically, round tripping gold flows are completely separated from the Chinese domestic gold market and the SGE system, therefor they can not inflate SGE withdrawals. 

So round tripping is not a legitimate argument. To my understanding the WGC has abandoned this argument all together, though GFMS still thinks round tripping inflates SGE withdrawals. In their Gold Survey 2015 it’s written (page 78):

…the round tripping flows between Hong Kong and the Chinese mainland, which also inflates the SGE turnover and withdrawal figures…

4) GOLD LEASING. The other CCFD is leasing. In the WGC report from April 2014 it’s stated:

No statistics are available on the outstanding amount of gold tied up in financial operations linked to shadow banking but Precious Metals Insights [PMI] believes it is feasible that by the end of 2013 this could have reached a cumulative 1,000t…

PMI insinuated 1,000 tonnes is tied up in CCFDs, but as I’ve clearly demonstrated in The Chinese Gold Lease Market And Chinese Commodity Financing Deals Explained, this is not true. There is no need to go over this again – if you wish please read my previous post for a detailed analysis. (Even the WGC has turned its back on this argument.)

5) OFFICIAL PURCHASES. Often it’s being thought in the gold space SGE withdrawals end up in the vaults from the People’s Bank Of China (PBOC). Early 2014 the WGC (in China’s Gold Market: Progress And Prospects) speculated the difference could be explained by official purchases, though, later that year the Council changed its mind. From the July 2014 WGC report on China, Understanding China’s Gold Market, we can read:

China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. But there are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBoC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.

In my post PBOC Gold Purchases: Separating Facts from Speculation I’ve analyzed why the PBOC does not purchase gold through the SGE. The firms (WGC and GFMS) must agree with me by now and thus official purchases cannot make up the difference we’re after.

6) RECYCLED DISTORTION. The most obvious argument to explain elevated SGE withdrawals, one would think, is recycled gold through the bourse counted over and over as withdrawn. However, SGE rules state bars withdrawn are not permitted to re-enter the vaults before being remelted and assayed by an SGE approved refinery. Which is not say it doesn’t happen.

Arguments presented by the firms regarding recycled gold must be divided in subcategories. There is process scrap, arbitrage refining, and there are VAT schemes.   

6.1) Process scrap. This argument was first presented by CPM Group. In short, CPM states industrial companies produce 50 – 70 % scrap supply of the gold used in manufacturing. The scrap spillover flows directly back to the SGE. Process scrap thus inflates SGE demand and supply, because the gold was bought at the SGE (demand), but a significant part flows back to the SGE (supply). The part that is recycled through the SGE has no impact on the price.

Although, it’s unknown how much of process scrap actually flows back to the SGE or is brought to a refinery for toll refining (a refinery producing bars or wire from the process scrap for the industrial company in return for a fee).

Process scrap, described first in detail by Jeffrey Christian in November 2014 in the chapter “CPM Group” at the very end of this post, is a form of recycled distortion, and is a legitimate argument.

6.2) Arbitrage refining. This argument was brought forward by GFMS on 17 February 2015 at the Reuters Global Gold Forum when Jan Harvey interviewed Samson Li (GFMS).

Jan Harvey:

Some people see withdrawals on the Shanghai Gold Exchange as a proxy for Chinese demand. Do you think this is valid?

Samson Li:

It depends on the methodology used. For example there are refiners that would, at times, withdraw 9995 gold bars from the SGE, refine it into 9999 bars whenever there is profitable opportunity, and then deposit it back into SGE vault……

Presumably, there can be an arbitrage opportunity at the SGE if Au99.95 gold is an X percentage cheaper than Au99.99 gold. Such a spread would be a classic example of one of the contracts being under or overvalued relative to the other.

I’m not a trader, but I can imagine a way to close the arbitrage through gold leasing. This is my theory: if a spread occurs Au99.95 is bought, concurrently Au99.99 (LAu99.99) is borrowed and immediately sold. Then the Au99.95 is withdrawn, refined into Au99.99 and returned to the lender.

If the arbitrage described above exists, inter alia depends on the speed to which a lease contract can be settled. If a spread occurs and the refiner has to wait 2 days before it can take delivery of Au9999, the arbitrage won’t fly. I’ve asked the ICBC gold lease desk what would be the fastest possibility to sign a lease contract. They told me usually it takes several days or weeks as the lessee’s credit rating must be determined. Though, for regular customers the lease ca be executed in one hour.

It’s hard for me to say if arbitrage refining is really possible according to the aforementioned theory, because it depends on many variables and the established relationship between lessor and lessee. In addition, why would anybody sell Au99.95 if it was undervalued? In my opinion the argument that arbitrage refining inflates SGE withdrawals can be doubted.

6.3) VAT schemes. This argument brought forward by GFMS in The Gold Survey 2016 is legitimate. Though, it’s unknown to what extent it has been used. Read more about the value-added tax system in China’s domestic gold market by clicking here, and read why I think the VAT scheme can only have had a limited impact on SGE withdrawals in the chapter “Tax Avoidance” in this post.

7) EXPORT. This argument was brought forward by PMI. On a conference in London (2 May 2015) Phillip Klapwijk, Managing Director of Precious Metals Insights Limited (PMI), stated China exports about 1,000 tonnes a year from the domestic gold market. However, at this stage the rules prohibit gold export from the Chinese domestic gold market. I’ve written an extensive analysis on Klapwijk’s presentation (click to read), no need to go over this again here. The export argument is not legitimate.

8) CHINESE COMMERCIAL BANK BALANCE SHEETS. Over the years, on countless gold blogs the “precious metals” (more than 2,500 tonnes by now) on Chinese commercial banks’ balance sheets have been identified as the “surplus” in the Chinese gold market. But not according to my research. After a thorough study I think the gold on the banks’ balance sheets reflect a mixture of GAP gold, retail inventory, gold held for hedging, gold outside China, but most importantly back-to-back leasing and synthetic leasing. The leasing business by banks can make it appear the banks “own” gold assets, while in fact it’s just accounting that makes it seem that way.

For a full analysis read my post What Are These Huge Tonnages In “Precious Metals” On Chinese Commercial Bank Balance Sheets?. The commercial bank balance sheets are not a legitimate argument in my very humble opinion.

9) FINANCIAL STATEMENT WINDOW DRESSING. Another argument that was presented by GFMS in their Gold Survey 2016. In short, the argument is false. If you want to know why please read the chapter “Financial Statement Window Dressing” in this post.

10) RETAILER SELLING UNSOLD INVENTORIES DIRECTLY TO REFINERS. Another argument that was presented by GFMS in their Gold Survey 2016. The argument can be true. If you want to learn more please read the chapter “Retailers Selling Unsold Inventories Directly to Refiners” in this post.

11) THE SHANGHAI INTERNATIONAL GOLD EXCHANGE. This argument was conceived by myself. As we could have read in The Workings Of The Shanghai International Gold Exchange (and SGE Withdrawals In Perspective)the gold withdrawn from the SGEI vaults in the Shanghai Free Trade Zone (SFTZ) – note, this tonnage is included in “SGE withdrawals” – can, (i) either be imported into the Chinese domestic gold market, or, (ii) exported abroad and thereby distorting Chinese wholesale gold demand when measured by SGE withdrawals. However, up until December 2015 we know SGEI withdrawals have rarely been exported abroad, according to several sources.

Another way of checking possible SGEI withdrawals that have been exported abroad is simply examining the gold imports of all countries on earth from China since 2014. As far as I can see the exports from China have been tepid. For example, 7 tonnes were exported to Thailand in 2015 and 8 tonnes to the UK in 2016, but that’s about it. Except for Chinese exports to Hong Kong: in 2016 these accounted for roughly 90 tonnes. But, most likely this gold didn’t come from the SFTZ (SGEI), but from the Shenzhen Free Trade Zone just across the border from Hong Kong where China’s jewelry manufacturing base is located. Gold export from the Shenzhen Free Trade Zone to Hong Kong has existed long before the SGEI was erected (and these flows are offset when I compute net gold flows into China from Hong Kong). How it works is that Shenzhen gold manufacturers import gold through processing trade, fabricate the materials into jewelry and ornaments after which the finished products are exported through processing trade back to Hong Kong where they are sold locally or distributed across Asia.

All in all, I’m still not seeing a lot of gold being withdrawn from SGEI vaults and exported abroad.

One last possibility that would inflate “SGE withdrawals” is when (Asian) central banks buy gold on the SGEI, after which it’s withdrawn and exported. Because central banks can monetise gold, which is exempt from being disclosed in customs data, we would never see these exports out of the SFTZ. Effectively we would only see export to China and high SGE withdrawals, while gold is withdrawn in the SFTZ and covertly exported abroad. At this point not a very plausible scenario because SGEI gold trades at a premium from gold in London, Singapore, Hong Kong, etc, but certainly possible.

12) SMUGGLING. Naturally, smuggling can cause SGE withdrawals to be inflated. Indians could buy gold in Shenzhen, withdraw from the SGE vault and smuggle it home. Although, we have no numbers on smuggling so I can’t take it into account for our calculation of true Chinese gold demand.

How Much Is True Chinese gold Demand?

The answer is we don’t know. But we can set a lower and upper bound. Remember the equations and the graph from The Mechanics Of The Chinese Domestic Gold Market

True Chinese Gold Demand = Import + Mine + Scrap Disinvestment = SGE Withdrawals – Recycled Distortion

chinese-domestic-gold-market-supply-demand-balance-examplexs
Exhibit 2.

Unfortunately we don’t know how much disinvestment is in China, and as a consequence neither do we know recycled distortion. But we’ll set the lower bound by apparent supply and upper bound by SGE withdrawals, and work from there.

From 2007 until 2016 apparent supply in the Chinese domestic gold market – assuming all net exports from the UK, Switzerland, Australia and Hong Kong went to the domestic market and SGEI vault inventory is insignificant – was 12,183 tonnes, and total SGE withdrawals over this period accounted for 13,388 tonnes.

data china 2007 2016 gold
Exhibit 3.

So the lower bound of true Chinese gold demand over 2007-2016 was 12,183 tonnes, and the upper bound was 13,388 tonnes. Adjusting the upper bound by wholesale inventory increase (125 tonnes) makes 13,263 tonnes. Effectively, true Chinese gold demand must have been somewhere in between 12,183 tonnes and 13,263 tonnes (instead of the 7,356 tonnes GFMS has presented the world). Let’s, for the sake of simplicity, take the middle of the 12,183 and 13,263 as a number for true Chinese gold demand to work with – which is 12,723 tonnes.

The gap between GFMS demand (7,356 tonnes) and our estimate of true demand (12,723 tonnes) is a staggering 5,367 tonnes. It’s impossible to deny this immense tonnage has not been demand from high net worth individuals and institutions, purchased directly at the SGE. Although, the remaining difference between 12,723 tonnes and 13,263 tonnes could have been caused by process scrap, VAT schemes, retailers selling unsold inventory to refiners etc.

Ironically, the WGC wrote in its recent GDT Q2 2017:

Purchases made directly from the SGE continued to gain traction accounting for a significant proportion of Q2 bar demand. Investors benefit from better pricing bars from the SGE are usually 5-10 yuan per gram lower than those bought from commercial banks – and a sense of security from knowing they are buying gold from a trusted provider. With a minimum lot size of 100 gram direct withdrawals from the SGE largely serve China’s high net worth individuals.

Finally, after four years of debating (between me and the WGC/GFMS)  the WGC admits that the majority of the difference simply reflects direct purchases of high net worth individuals and institutions at the SGE. Case closed.

To this date, October 2017, I still think SGE withdrawals provide a useful indicator of Chinese wholesale gold demand.

The Chinese Gold Lease Market And Chinese Commodity Financing Deals Explained

This post is part of the Chinese Gold Market Essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated late 2017. 

The main arguments presented by Western consultancy firms, such as GFMS and the World Gold Council (WGC), to explain the difference between SGE withdrawals and Chinese consumer gold demand relate to Chinese Commodity Financing Deals (CCFDs). However, this analysis is incorrect as I will demonstrate in this post.

CCFDs are used by Chinese speculators to acquire cheap funds using commodities as collateral. When it comes to using gold as collateral for CCFDs there are two options: round tripping and gold leasing. First we’ll discuss round tripping.

Round Tripping

Goldman Sachs (GS) has properly described the round tripping process in a report dated March 2014. We’ll start by reading a few segments from GS about financing deals [brackets added by me]:

While commodity financing [round tripping] 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

Important to understand is that gold in round tripping needs to be physically imported into China and then exported, in contrast to copper. The reason for this, which GS fails to mention, is that the cross-border trade rules for gold in China are different than for all other commodities. Only through processing trade gold can be imported into China mainland by enterprises that do not carry a PBOC gold trade license. Round tripping by speculators can only be done through processing trade, as it’s not possible through general trade to ship gold into China without a PBOC license. Consequently, round tripping flows are completely separated from the Chinese domestic gold market where the SGE operates. And hence, round tripping cannot inflate SGE withdrawals.

Only by bending the rules – set up a fake jewelry enterprise in a CSSA – speculators can import gold to round trip. By using processing trade, in order to import gold into China, speculators are required to subsequently export the exact same amount of gold, because these speculators pretend to be jewelry manufacturers importing gold for genuine production, which upon completion must be exported. This is why the gold is round tripped. The requirement for export in processing trade can be read in the official PRC Customs Supervision and Administration of Processing Trade Goods Procedures (2004):

“Processing trade” shall refer to the business activity of import of operating enterprises of all or some raw and auxiliary materials, components, parts, mechanical components and packing materials (Materials and Parts) and the re-export thereof as finished products after processing or assembling.

Now we can understand why GS wrote [brackets added by me]:

Specifically, gold financing deals [round tripping] involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China… 

The speculators export semi-fabricated gold products to keep up the appearance they are genuine gold fabricators, for which the gold imported must be processed and exported.

On a side note, the amount of gold used in round tripping can be at most the amount of gold yearly exported from China (to Hong Kong). Though the total exported gold will also contain genuine processing trade, so round tripping will likely be less than this amount.

Round tripping does not inflate net export from Hong Kong to China, only gross trade. The net amount of gold imported into China is shipped through general trade, via the SGE, into the Chinese domestic gold market and is prohibited from being exported.

Hong Kong - China gold trade

In the chart above we can see China exported 330 tonnes to Hong Kong in 2013. Let’s guess 200 tonnes of that was genuine processing trade (jewelry manufactured in a Chinese CSSA).

330 – 200 = 130 tonnes

Possibly, there was 130 tonnes imported into China for round tripping and subsequently exported back to Hong Kong. Or, 10 tonnes was imported into China for round tripping and subsequently exported to be round tripped an additional 12 cycles, making 13 rounds in total.

13 x 10 = 130 tonnes

In the latter scenario a lot less physical gold is involved (10 tonnes versus 130 tonnes). In reality it’s more likely a gold batch used in round tripping is making multiple rounds than one round.

The Chinese Gold Lease Market

The other gold financing deal that can be conducted by Chinese speculators is gold leasing (which is the same as gold lending). In general gold leasing is a normal market practice.

To become familiar with the lease market I have categorized all potential gold lessees (borrowers) in three groups for us to have a look at examples (with US dollars) of how gold lending is done in financial markets:

  1. A gold miner needs funds to invest in new production goods. It can borrow dollars from a bank at a 7 % interest rate, or borrow gold at 2 % – the gold lease rate is usually lower than the dollar interest rate. The miner chooses to borrow 10,000 ounces and sells it spot at $1,500 an ounce. The proceeds are $15,000,000 that can be used to invest in new production goods. In a years time the miner has mined 10,200 ounces to repay the principal debt plus interest (the interest on gold loans can be settled in gold or dollars, depending on the contract). Through gold leasing the miner has acquired cheap funding compared to a dollar loan.
  2. A jeweler needs funds to buy gold stock for production. It can borrow dollars from a bank for 7 %, or borrow gold for 2 %. The jeweler borrows 10,000 ounces of gold, with which it can start fabricating jewelry. To hedge itself against price fluctuations the jeweler can sell spot, for example, 10 % of the 10,000 ounces it has borrowed (1,000 ounces at $1,500 makes $1,500,000) to buy gold futures contracts in order to lock in a future price. After a year the jeweler has sold the 9,000 ounces (as jewelry) for dollars and can take delivery of the long futures contracts to repay the gold loan.
  3. A speculator is looking for cheap funds. It can borrow dollars from a bank for 7 %, or borrow gold for 2 %. He borrows 10,000 ounces and sells it spot at $1,500 an ounce. The proceeds are $15,000,000 and subsequently these newly acquired funds can be used to invest in higher yielding products (> 2 %). If the trader chooses to hedge itself in the futures market is up to him. After a year the 10,000 ounces plus interest need to be repaid, either the trader can purchase gold with the profits made on the higher yielding investment or from delivery of futures contracts.

In China gold leases are settled and transferred through the SGE. The mechanics of the lease market in China was best described in an essay by the PBOC from 2011:

…the SGE provides a crucial role in gold leasing. The SGE’s block trading system is the trading platform used by gold leasing participants; the SGE also provides transfer and settlement services.

China’s gold leasing does not involve the central bank. Gold leasing takes place between commercial banks and enterprises as well as between commercial banks, the former being key.…

  1. An enterprise that intends to be a lessee approaches a branch office of a commercial bank with a rate request and application.
  2. The commercial bank carries out due diligence and then submits a review to their head office for approval.
  3. Upon approval the head office quotes a lease rate with the international gold lease rate as a benchmark plus additional basis points taking into account the potential lessee’s credit, physical gold management costs and other factors.
  4. If the potential lessee accepts the offer, a commercial bank branch manager will sign a lease contract with the customer including the terms and conditions clearly laid out.
  5. According to the “Shanghai Gold Exchange Lease Transfer Procedure”, after signing the lease, the head office of the commercial bank and lessee, or his agent, shall make a lease application through the exchange’s membership system. After verification, the SGE shall transfer the commercial bank’s gold from its SGE bullion account to the lessee’s SGE bullion account. The lessee can now trade the physical gold that it has leased or withdrawal the gold from the vaults.
  6. Upon expiration of the lease the lessee shall deposit or purchase physical gold through the SGE to repay the gold. Corresponding physical gold will be transferred from the lessee’s SGE bullion account to the commercial bank’s bullion account. Leasing fees involved will be settled in currency. At this point, the lease is completed.

I would like to insert a comment supplementing the PBOC’s description of gold leasing in the Chinese domestic gold market. In the paper it says:

“After verification, the SGE shall transfer the commercial bank’s gold from its SGE bullion account to the lessee’s SGE bullion account. The lessee can now trade the physical gold that it has leased or withdrawal the gold from vaults.”

My source at ICBC’s precious metals trading desk told me ICBC has little gold of itself for leasing, most of the gold lend out is sourced from third parties. These parties are either SGE members or overseas banks that supply gold through the Chinese OTC market. ICBC operates in the lease market as an intermediary by connecting supply and demand, it can lease from international banks or local gold owners with an SGE Bullion Account and lend the gold to miners, jewelers or speculators. My suspicion is that the international gold lease rate is lower than the Chinese gold lease rate, which can attract gold from the international market into the Chinese domestic gold market.

The Chinese lease market in short: in China all gold leases are settled through the SGE (there can be an off-SGE lease market, but it would be highly illiquid). Both lessor (lender) and lessee (borrower) are required to have an SGE Account. If a lease is agreed between two parties gold is transferred from one SGE Bullion Account to the other, when the lease comes due the gold is returned. At SGE level it’s as simple as that.

There is a big difference between jewelers that lease gold in contrast to miners and speculators. Jewelers lease gold because they need physical gold for fabrication; miners and speculators lease gold because they are seeking cheap funds, they will always sell spot the leased gold (without withdrawing the metal) at the SGE to use the proceeds. Why would a speculator withdrawal the metal?

Therefor, if SGE withdrawals capture leased gold this is for genuine jewelry fabrication that eventually ends up at retail level. When a jeweler needs to repay the lease it simply buys gold at the SGE to subsequently transfer it from its SGE Bullion Account to the lessor’s SGE Bullion Account. It’s not likely a jeweler would buy gold off-SGE to repay a lease, which then would need to be refined into newly cast bars by an SGE approved refiner to enter the SGE vaults. Gold leasing by jewelers can increase SGE withdrawals (for genuine gold business) but not so much supply to the SGE.

In a report the World Gold Council (WGC) released in April 2014, China’s gold market: progress and prospects, it was stated:

… No statistics are available on the outstanding amount of gold tied up in financial operations … but Precious Metals Insights [PMI] believes it is feasible that by the end of 2013 this could have reached a cumulative 1,000t…

This 1,000 tonnes figure is based on a misunderstanding regarding the Chinese gold lease market. PMI assumed there was 1,000 tonnes of gold tied up in financing deals based on the yearly lease volume in China, which was 1,070 tonnes in 2013. However, the yearly lease volume is not the gold that is leased out at any point in time, but reflects the aggregated volumes disclosed on all lease contracts that are executed over one year’s time in the Chinese domestic gold market (turnover). Meaning, if 100 mining companies lease 2 tonnes of gold for 1 month in 2016 and all leases are rolled over 4 additional months, the yearly lease volume would be 1,000 tonnes (100 x 2 x (1 + 4)), while on 31 December 2016 the total amount of gold leased out could be nil. (It’s impossible there was 1,000 tonnes used in round tripping as gross export from China has never been more than 330 tonnes)

In addition, the WGC used the words ‘tied up‘ for the gold used in financing operations, which sounds as if the market will be flooded when the gold is untied. The words ‘tied up’ can be misleading, let me explain: If a speculator borrows gold he will promptly sell it spot, this gold will not leave the SGE system. During such a lease period there is nothing tied up, there is just a debt to be repaid. When the lease comes due the lessee has to buy gold in the market (SGE) to settle the debt, which is the opposite of what the WGC insinuates what happens when gold is untied. In case a jewelry company leases gold the words tied up are more appropriate, in my view, as the borrowed gold bars are in transit from being processed to being sold as jewelry. Gold involved (tied up) in these leases can only be a share of the total amount of gold leased out in any point in time, because we all agree most leases in China are done for financing. There is only a small percentage of total gold loans tied up by jewelry companies.

Phillip Klapwijk, analyst with Precious Metals Insights (PMI) in Hong Kong, previous Executive Chairman of Thomson Reuters GFMS and consultant for the World Gold Council, has stated:

… a good part of the withdrawals represent gold that is used purely for financing and other end-uses that are not equivalent to real consumption.

Needless to say I don’t agree for the reasons just mentioned regarding gold leasing (speculators and miners borrowing gold will never withdraw the metal). Am I the only one? No. When Na Liu of CNC Asset Management Ltd, visited the SGE in May 2014 he spoke to the President of the SGE Transaction Department. From Na:

First, the withdrawal data reflects the actual gold wholesales in China. In 2013, the total gold withdrawal from the SGE vaults amounted to 2,196.96 tonnes. The President of SGE Transaction Department (The President) said: “This 2,200 tonnes of gold, after leaving our vaults, they entered thousands of Chinese households in the form of jewellery and investment purchases.”

… Second, none of the 2,200 tonnes of gold was bought by the Chinese central bank. The President said: “The PBOC does not buy gold through the SGE.”

… Third, the financing deals do not exaggerate SGE’s assessment of China’s gold demand. This is because “the financing deals do not take place after the gold leaves the vaults.”

The President of the SGE’s Transaction Department is clearly stating most leasing happens within the SGE system and this metal is not withdrawn. Therefor, gold leasing by speculators does not inflate SGE withdrawals and thus does not explain the difference between SGE withdrawals and Chinese consumer gold demand as disclosed by the GFMS.

Remarkably, when I asked the WGC about the details in 2014 they replied [brackets adde by Koos Jansen]:

Gold leasing: Banks have built up this business to support China’s burgeoning gold industry. Miners, refiners and fabricators all have a requirement to borrow gold from time to time. For example, fabricators borrow gold to transform into jewelry, sell and then repay the bank with the proceeds. It is an effective way for the fabricator to use the bank’s balance sheet to fund its business. Banks have strict policies in place for who they can lend to, and these have been tightened over recent years, but during PMIs field research it identified that, in some instances, organizations other than genuine gold business had used this method to obtain gold, which it would then sell to obtain funding [in this case the gold wouldn’t be withdrawn from the SGE vaults]. It would then hedge its position. According to PMI, this can generate a lower cost of funding than borrowing directly from the bank. Our colleagues in China think this would be a very small part of total gold leasing; the majority of it would be used to meet the demands of genuine gold businesses.

In their email the World Gold Council admits gold leases that are withdrawn from the SGE vaults are used for genuine gold business and being part of true gold demand. This is more confirmation gold leasing cannot explain the difference.

More recently (August 2016) the World Gold Council officially stated little borrowed gold leaves the SGE system [brackets added by me]:

Over recent years we have observed a rising number of commercial banks participating in the gold leasing market. … It’s estimated that around 10% of the leased gold leaves the SGE’s vaults. The majority is for financing purposes and is sold at the SGE [and stays within the SGE vaults] for cash settlement.

In conclusion, (i) round tripping gold flows are completely separated from the Chinese domestic gold market (SGE) and therefor cannot have caused the difference. In addition, (ii) gold leasing only inflates SGE withdrawals when used for genuine gold business and therefor cannot have caused the difference either.

More detailed information about the Chinese gold lease market can be found in my posts A Close Look At The Chinese Gold Lease Market, Gold Chat About The Chinese Gold Lease MarketZooming In On The Chinese Gold Lease MarketChinese Gold Leasing Not What It Seems and Reuters Spreads False Information Regarding The Chinese Gold Lease Market

Gold In London & Hong Kong Is Used To Settle COMEX Futures

Physical gold located in Hong Kong and London is used to settle COMEX gold futures contracts through “Exchange For Physical” trading in the over-the-counter market.

This post is a sequel to Understanding GOFO And The Gold Wholesale Market and COMEX Gold Futures Can Be Settled Directly With Eligible Inventory – in which Exchange For Physical (EFP) trading is explained and how it can increase or decrease open interest at the COMEX. If you’re new to this subject it’s advised to first read my previous posts.

Most gold analysts surmise COMEX 100-ounce gold futures contracts (GC) can only be physically settled through taking and making delivery. This is technically true when excluding the possibility of EFP trading in GC through the over-the-counter (OTC) market. While on Exchange trading in GC is “executed openly and competitively”, trading GC in the OTC realm (and thus the price of the gold, its form and location) is a “privately negotiated transaction” between buyer and seller. The COMEX is a subsidiary of CME Group, which offers its clients OTC trading on a platform called ClearPort.

Because the COMEX in New York is the most liquid gold futures exchange globally – offering precious metals futures denominated in the world most used currency the US dollar, gold industry participants use GC for a variety of reasons, including hedging metal held outside the contract’s deliverable geography. Subsequently, the contracts can be physically “settled” anywhere at any price through EFP.

In EFP two parties sign a futures contract (short and long) and simultaneously execute a reverse spot transaction (buy and sell). One side sells short the futures contract and buys spot gold (the spot leg is referred to as the related position by CME), while the other buys long the futures contract and sells the related position. EFP trading can increase the open interest, decrease the open interest, or not change it, depending on the existing positions held by both parties before they enter into an EFP transaction. When EFP decreases the open interest the phrase “settle positions” is applicable. Another way of saying it would be “offsetting positions” or “netting out positions”.

Let us have a look at a real life example. The next picture was sent to me by data wrangler and gold specialist Nick Laird (website Goldchartsrus.com). It’s taken from the book The Prospect for Gold: The View to the Year 2000 by Timothy Green. In the excerpt the author describes how the Russians sold their gold in Switzerland during the eighties.

screen-shot-2016-12-05-at-12-59-56-pm
Exhibit 1.

This example matches my previous one regarding EFP (hedging metal held outside the contract’s deliverable geography). Any bullion bank, miner or refinery can sell short on COMEX and when the gold needs to be physically “settled”, for example in Switzerland, the short position can be unwound through EFP. The only requirement is that “the quantity of the related position component … must be approximately equivalent to the quantity of the Exchange component” – meaning the spot leg must be more or less 100-ounces of gold, which is the underlying asset of GC. In this example the GC short holder connects through CME ClearPort to Exchange For Physical. In the EFP transaction he will buy long a futures contract and simultaneously sell spot. His long and short will then be netted out while he sells spot the physical in Switzerland. Effectively, a COMEX short has been physically settled outside the contract’s deliverable geography. Naturally, a long position can also be unwound in Switzerland, which is then the other side of the trade.

EFP Moves Kilobars Through CME’s Hong Kong Vaults

In March 2015 CME launched a Gold Kilo Futures contract (GCK) physically deliverable in Hong Kong, but ever since implementation there has been poor participation in this instrument. From the start GCK trading volume has been close to nothing and deliveries rarely occur. Notwithstanding, there are massive volumes of kilobar gold flowing through the CME approved warehouse in Hong Kong owned by Brink’s, Inc.. On average 3.9 tonnes per day are withdrawn from this vault, but sometimes daily withdrawals are as high as 20 tonnes.

cme-gold-kilo-hong-kong-data
Exhibit 2. CME Kilobar delivery volume is so low it’s not visible.

Because volume and delivery for GCK on Exchange is so low, the withdraws must be explained by OTC trades. A CME representative actaully confirmed this to me; the physical movement through the Hong Kong vaults is caused by EFP transactions.

But if we look at the GCK volume page we can never observe any EFP trades being disclosed. In contrast, EFP volume of GC is substantial. Can it be gold kilobars in CME’s approved warehouses in Hong Kong are used to settle the 100-ounce futures contracts? Yes.

The underlying asset of GC is “either one (1) 100 troy ounce bar, or three (3) one (1) kilo bars, … with a weight tolerance of 5% either higher or lower, … [assaying] to a minimum of 995 fineness”, the underlying asset of GCK is “one kilogram bar (32.15 troy ounces) … [and] shall assay to a minimum .9999 fineness”. It’s thus within the indicated confinements on EFP trading that the 100-ounce gold futures contract is physically settled with three kilobars in Hong Kong.

My theory is that kilobars bought by bullion banks in the West, for example at Swiss refineries, to be consigned to China are hedged on the COMEX and once the gold arrives is Hong Kong the shorts are unwound through EFP. From there the gold is transported by armored truck to Shanghai Gold Exchange designated warehouses in Shenzhen by Brink’s that has a cross-border logistics license from the Chinese government. Supportive to my theory, see exhibit 3 below. Notice the strong correlation between “gold import into Hong Kong versus kilobars received in CME’s vaults” and “re-export from Hong Kong versus kilobars withdrawn from CME’s vaults”.

hong-kong-monthly-gold-trade-vs-cme-hong-kong-kilobar-vault-activity
Exhibit 3.

The correlation points out most gold moving through Hong Kong, which is headed for China, is in kilobar form and moves through CME’s vaults. And because most of this throughput is EFP related, I assume the kilobars are used to settle COMEX futures.

It’s hard to test if my theory is accurate because EFP transactions are executed in the OTC realm and little information is available. Possibly, al throughput in Hong Kong is EFP related but doesn’t impact the GS open interest. If anyone has a different theory please comment below.

London Gold Offsets COMEX Futures

We’ve established gold in Switzerland and Hong Kong is used to “settle” gold futures. But there is also proof gold in London is used to phase out positions on the COMEX. When researching this topic I reached out to William Purpura who is, inter alia, Chairman at Northport Commodities, member of the COMEX Governors Committee, and previously traded on the COMEX floor from 1982 to 2007. I asked Purpura for an example of how EFPs are used. He replied [brackets added by me]:

Most of it [EFP] is done by bullion banks. … It’s mainly for netting out. Lot’s of times London versus New York. You see lots of EFPs posted around 8am in New York on COMEX.

There it is, “London versus New York”, and, “netting out”. From this quote we learn loco London gold is used to execute EFPs to wash out New York futures positions. One can argue the related position in London is “unallocated” – I’m not sure. In the latest formulation by CME on EFP (Market Regulation Advisory Notice RA1311-5R) it’s stated:

Where the related position component … is a physical transaction … the transaction should be submitted for clearing as an EFP transaction type.

Often in wholesale gold market parlance physical is also used for “unallocated gold”, which is not exactly physical in my opinion.

I’m sure there are many more methods than I’ve mentioned to use EFP, or any other privately negotiated transaction (PNT) available on ClearPort, that influences the open interest at the COMEX. One thing is for sure, conventional delivery is not the only way to terminate futures positions. In the gold futures rulebook this is explicitly noted by CME Group. The excerpt below is about terminating a gold futures contracts [brackets added by me].

113102.E. Termination of Trading

No trades in Gold futures deliverable in the current month shall be made after the third last business day of that month. Any contracts remaining open after the last trade date must be either:

(A) Settled by delivery which shall take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but no later than the last business day of the delivery month.

(B) Liquidated by means of a bona fide Exchange for Related Position [/EFP] … .

This is important for our comprhension of the global paper and physical gold market. COMEX gold futures delivery statistics are not all there is to it.

H/t Ronan Manly, Bron Suchecki, Nick Laird from Goldchartsrus.com

The Chinese Gold Market Essentials Guide

Everything there is to know about the Chinese gold market and the true size of Chinese private and official gold demand. Start here. This post was updated in late 2017. 

This post will guide you through all relevant articles that have been published on BullionStar Blogs over the years that elucidate the mechanics of the Chinese (domestic) gold market and true Chinese gold demand. If you are new to the Chinese gold market or like to refresh your memory, this post provides a staring point from where to navigate through all segments of the market you like to study. For example, Chinese gold demand metrics, the Shanghai Gold Exchange (SGE) system, Chinese cross-border gold trade rules, the “precious metals” on Chinese commercial banks’ balance sheets, the Chinese gold lease market and official gold reserves held by China’s central bank the People’s Bank Of China (PBOC).

The BullionStar blog posts that collectively clarify all facets of the Chinese gold market are titled the Chinese Gold Market Essentials. If there is anything unclear, if you have additional information or if you have a suggestion to improve the Chinese Gold Market Essentials, please send me an email at koos.jansen@bullionstar.com.

Understanding The Chinese Gold Market Step By Step

The unique structure of the Chinese domestic gold market, the SGE system, and why the amount of physical gold withdrawn from the vaults of the SGE (published on a monthly basis) can be used as a measure for Chinese wholesale gold demand is explained in part one: The Mechanics Of The Chinese Domestic Gold Market. It also provides a basic understanding of contrasting metrics applied to measure Chinese gold demand, and the difference between SGE withdrawals and Chinese consumer gold demand as disclosed by the Thomson Reuters GFMS, which has aggregated to 6,000 tonnes from 2007 until 2016. GFMS and its affiliates have continuously presented feeble arguments that should explain the difference. The Chinese Gold Market Essentials debunks these arguments where necessary, back up by facts, in order to make our best estimate of true Chinese gold demand.

More detailed rules regarding cross-border gold trade in and out of the Chinese domestic gold market and Free Trade Zones in China are discussed in part two: Chinese Cross-Border Gold Trade RulesWhen fully comprehending the mechanics of the Chinese domestic gold market and Chinese cross-border gold trade rules you can continue reading Workings Of The Shanghai International Gold Exchange about the international subsidiary exchange of the SGE set up to become the major physical gold trading hub in Asia.

At this point you should have a thorough understanding of the Chinese gold market. To Study more about the difference please continue with The Chinese Gold Lease Market And Chinese Commodity Financing Deals Explained. The post also includes many links to additional posts about the Chinese gold lease market, among others, a paper written by the PBOC in 2011 exclusively translated by BullionStar. Next you should get aquatinted with The Value-added Tax System In China’s Domestic Gold Market, What Are These Huge Tonnages In “Precious Metals” On Chinese Commercial Bank Balance Sheets? (updated until 2015), and China’s Rising Gold ETF Market: A Hybridbefore you can read a detailed study on the difference, and thus true Chinese gold demand: Why SGE Withdrawals Equal Chinese Gold Demand And Why Not (The Argument List).

Finally, please read PBOC Gold Purchases: Separating Facts from Speculation for studying the amount of gold accumulated by China’s central bank in recent years in addition to private reserves. At the end of the post you can find an overview of the estimated amounts of above ground gold in China (privately owned gold and official holdings), updated in July 2017.

UN Preparing For Global Sovereign Debt Restructuring

An open letter to all pension funds 

The United Nations (UN) is preparing a Multilateral Legal Framework for Debt Restructuring Processes. At the highest level an orderly sovereign debt restructuring for developed countries is designed.

As I’ve stated before on these pages, effectively the only thing Quantitative Easing (QE) can buy is time. Since 2008 our monetary wizards have merely been able to keep the can on the road, perpetually kicking it further into the abyss through QE. Solutions are still debated between policy makers behind closed doors, as our current fragile international monetary system does not allow public debate on significant changes or it will risk implosion.

If sustainable monetary solutions can be implemented at all from the top of governing bodies within a society waiving the flag of capitalism remains to be seen. In my opinion our system, which is still presented as capitalism, can only survive from the essential input of the economic agents operating at the bottom of the market, producing goods with labor, setting prices, taking risk and creating real wealth. Denying these fundamentals is what brought us into this crisis.

Please read below a few snippets from resolution 68/304 drafted by the United Nations (UN) in September 2014 on global sovereign debt restructuring. Reading between the lines the UN admits our current system is unsustainable and because of “systemic fragilities reform to strengthen the international financial system” is needed; a monetary reset.

UN-flag

Resolution adopted by the General Assembly on 9 September 2014

68/304. Towards the establishment of a multilateral legal framework for sovereign debt restructuring processes

107th plenary meeting

Recalling further the International Conference on Financing for Development and its outcome document, in which sustainable debt financing is recognized as an important element for mobilizing resources for public and private investment, and the Follow-up International Conference on Financing for Development to Review the Implementation of the Monterrey Consensus and its outcome document, the Doha Declaration on Financing for Development, as well as General Assembly resolution 68/204 of 20 December 2013,

…Noting that sovereign debt crises are a recurring problem that involves very serious political, economic and social consequences and that the restructuring processes of sovereign debt are a frequent phenomenon in the international financial system,

Stressing the importance for developing countries, on a case-by-case basis, of debt relief, including debt cancellation, as appropriate, and debt restructuring as debt crisis prevention and management tools,

Stressing also the need to work towards the establishment of responsible and preventive financial crisis policies to enhance transparent and sustainable national financial systems,

Recognizing the sovereign right of any State to restructure its sovereign debt, which should not be frustrated or impeded by any measure emanating from another State,

Recognizing also that the efforts of a State to restructure its sovereign debt should not be frustrated or impeded by commercial creditors, including specialized investor funds such as hedge funds, which seek to undertake speculative purchases of its distressed debt at deeply discounted rates on secondary markets in order to pursue full payment via litigation,

…Noting also the concern expressed in the declaration of the Summit of Heads of State and Government of the Group of 77 and China on the theme “For a New World Order for Living Well”, held in Santa Cruz de la Sierra, Plurinational State of Bolivia, on 14 and 15 June 2014, concerning the so-called “vulture funds” and their actions of a highly speculative nature, which pose a risk to all future debt restructuring processes, for both developing and developed countries,

…Recalling, among other things, the work carried out by the International Monetary Fund in 2003, with the support of the International Monetary and Financial Committee, to formulate a proposal for a sovereign debt restructuring mechanism,

…Stressing also the need to continue to address systemic fragilities and imbalances and the need for continuing efforts to reform and strengthen the international financial system,

Noting with concern that the international financial system does not have a sound legal framework for the orderly and predictable restructuring of sovereign debt, which further increases the cost of non-compliance,

Recognizing the need to create a legal framework that facilitates the orderly restructuring of sovereign debts, allows the re-establishment of viability and growth without creating incentives that inadvertently increase the risk of non-compliance and acts as a deterrent to disruptive litigation that creditors could engage in during negotiations to restructure sovereign debts,

Stressing, in this context, the importance of establishing a clear set of principles for the management and resolution of financial crises that take into account the obligation of sovereign creditors to act in good faith and with a cooperative spirit to reach a consensual rearrangement of the debt of sovereign States, 

  1. Emphasizes the special importance of a timely, effective, comprehensive and durable solution to the debt problems of developing countries in order to promote their inclusive economic growth and development;
  1. Calls for the intensification of efforts to prevent debt crises by enhancing international financial mechanisms for crisis prevention and resolution, in cooperation with the private sector, with a view to finding solutions acceptable to all;
  1. Calls upon all Member States and the United Nations system, and invites the Bretton Woods institutions and the private sector, to take appropriate measures and actions for the implementation of the commitments, agreements and decisions of the major United Nations conferences and summits, in particular those related to the question of the external debt sustainability of developing countries;
  1. Recognizes the roles of the United Nations and the international financial institutions in accordance with their respective mandates, and encourages them to continue to support global efforts towards sustainable development and a durable solution to the problem of the debt of developing countries;
  1. Decides to elaborate and adopt through a process of intergovernmental negotiations, as a matter of priority during its sixty-ninth session, a multilateral legal framework for sovereign debt restructuring processes with a view, inter alia, to increasing the efficiency, stability and predictability of the international financial system and achieving sustained, inclusive and equitable economic growth and sustainable development, in accordance with national circumstances and priorities;
  1. Also decides to define the modalities for the intergovernmental negotiations and the adoption of the text of the multilateral legal framework at the main part of its sixty-ninth session, before the end of 2014.

Additional ad hoc meetings on a Multilateral Legal Framework for Debt Restructuring Processes, open to all Member States and observers of the United Nations, were held in February this year and will continue through March, May and June in New York.

h/t Matt McBride

The Mechanics Of The Chinese Domestic Gold Market

This post is part of the Chinese Gold Market Essentials series. Click here to go to an overview of all Chinese Gold Market Essentials for a comprehensive understanding of the largest physical gold market globally. This post was updated until 2016.

The largest physical gold market globally is the Chinese domestic gold market. At the core of this market is the Shanghai Gold Exchange. This article is serves as an introduction to both.

The Shanghai Gold Exchange (SGE) is the largest physical gold exchange globally because China is both the largest gold importer and mine producer, and nearly all supply channels in the Chinese domestic market flow through the SGE. Since 2013 the yearly amount of physical gold withdrawn from the SGE vaults has exceeded 2,000 tonnes.

While Western consultancy firms like the World Gold Council (WGC) and Thomson Reuters GFMS (GFMS hereafter) report annual Chinese gold demand to be roughly 900 tonnes, the China Gold Association (CGA) states Chinese demand equals SGE withdrawals and thus is more than twice as much as is portrayed by the WGC and GFMS.

This article examines the basic mechanics of the Chinese domestic gold market and how nearly all physical gold in China flows through the SGE, in order to achieve the best understanding of the size of this market and true Chinese gold demand. In addition, the enormous difference between SGE withdrawals and Chinese gold demand as disclosed by GFMS is highlighted.

According to my analysis the structure of the Chinese domestic gold market with the SGE at its core has been designed by the People’s Bank Of China (PBOC), (i) to provide the Chinese citizenry direct access to the gold wholesale market, (ii) to grant all gold traded in the Chinese wholesale market to be of the highest quality, (iii) to be able for the PBOC to monitor the gold traded in the Chinese market, and (iiii) keep track of the amount of gold added to Chinese (non-government) reserves. Sprouted from the centrally minded Chinese authorities the SGE system was conceived in 2002 to facilitate the citizenry to buy physical gold, strengthen the Chinese economy, develop the Chinese gold market and to support renminbi  internationalization.

For our analysis of the Chinese domestic gold market I’ve relied on Chinese laws, annual reports drafted by the CGA, SGE, PBOC and Shanghai Futures Exchange (SHFE), next to sources in China at commercial banks and individual traders. The aforementioned reports are:

  • China Gold Association (CGA) Gold Yearbook 2006, 2007, 2008, 2013 (Chinese).
  • SGE Annual Report 2007, 2008, 2009, 2010, 2011 (English and Chinese).
  • SGE Monthly Report December 2013.
  • China Gold Market Report 2008, 2009, 2010, 2011 (English and Chinese).

Most of these reports have been written in conjunction by the CGA, SGE, PBOC and SHFE.

Screen Shot 2015-03-10 at 3.25.12 PM
Exhibit 1. Courtesy China Gold Market Report 2011.

All the English reports were available on the SGE website until 2014, after which they’ve been taken offline.

Introduction

Prior to 2002 the Chinese gold market was practically non-existent. Back then the PBOC had the monopoly in trading gold in China and the people were only allowed to buy jewelry in designated shops. In 2002 the PBOC erected its subsidiary the SGE to allow the free market to take over the the pricing and allocation of gold. However, the Chinese domestic gold market didn’t change over night.

By approximation, the Chinese domestic gold market functioned as was planned starting in 2007, as in that year for the first time the amount of physical gold withdrawn from SGE vaults equaled Chinese wholesale gold demand that year. All supply and demand was matched at the SGE, without the interference of the PBOC in 2007. In the CGA Gold Yearbook 2007 it’s stated [brackets added]:

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,

In 2007, the amount of gold withdrawn from the warehouses of the Shanghai Gold Exchange, the total [wholesale] gold demand of that year, was 363.194 tonnes …

From 2002 until 2007 Chinese wholesale gold demand did not equal SGE withdrawals, to which we conclude the reform of the market wasn’t fully worked out in those years. From 2007 until 2011 SGE withdrawals exactly matched Chinese wholesale gold demand, from 2012 until present SGE withdrawals roughly matched Chinese wholesale gold demand, according to the metrics used by the CGA in its Gold Yearbooks published in Chinese print.

Until this date (2017) we deem SGE withdrawals to be a useful indicator for Chinese wholesale gold demand, though true Chinese gold demand is slightly lower.

There are a few basic rules in the Chinese domestic gold market that make SGE withdrawals equal Chinese wholesale gold demand, these rules compound to the mechanics of this market. In the following these rules are expanded upon. First with respect to the supply side, then the demand side.

Chinese Gold Import

Since 2011 the main conduit of supply into the Chinese domestic gold market has been bullion import. Gold bullion import into the domestic market can be done by banks that enjoy approval by the PBOC, though for every shipment a new License must be requested at the central bank. This policy is referred to as “one batch, one License”. Bullion export from the Chinese domestic gold market is prohibited as far as is publicly known.

Currently there are thirteen banks that have been approved by the PBOC to import bullion, presented in random order:

  1. HSBC Bank (China) Ltd
  2. Australian and New Zealand Bank (China) Company Ltd
  3. Standard Chartered Bank (China) Ltd
  4. United Overseas Bank (UOB)
  5. Industrial and Commercial Bank of China (ICBC)
  6. China Construction Bank (CCB)
  7. Bank of China
  8. Agricultural Bank of China (ABC)
  9. Bank of Shanghai
  10. China Minsheng Bank (CMB)
  11. Industrial Bank
  12. Shenzhen Development Bank (SDB) / Ping An Bank
  13. Everbright

All bullion imported into the Chinese domestic gold market by one of the thirteen banks must be standard gold and sold first through the SGE. Standard gold in China is bullion casted by an LBMA or SGE approved refinery in bars or ingots of 50g, 100g, 1Kg, 3Kg or 12.5Kg, with a fineness of 9999, 9995, 999 or 995. Solely standard gold is allowed into SGE certified vaults to be traded through the SGE system. The Chinese cross-border gold trade rules state [brackets added]:

Gold to be imported … shall be registered at a spot gold exchange [SGE] approved by the State Council where the first trade shall be completed.

It’s possible non-bank gold enterprises, if approved by the PBOC, can import (and export) gold doré, ore and jewelry into / out of the domestic market if accompanied by a License, but this tonnage is insignificant in the greater scheme of things. Most gold imported is standard gold and very little gold is permitted to be exported. An exception, for example, is the Chinese Mint that can export golden Panda coins from the domestic market.

The Chinese domestic gold market with the SGE at its core is separated from Chinese Free Trade Zones (/Customs Specially Supervised Areas) where different cross-border trade rules are applicable.

Individuals can freely import and export 50 grams of gold when traveling abroad. However, the rule isn’t very stringent on the import side. Many mainland tourists visit Hong Kong to buy jewelry and bring as much jewelry as they like across the border when they return home. In Hong Kong jewelry doesn’t carry Value-Added Tax which makes these products less expensive than in China mainland.

The Value-Added Tax System

When standard gold is traded over the SGE or SHFE it’s exempt from Value-Added Tax (VAT). When standard gold is not traded over the SGE or SHFE it’s not exempt from VAT. In addition, when non-standard gold, for example 200 gram bars, is traded in the Chinese domestic gold market off-SGE it’s exempt from VAT.

The VAT rules in the domestic market incentivize wholesale gold supply to be traded in the form of standard gold through the SGE which is the most liquid exchange. (Also because gold within the SGE system is granted to be of the highest quality, which attracts most of demand in China. Any gold sold off-SGE can be of inferior quality.)

In the table below the different types of gold in China and the related VAT rates are listed.

Exhibit 2. Chinese domestic gold market VAT rates.

Domestic Gold Mining

The People’s Republic of China has the biggest gold mine production globally with an output of roughly 453.49 tonnes per annum (2016). The vast majority of this output is sold first through the SGE, as Chinese miners are required to sell standard gold over the SGE (another incentive to channel supply to the SGE).

Overseas gold mining output can be imported into the Chinese domestic gold market, subsequently to be refined into standard gold by an SGE approved refinery and traded over the SGE.

Because of the aforementioned rules the best trading liquidity in China is at the SGE and thus gold mining companies are incentivized to cast their output in standard gold bars to sell on the SGE. However, miners are also allowed to sell non-standard gold or gold products off-SGE. For example, China National Gold Group Corporation is a mining company that has its own physical stores to sell bars and ornaments.

Recycled Gold

All supply that is not domestically mined or imported into China we’ll label as recycled gold. Because of the liquidity on the SGE and the VAT rules regarding standard gold, recycled gold in the domestic market has an incentive to flow through the Chinese center bourse as well. Recycled gold is not required to be sold through the SGE, yet many refineries cast standard gold and thus most finds its way to the center bourse.

SGE bar small hi-res
Exhibit 3. Standard gold bar 100g

1. 上海黄金交易所标准金条 SGE Standard Gold Bar.
2. 上海黄金交易所标志 SGE Logo.
3. 品牌标志 Brand Logo.
4. 金条品牌 Bar Brand (泰山 is Mount Tai, which is produced by Shandong Gold).
5. 成色 Fineness.
6. 重量 Weight.
7. 金条编号 Bar Serial Number. 

When it comes to measuring recycled gold supply it gets complicated as all sources available (CGA, GFMS, Metals Focus, CPM Group) for this data do not use the same methodology and nomenclature. In the remainder of this article the focus will be on the differences between GFMS and CGA metrics and nomenclature. The most significant difference with respect to recycled gold is that GFMS merely discloses scrap (old jewelry and industrial products that are sold by consumers) in their statistics, where the CGA discloses scrap, disinvestment, and “recycled distortion, lumped together as recycled gold.

The significance of differentiating between several recycled gold types is to separate the ones that have no net effect on the price from the ones that do. Recycled gold can be subdivided in three categories (the following is BullionStar nomenclature):

  1. Scrap: old gold products (jewelry or industrial) sold for cash by consumers at retail level, and therefore true supply having a net effect on the gold price. These scrap flows are included by both GFMS and the CGA in their statistics.
  2. Disinvestment: bullion wholesale supply. Fact is, in China any individual or institutional investors can buy (demand) gold directly at wholesale level (SGE). If down the road these investors decide to sell (supply) gold they can do so directly to a refinery. Such disinvestment can then make its way to the SGE. An investor wanting to sell 1500 Kg in gold bars is not likely to walk into a jewelry store to sell its materials, more likely he will approach a refinery. Because disinvestment surpasses retail stores (jewelry shops and banks) it’s not included by GFMS in their supply statistics. The CGA does include disinvestment in their supply statistics. Disinvestment has a net effect on the price. It can also be referred to as institutional supply.
  3. Recycled distortion: recycled distortion can be for example process scrap, which is metal spilled in manufacturing processes of jewelry or industrial products. Suppose, a jewelry manufacturer buys 1 tonne of gold at the SGE and starts fabricating jewelry. During production 800 Kg makes it into finished products while 200 Kg is scrap spill over. The spill over, called process scrap, is directly being sold back from the jewelry manufacturer to a refinery making its way to the SGE. Effectively the 200 Kg has been recycled through the SGE being both demand and supply, having no net effect on the price. Therefore, process scrap overstates the supply and demand balance. Next to process scrap there can be other forms of gold being recycled through the SGE (i.e. gold used in VAT schemes), which we’ll collectively label as recycled distortion. Recycled distortion is not included in GFMS data, but is included in CGA data.

Have a look at an overview on how recycled gold types are named by all consultancy firms, next to if they’re included in their statistics.

china-scrap-xx
Exhibit 4. China recycled gold flows.

Because in terms of trading total supply and total demand are exactly equal – one cannot sell gold without a buyer or buy gold without a seller – consequently we can gauge demand by measuring supply. And, as GFMS publishes incomplete Chinese gold demand statistics, it’s essential to measure all types of supply to get the best estimate of true Chinese gold demand.

Just like the London Bullion Market Association (LBMA) the SGE respects a chain of integrity. Meaning, only SGE approved refineries can supply bars to the SGE system and once bars are withdrawn from SGE certified vaults they leave the chain of integrity. To prevent fraud, hereafter, the bars that are withdrawn are not allowed to re-enter the SGE vaults. The only way they can re-enter the SGE system (the Chinese wholesale market) is if the bars are melted down and recast into new bars by an SGE approved refinery. In the SGE’s Detailed Rules for Physical Delivery of the Shanghai Gold Exchange it’s stated:

Article 23

Any gold bullion withdrawn by a member or customer shall not be loaded into any Certified Vault in the future.

The same rule is disclosed on the websites of China’s largest banks that offer customers SGE trading accounts. On ICBC’s website it’s stated (point 2):

ICBC SGE rule gold bars
Exhibit 5. Courtesy ICBC.

This rule is important for comprehending the mechanics of the Chinese domestic gold market, because traders cannot easily recycle gold through the SGE.

SGE Withdrawals Equal Chinese Wholesale Gold Demand 

Above has been established that (in general) supply equals demand and in the Chinese domestic gold market nearly all supply flows through the SGE. Consequently, the volume of gold being withdrawn from SGE vaults is a proxy for Chinese wholesale gold demand. Additionally, we saw that that there is recycled distortion flowing through the SGE that is overstating the supply and demand balance. Simply put, when the volume of recycled distortion is subtracted from SGE withdrawals what is left is true Chinese gold demand. 

Presented below are a few equations for clarification:

SGE withdrawals = Chinese Wholesale Gold Demand

As import + mine + scrap + disinvestment + recycled distortion is total physical supply to the SGE and everything that is withdrawn is total demand:

SGE Withdrawals = Import + Mine + Scrap + Disinvestment + Recycled Distortion = Total Supply = Wholesale Demand 

But as was mentioned before recycled distortion blurs our view of demand, it has no net effect on the price, so it has to be subtracted from SGE withdrawals:

True Chinese Gold Demand = Import + Mine + Scrap + Disinvestment = SGE Withdrawals – Recycled Distortion

Chinese Wholesale Gold Demand = True Chinese gold demand + Recycled Distortion = SGE Withdrawals 

In a graph:

chinese-domestic-gold-market-supply-demand-balance-examplexs
Exhibit 6. Example Chinese gold supply and demand balance.

Please note, in our Chinese gold supply and demand study two elements are left out. On the supply side we left out stock carry over in SGE vaults from previous years, as this information is not publicly available, on the demand side we left out gold bought at the SGE that was not withdrawn from the vaults (i.e. GAP and ETF holdings), as this information is not precisely known.

The formulas are supported by reports from the CGA and SGE from 2007 until 2013, as every year SGE withdrawals equaled wholesale gold demand in these documents. Presented are CGA demand figures and SGE withdrawals from 2007 until 2013:

2007: SGE Withdrawals 363.2 Tonnes

Screen Shot 2015-03-12 at 4.54.58 PM
Exhibit 7. SGE Annual Report 2007: framed in red are total SGE withdrawals 2007 in Kg’s (363.19365 Kg).
Screen Shot 2015-03-11 at 10.27.37 AM
Exhibit 8. CGA Gold Yearbook 2007: framed in red is total demand in Kg’s (363.194 Kg).

2008: SGE Withdrawals 543.2 Tonnes 

SGE Annual Report 2008, total SGE withdrawals in Kg's
Exhibit 9. SGE Annual Report 2008, total SGE withdrawals in Kg’s.
Screen Shot 2015-03-11 at 10.59.54 AM
Exhibit 10. CGA Gold Yearbook 2008: framed in red is total demand 2008 in tonnes

2010: SGE Withdrawals 837.2 Tonnes

SGE Annual Report 2010, total SGE withdrawals in Kg's
Exhibit 11. SGE Annual Report 2010, total SGE withdrawals in Kg’s
China Gold Market Report 2010, total demand in tonnes
Exhibit 12. China Gold Market Report 2010, total demand in tonnes

2013: SGE Withdrawals 2,197 Tonnes

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Exhibit 13. SGE Monthly Report December 2013, framed in red is total 2013 SGE withdrawals in Kg
CGA Gold Yearbook 2013 demand
Exhibit 14. CGA Gold Yearbook 2013: framed in black is total demand 2013 in tonnes (Red = jewelry manufacturing, blue = small bar production, purple = industrial material, turquoise = coin manufacturing, yellow = other, green = net investment)
CGA Gold Yearbook 2013 supply
Exhibit 15. CGA Gold Yearbook 2013: framed in black is total supply 2013 in tonnes. (Purple = domestic and overseas mine output, green = recycled gold, blue = bullion import)

In the last screen shots (from the CGA Gold Yearbook 2013) we can see total supply/demand in 2013 was 2,198.84 tonnes, which is 1.88 tonnes higher than SGE withdrawals. This can be explained by jewelry import that was counted as demand, but not sold through the SGE.

Chinese Gold Demand Metrics

After having examined the supply side of the Chinese domestic gold market let’s move on to the demand side. From the fact most supply flows to the SGE, logically most demand is directed to to the SGE as well.

Chinese wholesale gold demand as disclosed by the CGA, which equals SGE withdrawals, is the widest measure of demand. It consists of consumer demandinstitutional demand and recycled distortion (see exhibit 6 and 15)Consumer demand includes jewelry, bar and coin sales at retail level and gold used in industrial fabrication. Institutional demand comprises, in the case of China, individual and institutional investors buying bullion directly in the SGE wholesale market.

The predominant reason for the difference between SGE withdrawals and Chinese gold demand as disclosed by GFMS, is the fact that GFMS only discloses consumer demand in its reports, not institutional demand. (And they do so not only for China but for the rest of the world as well, which is an incomplete and misleading representation of gold supply and demand. Hereby GFMS makes gold look like a commodity instead of a currency, denying its most important trading characteristics in price formation.) Stunningly, the difference between SGE withdrawals and GFMS demand has aggregated to an astonishing 6,032 tonnes from January 2007 until December 2016. The next graph illustrates the difference

Chinese Gold Supply & Demand
Exhibit 16. The difference between Chinese consumer gold demand and SGE withdrawals.

As on the supply side, we can draft simple equations for the demand side:

SGE Withdrawals = Consumer Demand + Institutional Demand + Recycled Distortion = Chinese Wholesale Gold Demand

Consumer Demand + Institutional Demand = True Chinese Gold Demand 

Consumer Demand = Jewelry + Retail Bar & Coin + Industrial 

 Institutional Demand = Direct Purchases At The SGE 

Direct Purchases At The SGE (Institutional Demand) = SGE Withdrawals – Recycled Distortion – Consumer Demand

In the CGA demand table for 2013 (exhibit 14) it’s stated the difference between consumer demand and total demand was labeled as net investment, which is calculated by the CGA as a residual, ‘SGE withdrawals minus consumer demand’. Demonstrated in equations:

Net Investment = Institutional Demand + Recycled Distortion 

Net Investment = SGE Withdrawals – Consumer Demand

Institutional Demand = Net Investment - Recycled Distortion

However, because the exact volume of recycled distortion and disinvestment is unknown, institutional demand is unknown as well. Our best estimate of institutional demand is net investment. Again, all this is clearly illustrated in exhibit 6.

Everyone In China Can Buy Gold Directly At The SGE

So what’s causing the massive direct purchases at the SGE? “Demand for gold”, is the simple answer. But there’s more that can be told on direct purchases.

In China not only wholesale enterprises such as jewelry manufacturers and bullion banks can trade gold on the SGE, everyone can open an SGE account and start trading. The next graph illustrates how wholesale manufacturers are responsible for approximately half of SGE withdrawals (for exact ratios see exhibit 16). These wholesale enterprises will buy gold at the SGE and subsequently withdraw the metal to fabricate products (ie jewelry, ornaments and bank bars) to be sold at retail level. Individual and institutional SGE customers are responsible for the other half of SGE withdrawals. These customers will buy gold directly at the SGE and withdraw the metal to store in private vaults.

sge-withdrawals-distribution-example
Exhibit 17. Example SGE Withdrawals Distribution.

According to my analysis the PBOC does not buy its monetary gold through the SGE, so effectively all gold flowing through the SGE ends up in the private sector.

Purchasing gold directly at the SGE is fairly simple in China. Every natural person, institution or wholesale enterprise can buy gold or trade derivatives at the SGE. For 50 RMB one can open an SGE account at his local commercial bank branch or via a smartphone application. Then, he or she receives a unique 10-digit trading number that gives access to the account consisting of a Bullion Account and Margin Account. The 10-digit trading number will stay with an individual forever, even if he or she switches banks. The procedure is illustrated in the picture below:

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Exhibit 18. Courtesy China Gold Market Report 2008.

When an SGE physical gold contract is exchanged the full amount of funds is promptly transferred from the buyer’s Margin Account to seller’s Margin Account. At the same time the related bullion is transferred from the seller’s Bullion Account to the buyer’s Bullion Account (settlement is T+0). Gold credited to a Bullion Account is allowed to be withdrawn from the vaults at any time.

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Exhibit 19. Courtesy China Gold Market Report 2011.

Early 2016 was the launch of the smartphone application Yijintong that allows anyone with an internet connection in China to open an SGE account and trade directly on the SGE wholesale platform appreciating the lowest spreads in China. The Yijintong smartphone app can be downloaded through the following QR-code:

SGE app qr code
Exhibit 20.

As fas as is publicly known, when Yijintong was launched the SGE already counted 8.3 million individual and 10,000 institutional customers, next to 246 members globally of which 183 domestic members and 63 international members. From the huge amount of individual and institutional customers we can easily understand the huge volumes of direct purchases at the SGE.

The only reason individual investors would buy gold in a jewelry shop or bank is because these bars are aesthetically superior and come in all sorts of shapes and sizes.

chow tai fook gold bar 2
Exhibit 21. Chow Tai Fook gold bar.

Though decorated bars come at a significant premium. Obviously, large investors would not buy retail bars but prefer relatively cheaper SGE bars. Which is the reason for the huge discrepancy between consumer demand and SGE withdrawals: many investors buy gold directly at the SGE.

Wang Zhe, Chairman & President of the SGE in 2010 wrote:

During the first four months of this year, the number of individual investors kept growing rapidly and now has exceeded two million. The Exchange has become the main channel of investment of physical precious metals, fulfilling the needs of domestic residents.

This quote describes that as early as in 2010 direct purchases at the SGE by individual clients exceeded retail bar purchases. And individual/institutional investors bypassing retail shops buying gold directly at the SGE has been a trend that has accelerated ever since (see exhibit 16).

Conclusion

By now a comprehensive framework has been provided of the basic mechanics of the Chinese domestic gold market. From all the equations and illustrations presented readers should be able to grasp the sheer size of this physical gold market.

Kindly note, to avoid confusion, in some publications the CGA discloses only consumption demand, similar to GFMS, excluding net investment. For example in 2014 [brackets added]:

Gold consumption in China grew to 1,176.40 tonnes [in 2013] … , with jewellery demand … 716.50 tonnes and [retail] bullion demand … 375.73 tonnes

The CGA states in the quote above consumer gold demand was 1,176.4 tonnes in 2013, while we read in other publications (exhibit 14) wholesale gold demand was over 2,000 tonnes.

Lastly, more examples are provided that confirm the more realistic size of Chinese gold demand. Na Liu, from CNC Asset Management Ltd, traveled to China in 2014 and spoke to The President of the SGE Transaction Department. Afterwards Na reported on Chinese gold demand in 2013 [brackets added]:

The President of SGE Transaction Department (The President) said: “This 2,200 tonnes of gold, after leaving our vaults, they entered thousands of Chinese households in the form of jewellery and investment purchases [consumer demand + direct purchases].”

…when we asked why the China Gold Association’s [consumer demand] number is so low, the President said: “They mainly cover the gold sales through the gold shops. This is their main source of information. And their number is quite useful in that way. However, our system [SGE withdrawals] has broader coverage.”

Clearly consumer demand is “gold sales through the gold shops” and SGE withdrawals have “broader coverage” (consumer demand + direct purchases at the SGE).

Needless to say, the people that run the SGE, CGA, PBOC and SHFE are all related. Depending on the occasion they choose to disclose consumer demand or wholesale gold demand. SGE Chairman, Xu Luode, said at the LBMA conference in 2014 [brackets added]:

Last year [2013], China imported 1,540 tonnes of gold. Such imports, together with the 430 tonnes of gold we produced ourselves, means that we have, in effect, supplied approximately 2,000 tonnes of gold last year.

The 2,000 tonnes of gold were consumed by consumers in China. Of course, we all know that the Chinese ‘dama’ [middle-aged women] accounts for a significant proportion in purchasing gold. So last year, our gold exchange’s inventory reduced by nearly 2,200 tonnes [SGE withdrawals], of which 200 tonnes was recycled gold.

Typically, Xu measures ‘import + mine production’ (∼2,000 tonnes in 2013) for Chinese gold demand, as this is the amount of gold added to Chinese private sector reserves (recycled gold doesn’t add anything to reserves). Indirectly Xu reveals his interest in the amount of private sector gold reserves within the domestic market.

All in all, there are several ways to measure Chinese gold demand. A next article is dedicated to the data and details of all metrics, for now, please have look at the next overview:

  • Gold sold at retail level (consumer demand) = GFMS demand
  • Import + mine = net gold added to Chinese private sector reserves
  • Import + mine + scrap + disinvestment = true Chinese gold demand
  • SGE withdrawals = wholesale gold demand

The definition of SGE withdrawals slightly changed late 2014 with the inception of the Shanghai International Gold Exchange. How it was changed can be read in the subsequent posts of the Chinese Gold Market Essentials (Workings Of The Shanghai International Gold ExchangeWhy SGE Withdrawals Equal Chinese Gold Demand And Why Not – The Argument List). 

How The World Is Being Fooled About Chinese Gold Demand

Kindly note the pattern

There is a story being told to the masses about Chinese gold demand that is grossly incorrect. The huge discrepancy between numbers from the World Gold Council (WGC) and actual gold demand is so wide yet cunningly hidden I must conclude there is essential information about physical gold demand deliberately kept privy.

Let’s go back to April 2013; the price of gold made a nosedive, which spawned an unprecedented physical buying spree across the globe, most notably in China. Withdrawals from the vaults of the Shanghai Gold Exchange (SGE), that equal Chinese wholesale demand, closed at 2,197 metric tonnes December 31, 2013, up 93 % y/y.

However, the WGC (the global authority on gold) initially stated Chinese consumer gold demand had reached 1,066 tonnes in 2013, an astonishing 1,131 tonnes less than wholesale demand. In the China Gold Association (CGA) Gold Yearbook 2013 it was disclosed China had net imported 1,524 tonnes and domestically mined 428 tonnes. Without counting scrap supply this adds up to 1,952 tonnes; adding scrap total supply has been well over 2,000 tonnes. It’s impossible consumer demand was only 1,066 tonnes.

Finally the WGC admitted their initial estimate of 1,066 tonnes of Chinese gold demand was grossly understated. By email they wrote me on February 12, 2015:

Dear Mr Jansen,

Thank you for emailing the World Gold Council, we apologize that your previous enquiry was missed.

Our figure for Chinese consumer demand in 2013 has since been revised upwards to 1,311.8 tonnes from the original figure of 1,066 tonnes published in the full year 2013 Gold Demand Trends report.  

That’s an increase of 23 % by the largest physical buyer on the planet. Although still far from actual demand, 23 % is quite a revision. Was there an official press release from the WGC to inform the world on this revision? No (I’ve asked the WGC, but I got no reply). Did the mainstream media properly cover the 23 % revision? Not that I’m aware of.

Actual Chinese gold demand 2013 has been knavishly hidden from the masses (99 % of the financial industry copies WGC numbers).

In 2014 the WGC again grossly understated Chinese gold demand. SGE withdrawals accounted for 2,102 tonnes, though the WGC stated Chinese consumer demand was only 814 tonnes. Again, a gap of more than 1,100 tonnes. All arguments the WGC has brought up to explain the surplus in the Chinese gold market can only make up about 15 % of the gap (gold-for-gold supply and stock movement change).

For 2014 grossly understating Chinese gold demand wasn’t enough for the Council to distract the world’s eye from China’s gold hunger; more was needed. By a few tonnes the WGC put India’s consumer gold demand ahead of China. In their Gold Demand Trends Full Year 2014 Indian demand is disclosed at 843 tonnes, transcending Chinese demand (814 tonnes) by 29 tonnes, just enough. Most media simply copied these numbers and are stating India is now the world’s largest gold consumer – no critical thoughts added. In my opinion this is the biggest fallacy in finance of our time.

WGC demand vs SGE withdrawals 2

In 2014 China imported at least 1,250 tonnes and domestically mined 452 tonnes. According to GFMS scrap supply was 182 tonnes, adding up to total supply at 1,884 tonnes. But, we’re supposed to believe India is the largest gold consumer on earth at 843 tonnes? Yes.

I’m open minded towards the possibility there is an agenda that is allowing China to buy as much gold for as little fiat as possible to make them accumulate whatever necessary before a monetary reset. I see no other explanation for the events unfolding in front of our eyes.

Can you imagine what would have happened to global gold sentiment if the WGC had disclosed 2013 Chinese demand at 2,100 tonnes and 2014 Chinese gold demand at 1,850 tonnes? Sentiment would have been influenced to say the least.

As I wrote in my first post on why SGE withdrawals equal Chines wholesale demand September 18, 2013:

If you think about it, the redistribution of gold is the only logical thing to happen given the state the world economy is in. … gold has to go to China in order to equalize the chips.

More Awareness About Chinese Gold Demand

Luckily my camp is growing. More and more analysts are using SGE withdrawals as a proxy for Chinese wholesale demand instead of inaccurate WGC data. CNC Asset Management wrote in a newsletter September 25, 2014:

To understand China’s real physical gold demand, investors should simply look at the weekly withdrawals from Shanghai Gold Exchange vaults. We visited the Shanghai Gold Exchange (SGE) in May and talked to the senior executives of the exchange. After reviewing the exchange’s trading mechanism, we are of the view that the weekly withdrawal figures provide a much more accurate data series that reflects China’s aggregate wholesale demand in a timely way.

More recently MarketWatch published SGE withdrawals and its significance, and Dr. Martin Murenbeeld, Chief Economist at Dundee Capital Markets, wrote in his newsletter on February 2015:

It follows from this opaque picture of Chinese supply and demand that some observers, including ourselves, have decided Shanghai Gold Exchange (SGE) deliveries data provides the best window on what might be happening on the demand side in China. (There are a number of observers who have noted the widely circulated estimates of gold demand are woefully inaccurate, precisely because these data are so significantly lower than SGE deliveries data.)

Latest data from the SGE shows withdrawals in the last five days around Lunar Year (February 16, 17 and 25, 26, 27) accounted for 38 tonnes. Total SGE withdrawals in the first two months of 2015 surpassed 410 tonnes. SGE withdrawals Q1 can reach 550 tonnes or more. However, don’t expect Chinese gold demand published by the WGC on Q1 to be anywhere near these figures.

Chinese Gold Trade Rules And Financing Deals Explained

One of the main causes some of my colleague gold analysts assume SGE withdrawals are inflated and cannot be used as a measure for Chinese wholesale gold demand, is because of Chinese Commodity Financing Deals (CCFDs). However, this analysis is incorrect as will be demonstrated in this post.

Round Tripping And Chinese Gold Trade Rules

CCFDs are ways for Chinese speculators to acquire cheap funds using commodities as collateral. When it comes to using gold as collateral for CCFD there are two options: round tripping and gold leasing. What is round tripping? Goldman Sachs (GS) has properly explained the process in a report dated March 2014. From GS [brackets added by me]:

While commodity financing [round tripping] 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

Important to understand is that gold in round tripping needs to be physically imported into China and then exported, in contrast to copper. The reason being, which GS fails to mention, that the trade rules for gold in China are different than for all other commodities.

General Trade vs Processing Trade

In essence gold bullion is prohibited from being exported out of the Chinese domestic gold market by the PBOC in general trade. For general trade fifteen banks enjoy a PBOC license to import gold.

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

All bullion imported through general trade is required to be sold first through the SGE, and consequently all gold flowing through the SGE is prohibited from being exported. Detail: a few jewelry companies also have a gold trade license for general trade, but this is insignificant. But there is more to it, which is another form of cross-border trade; processing trade. To explain what processing trade is, it would be best to first describe why it exists.

Since 2002 the State Council is active in stimulating the Chinese population to accumulate physical gold. Through commercial banks the Chinese people are informed about gold’s function in the economy and able to purchase gold granted of the finest quality. They can submit for a gold savings account, speculate in paper gold on the SGE or buy physical gold directly at the SGE, all through a commercial bank as a broker.

Some examples of how state-owned banks promote gold, from the Agricultural Bank China:

Physical gold is both a commodity and a financial product. It can be a gift or collection and may serve as an important investment vehicle for realizing preservation and appreciation. With a distinctive preservation function, physical gold is powerful to defend against inflation.

From ICBC:

☆ Considerations
1. Do not stop when gold price is low. Gold price may go up or down depending on the political and economic conditions and many other factors. Only by constant accumulation will the overall investment cost be reduced.
2. Persistence is the key. Investment risk is reduced by the average cost, the longer the investment period, the better in mitigating the impact of the fluctuation in gold price. When the market rallies, the gain will be protected and increase the investment. 

ICBC branch gold
Outside an ICBC branch in Shanghai
ICBC gold products
Inside an ICBC branch in Shanghai

The State Council’s strategy is to import as much gold as possible and export nil in order to build a strong economic and financial security barrier for China.

However, China doesn’t want to be left out in the global jewelry fabrication market, for which gold is required to be exported. To make China participate in the global jewelry fabrication market Chinese jewelry companies can import and export gold through processing trade. This is how it works, simplified:

In processing trade raw materials from abroad are imported, processed into finished goods and then these products are required to be exported. This processing is usually done (there can be exceptions) in Customs Specially Supervised Areas (CSSA), also called Free Trade Zones (FTZ). Gold processing trade doesn’t require a general gold trade license from the PBOC. Note, to export gold from a CSSA to a non-CSSA (the rest of the mainland) a general gold trade license from the PBOC is required.

The next illustration demonstrates two types of processing trade.

processing trade China gold

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 industry; 4000 manufacturers), then the gold is fabricated into “jewelry” (/changed in shape or form/processed) and imported back into Hong Kong. By the way, this trade would show up in Hong Kong’s customs report, but it wouldn’t affect Hong Kong net export to the mainland.

Through processing trade gold can be imported into/ exported out of China mainland, but these flows are completely separated from the Chinese domestic gold market where the SGE system operates. Gold imported through processing trade is therefor not required to be sold through the SGE – it is not even allowed to be traded through the SGE.

In the next illustration we can see Hong Kong (representing the rest of the world), the CSSA in Shenzhen and the mainland (the Chinese domestic god market).

CSSA Shenzhen Hong Kong Mainland

Processing trade is often done between Hong Kong and Shenzhen; all gold exported from China (CSSA) to Hong Kong or any other foreign nation is processing trade.

Hong Kong - China gold trade monthly January 2009 - November 2014

Round tipping by Chinese speculators can only be done through processing trade; it simply isn’t possible through general trade, as in general trade gold is prohibited from being exported. Round tripping flows are completely separated from the Chinese domestic gold market and the SGE, hence, round tripping doesn’t inflate SGE withdrawals. Only by bending the rules, set up a fake gold jewelry company in a CSSA, speculators can import and export gold to round trip. Consequently, GS notes gold needs to be physically imported and exported for round tripping, in contrast to copper.

In theory the gold tied up in round tripping can be at max the amount of gold yearly exported from China (to Hong Kong), at minimum a far smaller amount that is being used in many cycles, in every cycle being counted as import and export. Round tripping doesn’t inflate net export from Hong Kong to China.

The Chinese Gold Lease Market

The other gold financing deal that can be used by Chinese speculators is gold leasing (which is exactly the same as a gold loan). In general gold leasing is a normal market practice. For the sake of simplicity, I have categorised all potential gold lessees (borrowers) in three groups (gold miners, jewelers and speculators) to have a look at some examples (with US dollars) to learn how gold leasing is done in financial markets:

  • A gold miner needs funds to invest in new production goods. It can borrow dollars from a bank at an 7 % interest rate, or borrow gold from a central bank at 2 % – the gold lease rate is usually lower than the dollar interest rate. The miner chooses to borrow 10,000 ounces from a central bank and sells it spot at $1,500 an ounce. The proceeds are $15,000,000 that can be used to invest in new production goods. In a years time the miner has mined 10,200 ounces to repay the principal debt plus interest (the interest on gold loans can be settled in gold or dollars, depending on the contract). Through gold leasing the miner has acquired cheap funding, if compared to a dollar loan. The movement in the price of gold during the lease period is neglected in this example.
  • A jeweler needs funds to buy gold stock for production. It can borrow dollars from a bank for 7 %, or borrow gold for 2 %. The jeweler borrows 10,000 ounces, with which it can start fabricating jewelry. To hedge itself against price fluctuations the jeweler can sell spot, for example, 10 % of the 10,000 ounces it has borrowed (1,000 ounces at $1,500 makes $1,500,000) to buy gold futures contracts in order to lock in a future price. After a year the jeweler has sold the 9,000 ounces (as jewelry) for dollars and can take delivery of the long futures contracts to repay the gold loan. If one buys (long) 10,000 ounces through a futures contract for delivery in a year’s time, initially he is required to pay a margin, for example 10 %. When the contract expires and he wants to take physical delivery he must pay the remaining 90 %.
  • A pseculator is looking for cheap funds. It can borrow dollars from a bank for 7 %, or borrow gold for 2 %. He borrows 10,000 ounces, sells it spot at $1,500 an ounce. The proceeds are $15,000,000 and subsequently these newly acquired funds can be used to invest in higher yielding products (> 2 %). If the trader chooses to hedge itself in the futures market is up to him. After a year the 10,000 ounces plus interest need to be repaid, either the trader can purchase gold with the profits made on the higher yielding investment or from delivery of futures contracts.

In China all gold leases are settled through the SGE; both lessor (lender) and lessee are required to have an SGE Account. If a lease is agreed between two parties gold is transferred from one SGE Bullion Account to the other, when the lease comes due the gold is returned. At SGE level it’s as simple as that.

There is a big difference between jewelers that lease gold in contrast to miners and speculators. Jewelers lease gold because they need physical gold for fabrication; miners and speculators lease gold because they are seeking cheap funds, they will always sell the leased gold (without withdrawing the metal) spot at the SGE to use the proceeds. Why would a speculator withdrawal the metal?

Therefor, IF SGE withdrawals contain leased gold this is for jewelry fabrication that eventually ends up at retail level. When a jeweler needs to repay the lease it simply buys gold at the SGE, subsequently this gold will be transferred from his SGE Bullion Account to the lessor’s SGE Bullion Account. It’s not likely a jeweler would buy gold off-SGE to repay a lease, which than would need to be refined into newly cast bars by an SGE approved refiner to enter the SGE vaults and to be credited to the lessors SGE Bullion Account.

Phillip Klapwijk, analyst with Precious Metals Insights (PMI) in Hong Kong, previous Executive Chairman of Thomson Reuters GFMS and consultant for the World Gold Council, has stated there is 1,000 tonnes of gold tied up in CCFD (not true!). Additionally, he said:

… a good part of the withdrawals represent gold that is used purely for financing and other end-uses that are not equivalent to real consumption.

Needless to say I don’t agree. Am I the only one? No. When Na Liu of CNC Asset Management Ltd., visited the SGE in May 2014 he was told by the President of the SGE Transaction Department:

First, the withdrawal data reflects the actual gold wholesales in China. In 2013, the total gold withdrawal from the SGE vaults amounted to 2,196.96 tonnes. The President of SGE Transaction Department (The President) said: “This 2,200 tonnes of gold, after leaving our vaults, they entered thousands of Chinese households in the form of jewellery and investment purchases.”

… Second, none of the 2,200 tonnes of gold was bought by the Chinese central bank. The President said: “The PBOC does not buy gold through the SGE.”

Third, the financing deals do not exaggerate SGE’s assessment of China’s gold demand. This is because “the financing deals do not take place after the gold leaves the vaults.” 

The President of the SGE’s Transaction Department is clearly stating most leasing happens within the SGE system and the metal is not withdrawn. I’m not saying it can’t occur a speculator would withdrawal metal from the SGE vaults, but in general he would not. Therefor, gold leasing by speculators does not inflate SGE withdrawals and therefor does not explain the difference between SGE withdrawals and Chinese consumer gold demand as disclosed by the World Gold Council.

As mentioned before jewelers do withdraw gold from the SGE vaults, but this is eventually to be sold as jewelry. However, the amount of gold leased and withdrawn by jewelers that has not yet been sold as jewelry, is stock inventory (likely hedged in the futures market) and thus can be excluded from gold demand depending on what metric is used.

The WGC had also stated in a report 1,000 tonnes was tied up in CCFD, based on PMI’s data. But, when I send the WGC an email to ask about the details, they replied [brackets adde by me]:

Gold leasing: Banks have built up this business to support China’s burgeoning gold industry. Miners, refiners and fabricators all have a requirement to borrow gold from time to time. For example, fabricators borrow gold to transform into jewelry, sell and then repay the bank with the proceeds. It is an effective way for the fabricator to use the bank’s balance sheet to fund its business. Banks have strict policies in place for who they can lend to, and these have been tightened over recent years, but during PMIs field research it identified that, in some instances, organizations other than genuine gold business had used this method to obtain gold, which it would then sell to obtain funding [in this case the gold wouldn’t be withdrawn from the SGE vaults]. It would then hedge its position. According to PMI, this can generate a lower cost of funding than borrowing directly from the bank. Our colleagues in China think this would be a very small part of total gold leasing; the majority of it would be used to meet the demands of genuine gold businesses.

Here the World Gold Council admits gold leases that are withdrawn from the SGE vaults are used for genuine gold business (being part of true gold demand). More confirmation gold leasing does not explain the difference

More detailed information about the Chinese gold lease market can be found in my posts A Close Look At The Chinese Gold Lease Market, Gold Chat About The Chinese Gold Lease MarketZooming In On The Chinese Gold Lease MarketChinese Gold Leasing Not What It Seems and Reuters Spreads False Information Regarding The Chinese Gold Lease Market

Conclusion

Round Tripping gold flows are completely separated from the Chinese domestic gold market (SGE) and gold leasing only inflates SGE withdrawals when used for genuine gold business. Therefor, SGE withdrawals equal Chinese wholesale gold demand.

Where Did The Gold In Fort Knox Come From? Part One

In contrast to what is widely assumed, the gold in Fort Knox has not mainly been supplied by gold coins in circulation in the United States before the Great Gold Confiscation by President Roosevelt in 1933.

Whilst me and Mr. Manly are researching how much gold is left in the vaults in the United States – at the Federal Reserve Bank of New York (FRBNY) and at Fort Knox – I thought it would be useful to examine historic US mining, minting, refining and gold trade data as far back as possible. Through historic USGS Mineral Yearbooks, Federal Reserve Bulletins and US Mint Annual Reports I was able to find detailed information. Additionally I used the books Currency Wars, The London Good Delivery List 1750-2010 and War On Gold for references. Our investigation starts before World War II. 

The Gold Standard

United States suspends gold standard-On April 19, 1933, closely following the bank holiday, March 6-13, for the second time in its history the United States was off the gold standard. Although Great Britain, followed by many other countries, was off the gold standard in September 1931 …

To get a better understanding of the monetary era we’re investigating it’s important to understand there are many varieties of the gold standard. For example, a gold coin standard, the classic gold standard, the gold exchange standard and Bretton Woods. Without exception it’s a monetary system whereby, at least a part, of the money supply is backed by gold at a fixed price; the monetary unit is tied to a certain weight of gold. Countries participating maintain these fixed prices by being willing to buy or sell gold to anyone at that price.

What was the weight in gold of one US dollar before World War II?

The act of February 12, 1873, provided that the unit of value of the United States should be the gold dollar of the standard weight of 25.8 grains and that there should be coined besides the following gold coins: A quarter eagle (2.5-dollar piece), a 3-dollar piece, a half eagle (5-dollar piece), an eagle (IO-dollar piece), and a double eagle (20-dollar piece) all of standard weight proportional to that of the dollar piece.

In 1932 the price of gold in the US was still fixed at $20.67. In the next screen shot from the USGS Mineral Yearbook we can see the historic data of the gold price in the US since 1792 and the value denominated in the $10 gold eagle coin.

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The $10 eagle coin was 90 % (900 fine) pure gold, in total it contained 258 grains of which 232.2 fine grains of gold, each fine grain had a fixed parity to the dollar at $0.04306632 ($20.67183463 per fine troy ounce).

232.2 * 0.04306632 = $10

The $10 eagle weighed in total 0.5375 troy ounce, of which 0.48375 troy ounce was fine gold.

$10 / 20.67 = 0.48375

0.48375 / 0.9 = 0.5375

Eagle USA 1932 Coin $10
US $10 gold eagle, 1932. Total weight 0.5375 troy ounce, 900 fine.

The Great Depression in the US started on October 28, 1929, Black Monday, when the Dow Jones Industrial Average fell 12.8 % in one day. When Franklin Delano Roosevelt (FDR) became President on March 4, 1933, his ambition was to boost the economy by devaluing the dollar against gold – raise the price of gold. But, was that possible when gold coins with a fixed price engraved on it circulated in the economy? No. This is why FDR ordered all American citizens to sell all their gold coins and bullion, through Executive Order 6102, to the Federal Reserve in exchange for $20.67 paper dollars per ounce.

When all gold from the American people was tricked out FDR could raise the price of gold; the US proceeded to purchase gold in the open market in October 1933, steadily devaluing the dollar against gold.

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By February 1, 1934, the price of gold had reached $35 per ounce. In four months the dollar was devalued by a staggering 70 %. Although the citizenry was prohibited from owning gold since 1933, the dollar price of gold was still fixed and foreign central banks could still exchange dollars for gold at the US Treasury; from an international perspective the US remained on the gold exchange standard that was implemented after World War I.

US Official Gold Reserves

There is a well-known document from the World Gold Council (WGC) that discloses the historical official gold reserves of all major economies in the world; based on the numbers from this document I previously made the following chart.

US Official Gold Reserves
Note the first part of the X-axis is segmented in 5-year intervals. From 1950 the data is plotted yearly.

From additional sources I previously assumed most of the US official gold reserves build-up after 1933 was sourced from gold in the US domestic market. I’ve read many analyzes on how all the gold coins (900 fine) were taken out of circulation, melted into coin bars (900 fine) and transported to Fort Knox. The book War On Gold by Antony C. Sutton, published in 1977, discloses the unaudited reserves held by the US Mint on November 30, 1973.

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Supposedly 80.7 % of the gold stored by the US Mint (7,946 tonnes) at the time were coin bars, at 6,412 tonnes.

Without a doubt most coins (and bullion) privately owned in 1933 in the US were confiscated and melted into coin bars to be added to the Federal Reserve’s Stash, which in 1934 flipped ownership to the US Treasury. But, how many coins were confiscated? And where exactly did the 13,041 tonnes added to official reserves in between 1933 to 1940 come from?

Coins In Circulation Before 1933

How many gold coins circulated within US borders before 1933? Probably impossible to say exactly, but we can make an estimate.

The US mint was founded in 1792, form the Annual Report Of The Director Of The Mint (page 103) for the fiscal year that ended June 30, 1932, we can read roughly 6,700 tonnes of gold were minted into coins since its inception.

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We must consider not all these coins remained in existence; as the economy developed coins were melted into bars, to be stored at banks in return for dollar bills, or they got worn out and re-melted at the Mint. Additionally, we must consider trade; US coins were exported and imported – as well as foreign coins (foreign coins that came into possession of the US government were melted into bullion).

Calculating how many coins were re-melted, refined into bullion, exported or lost would be a very time consuming task, luckily the US Mint has done this for us. Periodically it used to make estimates of the value of gold coins present within US continental borders.

From the 1932 Annual Report (page 62):

Stock of domestic coin.-Consists of an estimate made in 1873 of gold and silver coin, the former of which was revised in 1907, with annual addition of new coinage and reported imports, and deduction of withdrawn coin, reported exports, and an estimate for industrial use; since 1928 the additional factor of old coin “earmarked” or set aside for foreign owners, has been considered, such transactions being equivalent to exports and releases thereof being equivalent to imports.… The monetary stock tables for a series of years have been revised back to the establishing of the Federal Reserve System (1914) to include earmarked gold,… The item of coin withdrawn as used in the stock compilation omits the coin received for recoinage but not yet reviewed, which coin is subject to classification adjustments.

That sounds like a fair estimate. So how much is it? From page 111:

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The total was worth $1,671,608,689, which equals to 2,515 tonnes of gold coin (900 fine) within the US at December 31, 1931.

My assumption is that this total was held in people’s wallets, homes or at banks as deposits. In the Mineral Yearbook 1931 we can see how much gold in the form of coins was held by banks (and the government):

Screen Shot 2015-02-27 at 11.14.47 AMThe first thing we notice in the above table is that all Coin and Bullion categories summed up do not equal Total stock of gold in 1931. For other years the categories do add up, perhaps there is a category not disclosed in the 1931 line. Processing the numbers we have gives:

Total Coins at US banks and the government in 1931 = 976,900,000 + 286,082,000 + 12,973,000 + 395,653,000 = $1,263,391,000

Total Bullion at US banks and the government in 1931 = 2,580,803,000 + 207,688,000 = $2,788,491,000

At a value of $20.67 an ounce:

Coins: 1,901 fine tonnes (presumably 900 fine)

Bullion 4,196 fine tonnes (presumably 900 or 995 fine)

The US Mint estimated that 2,515 tonnes of coins were in existence in the US, of which, apparently, 1,901 tonnes were held at banks and the government. Supposedly the difference, 614 tonnes, made US official gold reserves jump 13,041 tonnes – from 6,505 tonnes in 1933 to 19,546 tonnes in 1940. Obviously this is not possible.

Strikingly, in another table from the US Mint Annual Report (page 113) it’s disclosed $408,626,457 in Gold coin and bullion was in circulation, which equals to 614 tonnes.  

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Please note to what degree coins were used in the economy at that time. In The London Good Delivery List 1750-2010, by Timothy Green, it’s stated:

In 1919 the (fixing) price was now quoted for 400-ounce / 995 Good Delivery bars, rather than the traditional 916 standard coin bars which rapidly became extinct as minting of coin virtually ceased… In 1929 the Wall Street crash ushered in financial and economic instability, reflected by large international movements of gold coin, melted coin bars and bars of uncertain provenance. All had to be refined to Good Delivery status 

The London Gold market made a clear shift in 1919 to higher purity bars (995), as minting of coin virtually ceased. Though, coin bars were accepted until 1954; Good Delivery bullion could be either 899 – 901, 915.5 – 917 or 995 fine until 1954.

More confirmation the use of gold coins dropped long before 1933 we can read in the Federal Reserve Bulletin, published December 1, 1917:

DECEMBER 1, 1917. FEDERAL RESERVE BULLETIN.

Following is a circular letter issued on November 21 by the Federal Reserve Bank of Philadelphia:

To the banking institution addressed:

For your information your attention is again directed to a letter on the use of coin-counting machines, issued by the Federal Reserve Board some time ago, but which is especially appropriate at this time, reading as follows:

The use of gold coin in machines for counting money has proved that there is quite a serious abrasion of the coin. This draws attention to the fact that in our country, as well as in Europe, the use of gold coin as currency in the hands of the people is disappearing. The public does not want to carry gold coin, and its use leads to rapid abrasion and consequent loss of value. In the United States it may be truly said that as a practical matter coined gold is only used as security behind gold certificates, or for foreign exchange purposes, where nothing else can be used in adjusting international balances.

Not that many gold coins circulated in the American economy before 1933 and it’s impossible these have filled Fort Knox after the Great Confiscation. Why is this the story many experts have told us about Fort Knox?

US Historic Gold Import And Mine Output

The incredible surge in US official gold reserves after 1933 was mainly sourced from imports.

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From historical USGS Mineral Yearbooks and Federal Reserve Bulletins I’ve collected all trade data and plotted a chart starting in 1932 – because before 1932 no substantial net flows occurred.

US gold trade 1932 - 2014

When the US dollar price of gold was raised to $35 this triggered a huge flow of gold from Europe that hit the shores of the United States. From The London Good Delivery List 1750-2010:

In 1934 United States Assay Office was instructed to buy at that price [$35] all gold offered. “A flow gold commenced … which quickly reached flood proportions,” Samuel Montagu’s Annual Bullion letter commented. “Never before has such a huge movement of gold taken place in so short a time.… Accommodation of all mail steamers was booked well ahead and many other vessels than the regular liners were pressed into service as bullion carriers …. The US Treasury officials were overwhelmed by the inrush and at first there was considerable delay in making settlement for gold tendered.” Montagu estimated that at one moment almost 1,866 tonnes was on hold in London in private holdings, by the government or individual accounts. The mélange of bar markings added to the problem.

… given the flows across the Atlantic in pursuit of $35 (which Fort Knox in Kentucky was soon being build to house). The central banks of France, the Netherlands, Switzerland and Italy sold over 2,000 tonnes before the end of 1936.  

In 1939 a limited gold trade was tightly regulated by the bank of England. Gold flows continued to the US as European central banks were forced to sell their shrinking stock.

United States Gold Trade vs Official Gold Reserves

The correlation between the red and the blue line means most of the US official gold reserves were added through imports. All gold imported went straight to the Treasury, as well as US mining output, which had more than doubled from 71 tonnes in 1933 to 151 tonnes in 1940. Mining exploded after 1933 as one troy ounce’s purchasing power was increased by 70 %.

The USGS Mineral Yearbooks continued to disclose monetary gold export until 1978:

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As we can see the US was still exporting gold from its official reserves in 1977. I wonder why they stopped publishing monetary export data in 1978? From 1978 to 2013 the US has net exported 4,660 tonnes in non-monetary gold.

What I’m mostly after is what kind of bullion was exactly imported since 1934, coin bars or 995 bars, as we know now the gold in Fort Knox hasn’t been supplied by US coins in circulation before 1933, though the Fort Knox bar list shows most of the gold is 900 fine.

Where US official gold reserves exactly came from and what types of bars were supplied will be examined in part two!

SGE Withdrawals 59t in week 6, YTD 374t: Chinese Gold Soap Extended Another Season

The latest numbers from the Shanghai Gold Exchange (SGE) demonstrate a little over 59 tonnes have been withdrawn from the vaults in week 6 of 2015, down 0.35 % w/w. SGE withdrawals, which are often used as a proxy for Chinese wholesale gold demand, account for an amazing 374 tonnes year to date, up 17 % y/y.

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Blue (本周交割量) is weekly gold withdrawn from the vaults in Kg, green (累计交割量) is the total YTD.

Corrected by the volume traded on the Shanghai International Gold Exchange (SGEI), withdrawals in week 6 were at least 51 tonnes (read this post for a comprehensive explanation of the relationship between SGEI trading volume and withdrawals). Year to date withdrawals corrected by SGEI volume were at least 333 tonnes.

I can’t proof it at this stage, but I think domestic withdrawals are more likely to be 374 tonnes year to date than 333 tonnes. The Chinese import huge amounts of gold which obviously is not going through the SGEI. In addition, it seems unlikely every trade on the SGEI is withdrawn from the vaults in the Shanghai Free Trade Zone to be exported. The SGEI is not yet the place to buy gold.

Shanghai Gold Exchange SGE withdrawals delivery 2015 week 6

Shanghai Gold Exchange SGE withdrawals delivery only 2014 - 2015 week 6

According to my estimates China has imported 280 tonnes year to date (until February 13).

Here’s some more perspective; SGE withdrawals year to date are definitely not less than last year when we experienced how Chinese people can storm their local malls on a mission to buy as much gold as they can (perhaps that’s why this year lifeguards were on the scene to control the shoppers).

Lunar Year Withdrawals

Yes, demand has been huge in China, but not according to the price of gold. Technically speaking it doesn’t matter how much gold is bought to qualify demand, if supply is outstripping demand the price will go in one direction only, down. Officially, by tracking the price this should tell us everything about supply and demand of gold. A declining price means supply transcends demand, until a new price equilibrium is found, and vice versa.

If the price of gold is determined by physical supply and demand of gold we are supposed to believe that since April 2013 (see chart 1) there has been far more supply than demand as the price has come down substantially. Supposedly there has been so much supply, that Swiss refiners expanded their plants and worked in three shifts 24 hours a day to refine all this gold, which they fortunately could dump in China. The decline in the price was an enormous flood of supply and feeble demand!

Perhaps you can read my cynicism between the lines, as in my opinion there is more going on than the official story; for example, all leading Western consultancy firms have underreported 2013 and 2014 Chinese gold demand in both years by roughly 1,000 tonnes. As I have written a few hundred times on these pages: why the mainstream media isn’t covering this remains a mystery.

Most of the big potatoes in the gold realm sort of deny the amount of gold China is accumulating or present inaccurate arguments to defend their understated demand numbers.

On February 17, 2015, Mr Phillip Klapwijk, an analyst with Precious Metals Insights in Hong Kong, previous Executive Chairman of Thomson Reuters GFMS, was interviewed by Jan Harvey and Michael Wagner at the Reuters Global Gold Forum:

Harvey: The period in the run-up to the Lunar New Year is considered a peak season for gold demand in China. From what you have seen, how has buying been this year, compared to last year and the year before?

Klapwijk: In terms of the YoY, my sense is that 2015 is up moderately on 2014 but well below the exceptional demand seen in the same period in 2013.

Hmm, I beg to differ as we can see in chart 3.

Harvey: What sort of consumer trends have been noticeable this year – what sort of products are people favoring, and is gold buying overall as widespread as it has been in the past?

Klapwijk: This is partly a price and timing related phenomenon but also I think speaks to – by Chinese standards – a somewhat ‘soft’ environment for retails sales of jeweler this New Year.

I wrote a lengthy piece a couple of days ago stating retail sales do not make up the majority of gold sales in China.

Harvey: Do you consider withdrawals from the Shanghai Gold Exchange to be a useful measure of demand?

Klapwijk: The withdrawals show what the big picture is for physical “demand”. They are not per se an indication of the total demand for jeweler, investment products or industry.

This is because a good part of the withdrawals represent gold that is used purely for financing and other end-uses that are not equivalent to real consumption.

Wagner: Is financing with Gold a big deal in China?

Klapwijk: Therefore relying on SGE withdrawals to measure the size of and change in true demand is highly misleading. For example, withdrawals in 2013 came to 2,197t and in 2014 to 2,102t. This both overstates the true size of demand and, of course, completely understates the drop in jewelry and especially bar demand last year.

Yes, the difference is mainly the use of gold for financing. 

Harvey: How has that side of the market developed over the last few years? Is it still a growing area of business?

Klapwijk: The use of gold for financing… a kind of “gold carry trade”….has developed tremendously in recent years. Essentially borrowers in the shadow banking milieu are taking advantage of the availability of gold at comparatively very low rates of interest compared to straight forward RMB loans.

An indication of this is that at end 2013 the SGE reported gold loans by members totaled over 1,100 tonnes. My understanding is that number will have grown quite a bit in 2014.

There it is again, the amount of gold tied up in financing deals (CCFD’s) used as an argument to explain elevated SGE withdrawals. In my latest in-depth article on the Chinese gold market I expanded on why this can’t be the explanation as these deals only show up as SGE withdrawals if used for genuine gold business; jewelers leasing gold for production.

In a report the World Gold Council (WGC) released April 2014, China’s gold market: progress and prospects, it was stated:

… 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 1,000t…

Right, so we’re talking about the same gold, 1,000 tonnes has grown into 1,100 tonnes, but now the source of this number (Precious Metals Insights, Phillip Klapwijk, February 17, 2015) says this is simply the amount leased at the SGE (not disclosing what is withdrawn or not). When I emailed the WGC in 2014 to ask what kind of “financial operations” the 1,000 tonnes actually were, they replied:

Gold leasing: Banks have built up this business to support China’s burgeoning gold industry. Miners, refiners and fabricators all have a requirement to borrow gold from time to time. For example, fabricators borrow gold to transform into jewelry, sell and then repay the bank with the proceeds. It is an effective way for the fabricator to use the bank’s balance sheet to fund its business. Banks have strict policies in place for who they can lend to, and these have been tightened over recent years, but during PMIs field research it identified that, in some instances, organizations other than genuine gold business had used this method to obtain gold, which it would then sell to obtain funding [in this case the gold wouldn’t be withdrawn from the SGE vaults]. It would then hedge its position. According to PMI, this can generate a lower cost of funding than borrowing directly from the bank. Our colleagues in China think this would be a very small part of total gold leasing; the majority of it would be used to meet the demands of genuine gold businesses.

Here the WGC admits leased gold that is withdrawn from the SGE vaults is used for genuine gold businesses and only a small part of total leases is used in shadow banking! I rest my case. 

Koos Jansen vs WGC/GFMS/CPM Update

Recently Thomson Reuters GFMS released its global gold demand figures for 2014 in which they stated Chinese demand was 866 tonnes. I briefly expanded on why I didn’t agree with this number by a humongous margin in my post from January 30 – as Chinese supply was at least 1,834 tonnes. Followed by a post released January 31 on the fact that GFMS again had double counted Chinese gold volume traded on the Shanghai Gold Exchange and the Shanghai Futures Exchange. However, this quarrel does not exclude the World Gold Council and CPM Group.

In Gold Demand Trends Full Year 2014 the World Gold Council (WGC) discloses Chinese gold demand at 814 tonnes, far below the tonnage we see being supplied to China. My previous extensive post on my disagreement with WGC demand figures I wrote months ago, hence I feel a strong propensity to update the blogosphere with my latest insights regarding the Chinese market.

Recap; in China gold demand and thus import is greatly stimulated by the government; gold export is prohibited (in general trade), except for Panda coins; all imported and domestically mined gold is required to be sold first through the Shanghai Gold Exchange (SGE) before entering the Chinese marketplace; once gold is withdrawn from the vaults of the SGE it’s not allowed to re-enter these vaults before it’s re-cast into a new bars by an SGE approved refiner; tax incentives push scrap supply to be sold through the central bourse as well, if casted as new bars. Because of the structure of the Chinese gold market many analysts, including myself, use SGE withdrawals as a proxy for Chinese wholesale demand. Read these three posts (I)(II)(III) for more detailed information on the structure of this market. A simplified equation for the SGE is: 

SGE withdrawals = import + mine + scrap

When I started publishing SGE withdrawals and later connected them to Chinese wholesale demand (on September 18, 2013, December 12, 2013 and April 15, 2014) I was merely using numbers published in Chinese – from reports that are now all taken offline (CGA Gold Yearbook 2007-2009 & 2013, SGE Annual Report 2007-2011, China Gold Market Report 2007, 2008, 2010, 2011), the only two dots I connected was aggregated demand and SGE withdrawals, the rest became self-evident. In the next chart we can see total demand from 2004 to 2013 as disclosed by the China Gold Association (CGA) Gold Yearbook 2013, which is written in Chinese and only published in hard copies; the blue bars represent total demand in tonnes (LHS), the red line y/y growth in percentages (RHS).

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Exhibit 1. Chart total Chinese gold demand from the CGA Gold Yearbook 2013, scanned from page 50.

When I say Chinese wholesale demand in 2013 was nearly 2,200 tonnes I’m not making this up, these are metrics used by the CGA (SGE/PBOC).

Gold supply in China has been outstripping the WGC’s demand numbers by literally thousands of tonnes in the past years, to which the WGC is continuously seeking to find arguments that should explain the difference. In vain the Council has published two reports dedicated to the Chinese gold market that were permeated with incorrect statements. Jumping from one argument to the next hasn’t strengthened their case either. The oncoming chart gives you a rough approximation of the difference.

WGC demand vs SGE withdrawals
Exhibit 2. Chinese wholesale demand (SGE withdrawals) vs WGC demand

Kindly note the WGC has revised their Chinese demand numbers 2013 from 1,066 tonnes to 1,312 tonnes. The revision rebutted their initial data by 23 %.

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Exhibit 3.

For this post we’ll use data from 2013 as a model to examine the Chinese gold market.

Chinese Gold Supply And Demand Metrics

According to SGE chairman Xu Luode Chinese consumer demand in 2013 was 2,000 tonnes. In his speech at the LBMA forum in Singapore June 25, 2014, he noted:

Last year, China imported 1,540 tonnes of gold. Such imports, together with the 430 tonnes of gold we produced ourselves, means that we have, in effect, supplied approximately 2,000 tonnes of gold last year.

The 2,000 tonnes of gold were consumed by consumers in China. Of course, we all know that the Chinese ‘dama’ [middle-aged women] accounts for a significant proportion in purchasing gold. So last year, our gold exchange’s inventory was reduced by nearly 2,200 tonnes, of which 200 tonnes was recycled gold. 

The SGE chairman makes a distinction between SGE withdrawals (2,200 tonnes) and his measure of consumer demand (2,000 tonnes), which he calculates by subtracting recycled gold (200 tonnes) from SGE withdrawals. Xu’s consumer demand equates exactly to how much gold was added to Chinese non-government reserves; typically this is what Chinese leaders track, the amount of gold held among the population. Total demand (equals supply) minus scrap = import plus mined gold. Scrap supply doesn’t add to a country’s reserves, only import and mine supply increase reserves.

All players in this game use different metrics to produce supply and demand figures, partially this explains the difference. In this post we’ll examine these metrics and go through the arguments the authority on gold, as the WGC has crowned itself, has brought up to enlighten us in the past years.

To capture a nation’s gold demand the authority only publishes end-user demand data (consumer demand measured at retail level) in the Demand Trends Reports (page 26).

Consumer demand 

The sum of jewelry and total bar and coin purchases for a country i.e. the amount of gold acquired directly by individuals.

If you read the report you’ll notice the WGC measures end-user demand in the form of jewelry, bar and coin demand per country at retail level, next to “ETFs, OTC investment and stock flows” to compute global total investment. But, what if Chinese individuals buy physical gold at the SGE and have the gold withdrawn from the vaults to store the metal at their own discretion? Would this show up anywhere in demand numbers from the WGC? Fact is the SGE has over 5 million individual clients, according to the chairman of the SGE, next to 8,000 institutional clients!

The reason the WGC only discloses end-user demand is because that’s all that matters to the price of gold, if a jeweler has 2 tonnes of inventory this is hedged and therefor has no net effect on the price. But measuring Chinese gold demand at retail level is inaccurate as every single Chinese citizen can open an SGE account, buy gold and withdraw. Most SGE products are denominated is small lots, consumer sizes: 1 Kg, 100 grams, 50 grams, and 10 grams. There is one product to trade 12.5 Kg bars, though this contract has only been active on three days since its inception (total volume since its inception accounts for 3 tonnes, measured unilaterally). SGE customers (potentially every single Chinese citizen) can buy and withdraw bars as small as 50 grams at the SGE, granted of the highest quality.

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Exhibit 4.

This is one of the reasons there is such a huge discrepancy between retail demand (WGC) and SGE withdrawals. Not all Chinese citizens buy their bars at a jewelry shop, au contraire.

The CGA Gold Yearbook 2013 shows us how demand is composed.

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Exhibit 5. Overview Chinese gold demand 2013, from the CGA Gold Yearbook 2013.
  • Red = Jewelry manufacturing (716.5)
  • Blue = Small gold bar production (375.73)
  • Purple = Industrial material (48.74)
  • Turquoise = Gold coin manufacturing (25.03)
  • Yellow = Other (10.4)
  • Green = Net investment (1,022.44)
  • Black = Total (2,198.84)

I think Small gold bar production is the amount of non-SGE bars manufactured by jewelry companies, banks, etc.

If we add jewelry, bar, coin, industrial and other we get 1,176.4 tonnes. This is demand measured at retail level – which is close to what the WGC initially disclosed as demand. Than there is net investment of 1,022.44 tonnes. An SGE employee once told me this simply is a residual of SGE withdrawals minus what is measured at retail level, or, everything bought directly at the SGE that wasn’t sold at retail level. The huge difference between WGC demand and SGE withdrawals is mainly caused by net investment. The Council’s mission seems to be explaining why net investment is irrelevant, coming up with feeble arguments that should support this. Later on we’ll go through the argument list and what type of demand net investment can be.

Now, let’s have a look at the supply side.

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Exhibit 6. Overview Chinese gold supply 2013, from the CGA Gold Yearbook 2013.
  • Purple = Domestic and overseas mine output (445.417)
  • Green = Recycled gold (246.923)
  • Blue = Bullion import (1,506.50)
  • Black = Total (2,198.840)

From this article we know in 2013 China domestically mined 428.16 tonnes and 17.25 came from offshore activities, so actually 1,523.75 tonnes were imported. SGE withdrawals accounted for 2,196.96 tonnes in 2013, meaning 1.88 tonnes (2,198.4 – 2196.96) were imported in the form of ie jewelry that wasn’t required to be sold through the SGE.

In Understanding China’s Gold Market the WGC notes there are two types of recycled gold in China.

Recycling: There are two types of recycled gold: i) Gold-for-cash and ii) gold-for-gold. At a retail level consumers can sell gold for cash or, especially in the case of jewelry, exchange old pieces of gold for new pieces of gold. It may be that in tonnage terms, gold-for-gold recycling is similar in size to gold-for-cash recycling: we recently surveyed 1,000 consumers and found that 8% of gold owners had sold gold-for-cash, while 10% had exchanged gold-for-gold. At a wholesale level banks and jewelers may also sell or exchange gold stock with other suppliers.

I fully agree, again we see the difference in metrics; gold-for-cash is what GFMS measures (150 tonnes in 2013), gold-for-gold is measured by the CGA as a residual.

SGE withdrawals – import – mine – gold for cash supplied to the SGE = 96.923 tonnes

Hence total recycled gold in Exhibit 6 is disclosed at 246.923, this is gold-for-cash and gold-for-gold. More information on recycled gold in China according to CGA metrics we can read in the China Gold Market Report 2008 and 2009:

… At present, gold scrap in China mainly is in two major forms: repurchase of gold bars, only applicable to brand gold bars in reference to real-time gold price, and repurchase of gold jewelry through retailers.

… China’s actual gold recycling likely reached 100 tons in 2008. Physical gold withdrawals on the Shanghai Gold Exchange (SGE) topped 543.19 tons in the year, including gold imports of 81.44 tons by commercial banks, stock carry-over of 31.661 tons from 2007 and 282.007 tons of gold produced in the year. In theory, the gap of 148.082 tons was filled by recycled gold. Therefore the gold recycled in China in 2008 should have amounted to more than 100 tons in 2008.

A few years later (2014) from the WGC in Understanding China’s Gold Market:

Given the complexity of the market there could be many reasons, but the most likely explanation is that the SGE delivery figure includes the flow of recycled gold-for-gold as well as gold-for-cash. As explained previously, while recycled gold-for-gold will increase supply and demand, the net effect is market neutral. For this reason, demand and recycling estimates as reported in Gold Demand Trends and GFMS, Thomson Reuters’ Gold Surveys exclude recycled gold-for-gold. But because the structure of the Chinese gold market requires refined and recast recycled gold to be sold through the SGE [this is not mandatory, tax incentives stimulate refined gold to be sold through the SGE], it is likely the delivery figure captures this circulation of recycled gold-for-gold.

The next flow chart from the WGC is also quite helpful:

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Exhibit 7. Courtesy of the WGC. The red box is painted by me.

I hope it’s clear now what different metrics are used for both supply and demand. If we take another look at the Exhibit-2-chart, supplemented by import, mining and scrap data, it becomes more clear what the difference is.

WGC demand vs SGE withdrawals 2
Exhibit 8. The WGC mainly relies on data from GFMS for its Demand Trends Reports, though it doesn’t publish as detailed information on scrap supply as GFMS, hence I used GFMS’ scrap numbers.

Even if we take out gold-for-gold scrap supply (the green bars represent gold-for-cash scrap) total aggregated supply from 2007 to 2014 was 7,872 tonnes, while total aggregated WGC demand over this period was 5,469 tonnes. Leaving 2,403 tonnes to be explained by the Council in their argument list, which is focused on the ‘surplus’ in the Chinese gold market, but indirectly aimed at debunking the size of SGE withdrawals.

Chinese Commodity Financing Deals

Gold is used in two sorts of Chinese Commodity Financing Deals (CCFD) to raise cheap funds: round tripping and gold leasing (read this post on the details of round-tripping, this and this on gold leasing). CCFD’s are definitely on the WGC’s argument list.

As I’ve mentioned above the WGC has published two China specials to explicate where a few thousands tonnes of gold went missing somewhere on the Asian continent, next to all quarterly Gold Demand Trends.

1) China’s gold market: progress and prospects (April 2014)

2) Understanding China’s Gold Market (July 2014)

In the first report on page 56 it’s stated, “round-tripping can inflate the SGE delivery figures”. This is absolutely not true, as I have extensively written about in The Round Tripping Myth And Why It Doesn’t Hurt Chinese Gold Demand. No need to repeat myself.

Also on page 56:

The ‘surplus’ in the Chinese market mainly stems from either possible official purchases or the extensive use of gold for financial operations.

… 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 1,000t…

Although the mainstream media got completely carried away with the assumption 1,000t was tied up in CCFD’s, in reality it’s not so worrisome. Because it doesn’t involve round- tripping it can only be gold leasing. Somewhat simplified, only three parties engage in leasing gold to raise cheap funds: jewelers, miners and speculators. In China all gold leasing is settled through the SGE. If miners or speculators lease gold, they would instantaneously sell it spot at the SGE – they would not withdraw – and use the proceeds for investments. Only jewelers would withdrawal leased gold from the vaults to fabricate jewelry, subsequently sell the jewelry and use the proceeds to repay the gold loan. These withdrawals would eventually end up at retail sales. Additionally, it’s not likely a jeweler purchases gold off-SGE to have it refined and bring it to the SGE vaults to settle the lease, because the jeweler can simply buy directly at the SGE to settle the lease. This means gold leasing (CCFD’s in general) does not inflate SGE recycled gold supply.

In my opinion CCFD’s cannot substantially distort Chinese wholesale demand (SGE withdrawals). Occasionally I read numbers on the size of the Chinese gold lease market, though for me it is impossible to say what share is withdrawn or processed within the SGE system. I only know the part that is withdrawn is mostly genuine gold business.

In Gold Demand Trends Full Year 2014 the Council states:

The flow of gold into China has far exceeded the amount needed to meet domestic jewelry and investment demand in recent years [please tell us gold investors how much!]. The role of the commercial banks in using this gold for financing purposes has been well documented, including in our report Understanding China’s Gold Market and this activity expanded in 2014. To some extent, this helps explain why Shanghai Gold Exchange delivery figures are significantly higher than consumer demand.

If the only document they disclose on CCFD’s is Understanding China’s Gold Market, there is nothing new for us to learn. Yes, jewelers can lease gold, have it withdrawn and produce it into jewelry while it’s pending to be sold in retail. But this gold will not return to the SGE, so eventually it will be end-user demand. The part that is pending can partially explain the difference.

Commercial banks can have all sorts of gold (leases, pledges, ETF’s, gold savings accounts, etc) on their balance sheet, this doesn’t mean this gold has left the SGE vaults. In China gold ETF’s are backed by SGE contracts.

Official Purchases

We just read on page 56 from China’s gold market: progress and prospects, the difference might be explained by PBOC purchases. However, on page 9 from Understanding China’s Gold Market:

China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. But there are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBOC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.

That’s what I wrote in this post (April 2014), it seems the WGC turned 1800 and agrees the PBOC doesn’t buy gold through the SGE.

PBOC purchases remain a very tough subject to analyze. I know they buy gold, but I have weak evidence of how much. The theory of China implementing the Turkish model to build official reserves is interesting, yet one of many problems with this theory is that the PBOC has a very strong incentive to diversify $4 trillion in FX reserves from US dollars into physical gold. So, until I bump into any evidence that would suggest otherwise, the PBOC does not buy any gold through the SGE.

Import

There are incredible amounts of gold imported into China. The Council has often noted on the argument list exact data is hard to get by because round tripping and scrap flows may distort import figures. 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.

I’ve written an extensive post on why this is not true. In the CGA Gold Yearbook 2013, it’s precisely disclosed how much gold is imported. For other years data is available as well.

Stock Inventory

Next on the argument list is stock inventory. As demonstrated above, if a jeweler has 2 tonnes of inventory this is likely hedged, which makes it for the Council’s metrics not count as demand. From Understanding China’s Gold Market:

… It is, however, indicative that as jewelers expanded, so too did their inventory levels and it is our judgment that across the industry between 75t to 125t may have been absorbed in the supply chain since 2009.

Ok, let’s go along with this, 125 tonnes of gold (at max) is held by jewelers and alike as inventory.

The Shanghai International Gold Exchange

Something the WGC hasn’t listed on the argument list, which they should, is trading on the Shanghai International Gold Exchange (SGEI). Because SGE withdrawals at this stage also capture potential withdrawals from the SGEI in the Shanghai Free Trade Zone, this can distort withdrawal numbers in the domestic market. However, trading on the SGEI has been faint since its launch, so in my opinion it doesn’t play a substantial role now. Read this post for a detailed explanation.

Conclusion

The difference in metrics should be clear; SGE withdrawals are the widest measure to capture demand, whilst WGC demand is said to capture retail demand. Though, I think there is a lot of demand from individuals and institutions that buy directly at the SGE that is overlooked by the WGC.

If we stick to WGC metrics (not count gold-for-gold supply) the only legitimate argument that can explain the difference is stock inventory, either purchased at the SGE or leased at the SGE by wholesalers. According to the Council this accounts for 125 tonnes. Exhibit 8 showed us the gap between supply from 2007 to 2014 (7,872 tonnes) and WGC demand over this period (5,469 tonnes) is 2,403 tonnes. So, the difference is 2,403 tonnes and the only real WGC argument we can find to fill this void is 125 tonnes of stock inventory.

In my humble opinion stock inventory can be higher than 125 tonnes, say 300 tonnes, but this would still not fill the gap. Therefor the WGC massively understates Chinese gold demand. 2014 Chinese gold demand disclosed by the WGC is 814 tonnes, though supply was approximately 1,850 tonnes (excluding gold-for-gold), SGE withdrawals accounted for 2,102 tonnes.

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Exhibit 9. Boxed in red is the total amount of gold withdrawn from SGE vaults in 2014 (in Kg’s)

Gold-for-cash scrap (GFMS’ scrap numbers) supply is not required to be sold through the SGE, theoretically it could be refined into, for example,  goldwire and sold directly to jewelers. Aggregated mine and import supply from 2007 to 2014 is 6,934 tonnes. 

For anyone who is interested in analyzing the Chinese gold market, here are some numbers to begin with:

Chinese supply and demand numbers 2007 2014 SGE WGC GFMS
Exhibit 10.

One last point I want to make; if we look below at the weekly SGE withdrawal chart since 2010 we can see spikes around every New Year / Lunar Year (and from April – September 2013 due to the crash in the gold price) when traditionally the Chinese people buy presents for each other, often gold. Would this chart look the same if SGE withdrawals also contained CCFD’s or official purchases? Or would the chart than look more seasonally independent? In my opinion, IF the PBOC would acquire gold through the SGE the chart would look more seasonally independent.

Shanghai Gold Exchange SGE withdrawals delivery 2015 week 5, dips
Exhibit 11.

CPM Group

Somewhere in November 2014, Jeffrey Christian, Managing Partner of CPM Group, wrote an email to one of my colleagues, arguing SGE withdrawals are not what they seem. The post in which my colleague published the email and responded is taken offline (dead link), but here’s the email in full:

…,

Someone sent me a piece you wrote on gold, in China but also elsewhere.

One comment: You use SGE gold deliveries seemingly as a surrogate of gold demand. A significant amount of the gold purchased by jewelry and electronics manufacturers and used in making products is re-refined and returned to dealers as new or process scrap. I presume you know that. The scrappage rate for most manufacturing of gold products is between 50% and 70%, depending on the processes used in manufacturing various jewelry, electronics, dental implants, catalysts, and other products. This means that the ‘end demand’ of gold that goes off into products to customers is substantially less than the amount delivered, via the SGE or any other supplier anywhere in the world.

For example, let us assume a manufacturer – it could be a jeweler or an electronics component maker – uses sputtering targets, as most of them do for the past many, many years. The new scrappage rate in the manufacturing process is 70%. In this example, let’s say that the manufacturer is using 10,000 ounces per month, buying 10,000 ounces per month through the SGE, having it made into sputtering targets, using the targets (or, in reality, selling them to clients who use them), and then collecting the process scrap, having it re-refined, and returning it to a dealer. In reality, there are various companies involved in this loop, but let’s keep it simple and say, the manufacturer. So, each month the manufacturer is buying 10,000 ounces of gold via the SGE, using 3,000 ounces in products, and recycling 7,000 ounces. At the end of the year, it will have taken delivery of 120,000 ounces of gold, but will have used 36,000 ounces of gold. The remaining 84,000 ounces of gold will have recirculated through the market repeatedly, each time being counted as an SGE delivery. So, if you are trying to guess how much gold is being used in jewelry, electronics, and other manufacturing processes in China by looking at SGE deliveries, you would be over-estimating actual demand or use by 233%.

I assume anyone writing about fabrication demand levels for gold knows this, but thought I would mention it to you in case it’s news to you. I know that when I mention it in presentations to mining executives, institutional investors, Eric Sprott, the WGC, and other gold market participants or observers, they often have no idea of this, and sometimes cannot even understand the processes I am describing.

I hope this helps. See you soon, next year, I hope.

Sincerely,

Jeff Christian

The key takeaway of Mr Christian’s letter is that the scrap rate in China is much higher than we think and it’s all recycled through the SGE (note, in the process he describes the recycled gold is not required to go through the SGE). My reply is, if we look at Exhibit 6 we can see that by the widest measure SGE scrap supply is 247 tonnes. If we subtract all scrap (247) from SGE withdrawals (2,197), we get 1,950 tonnes. Mr Christian notes this over-estimates demand by 233 %. So actual demand was 585.6 tonnes in 2013??

Second Thoughts On US Official Gold Reserves Audits

This post is a sequel to “A First Glance At US Official Gold Reserves Audits”.

What is not often covered in the media or blogosphere are the audits of the US official gold reserves stored at the US Mint, which is the custodian for 95 % (7716 tonnes) of the stash – nowadays also referred to as custodial deep storage, and at the Federal Reserve Bank Of New York that safeguards the remaining 5 % (418 tonnes). The lawful owner of the US official gold reserves is the US TreasuryPart one covered the most recent records I could find published by the US government, in this post we’ll examine more historical records and approach this matter from a more critical angle. Because of the amount of information I found this post is split in multiple parts.

What Is A Gold Audit?

From Wikipedia:

Auditing is defined as a systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. In any auditing the auditor perceives and recognizes the propositions before him for examination, collects evidence, evaluates the same and on this basis formulates his judgment, which is communicated through his audit report.

Due to constraints, an audit seeks to provide only reasonable assurance that the statements are free from material error. Hence, statistical sampling is often adopted in audits.

To be sure, I’ve asked several bullion dealers about how their audits are being conducted. They all agreed an audit involves three parties: the owner of the gold, the custodian and an external (independent) auditor. The external auditor examines the gold, compares its findings with the statements of the custodian and then reports on the accuracy of the statements of the custodian to the owner of the gold. An example of an audit report by such an external auditor can be found here.

The fact that the auditor is an external party is essential; if the custodian itself would perform the audit it could easily falsify the reports and lend gold that isn’t often transferred in and out of the vaults.

What Is A Gold Assay?

Assaying gold is done to test the purity of the metal; to make sure a bar contains at least the amount of fine gold disclosed on its inscription. For assay tests often samples are taken from random bars (not from all bars of a specific inventory). From Wikipedia:

A metallurgical assay is a compositional analysis of an ore, metal, or alloy. Raw precious metals (bullion) are assayed by an assay office. Silver is assayed by titration, gold by cupellation and platinum by inductively coupled plasma optical emission spectrometry.

Ron Paul

Allegedly the deep storage gold at the US Mint is currently stored in 42 vault compartments at three different locations in the US. 4,583 tonnes is stored at Fort Knox, Kentucky, 1,364 tonnes in Denver, Colorado, and 1,682 tonnes at West Point, New York.

The last time the US official gold reserve audits were publicly discussed was in 2011 when Ron Paul, who was a well informed member of the US House of Representatives, proposed new legislation at the time to have a full audit of the US holdings: The Gold Reserve Transparency Act (H.R. 1495, not enacted). Strangely Dr Paul wasn’t up to date of the audit and assay procedures performed since 1974, while he was in politics because of gold since 1971. From Wikipedia:

When President Richard Nixon “closed the gold window” … on August 15, 1971, Paul decided to enter politics and became a Republican candidate for the United States Congress.

Only during the preparation of the congressional hearing Dr Paul became aware of the audit and assay procedures. From Paul’s opening statement at the hearing June 23, 2011:

For far too long, the United States Government has been less than transparent in releasing information relating to its gold holdings. Not surprisingly, this secrecy has given rise to a number of theories about the gold at Fort Knox and other depositories.

Some people speculate that the gold has been involved in gold swaps with foreign governments or bullion banks. Others believe that the gold has been secretly shipped out of Fort Knox and sold. And, still others believe that the bars at Fort Knox are actually gold-plated tungsten. Historically, the Treasury and the Mint have dismissed these theories rather than addressing these concerns with substantive rebuttals.

The difference between custody and ownership, questions about the responsibility for U.S. gold held at the New York Fed, and that issue of which division at Treasury is ultimately responsible for the gold reserves are just some of the questions that have come up during the research for this hearing. In a way, it seems as though someone decided to lock up the gold, put the key in a desk somewhere, and walk off without telling anyone anything. Only during the preparation for this hearing was my office informed that the Mint has in fact conducted assays of statistically representative samples of gold bars, and we were provided with a sample assay report.  

While the various agencies concerned have been very accommodating to my staff in attempting to shed some light on this issue, it should not require the introduction of legislation or a congressional hearing to gain access to this information.

Why did Paul not know about this? Why did it take a congressional hearing to get the details of the audit and assay tests? Why wasn’t this information easily accessible to him and the American people?

Gold Audits At Fort Knox

The construction of the notorious gold depository was finished in 1936 at the Fort Knox army base in Kentucky; large quantities of gold were first deposited in 1937. After President Roosevelt had ordered the people of the United States to sell all their gold coins and bullion for $20.67 per fine ounce to the Federal Reserve in 1933, through Executive Order 6102 (the great gold confiscation), a fortress was needed to store the bars that were coming out of the smelters of the seized gold. The bars that were melted from gold coins are approximately 90 % pure, the majority of the bars, allegedly, in Fort Knox are coin bars. Though, research has pointed out the huge growth in US official gold reserves after 1933 has primarily been sourced from imports, not by domestic coins.

US Official Gold Reserves

The Gold Reserve Act of 1934 required the Federal Reserve to transfer ownership of the official gold reserves to the Department of the Treasury, in return it received gold certificates (that are mere redeemable for dollars). The US Mint was assigned to safeguard the Treasury Department’s gold, silver and other assets at several depositories across the US, among others at Fort Knox and Denver.

Trains from New York and Philadelphia arrive in Kentucky to unload the gold, 1937 2

Trains from New York and Philadelphia arrive in Kentucky to unload the gold, 1937
Trains from New York and Philadelphia arrive in Kentucky to unload the gold. It took 552 train wagons to complete the transport.
Trucks arrive at the back door loading docks of the Fort Knox gold depository
Trucks arrive at the back door loading docks of the Fort Knox gold depository.
Local farmers were hired to unload the gold at Fort Knox, 1937
Local farmers were hired to unload the gold.
News paper article announcing when gold would arrive at Fort Knox 1937
Newspapers announced when gold shipments would arrive at Fort Knox in 1937.

1953

To research the integrity of the audits performed at Fort Knox (and the other depositories) in all of history, we’ll start from the beginning and work our way to the present. The first audit I could find dates from 1953, when total US reserves accounted for roughly 20,000 tonnes. Many researchers that have worked on this subject in the past refer to the first and last full audit of 1953. However, the audit in 1953 was anything but full.

During my research I came across many articles of researchers that have investigated Fort Knox audits – Ed Durell, James Turk and Tom Szabo, to name a few. Often these articles contained dead web links to documents on US government websites. Everything that was still accessible during my research I copied to my own servers to secure access to them at all times.

The next quotes are from the official report of the gold audit in 1953 (download here).

Fiscal Year Ended June 30, 1953

REPORT ON FISCAL OPERATIONS

VERIFICATION OF GOLD AND SILVER BULLION AND OTHER TREASURY ASSETS

…The audit was performed in accordance with procedures which were recommended by an advisory committee of consultants appointed jointly by the present Secretary and his predecessor in office. Members of the advisory committee were W. L. Hemingway, Chairman of the Executive Committee of the Mercantile Trust Company, St. Louis, chairman; Wm. Fulton Kurtz, Chairman of the Board, The Pennsylvania Company, Philadelphia; Sidney B. Congdon, President, National City Bank of Cleveland, Cleveland; and James L. Robertson, Member, Board of Governors, Federal Reserve System, Washington. As had been suggested by the advisory committee, the audit was conducted under the general supervision of a continuing committee representing both incoming and outgoing Treasury officials. Representatives of the Comptroller General of the United States observed the audits at each of the various audit sites.

In accordance with a recommendation of the advisory committee the special settlement committee at the Fort Knox depositary opened three gold compartments, or 13.6 per cent of the total of twenty-two sealed compartments at that institution containing 356,669,010.306 fine ounces [11,094 metric tonnes] of gold valued at $12,483,415,360.28. All of the gold contained in the three sealed compartments opened, amounting to 34,399,629.685 fine ounces [1,070 tonnes] valued at $1,203,987,038.94 or approximately 88,000 bars, was counted by members of the settlement committee and found in exact agreement with the recorded contents of the compartments. Slightly in excess of 10 per cent of the total gold values so counted, or some 9,000 bars weighing approximately 130 tons, was further verified through weighing upon special balance scales indicating exact weights to the 1/100 part of a troy ounce. All gold weighed was found in exact agreement with the recorded weight thereof. Further, test assays were made of 26 gold bars selected at random from the total gold counted. The reported results of the test assays indicated, that all gold tested was found to be of a fineness equal to or in excess of that appearing in the mint records and stamped on the particular gold bars involved. Gold samples used for test assay purposes were obtained through drilling from both the top and bottom of each representative gold bar. In final confirmation of the verification of the gold bullion asset values held in the Fort Knox depositary the special settlement committee reported in part as follows:

“0n the basis of assays, your committee can positively report that the gold represented, according to assay, is at the depositary. We have no reason, whatsoever, to believe other than, should all melts be assayed, the results would be the same.”

“We, the undersigned, found the assets verified, to be in full agreement with the assets as indicated by the joint seals affixed to the respective compartments on January 26, 1953.”

“It is the opinion of this committee that the same agreement would be found should all of the compartments be verified.”

In short; an advisory committee of “consultants” assembled special settlement committees that, under the supervision of Treasury officials and Representatives of the Comptroller General, audited 3 of in total 22 compartments filled with gold (it’s likely Fort Knox has many more compartments in total). 13.6 % – 1,070 tonnes – of all the gold bars held at Fort Knox was counted, of which 9,000 bars were weighed upon special balance scales and 26 bars were assayed. The document notes procedures at other depositories closely paralleled those employed at Fort Knox, though no numbers are disclosed.

In 1953 the US Treasury held approximately 1,300,000 gold bars at multiple depositories of which 88,000 were counted, 9,000 were carefully weighed and 26 bars (0.00002 %) were assayed; no external auditing firm was present. This was not a full audit.

1974

The other full audit that keeps buzzin around in the media was the one in 1974, because the media was actually allowed to enter the fortress back then. On September 23, 1974, roughly 100 journalists were allowed entrance, accompanied by 9 members of Congress.

Media allowed in Fort Knox 1974

When the total US official gold reserves had declined by 11,500 tonnes from 1953 to 1974, many Americans began to doubt if the US actually had any gold left at all, especially after Nixon had temporarily suspended the convertibility of dollars for gold at the US Treasury in 1971. The amount of gold at Fort Knox had dropped from 11,094 tonnes (stored in 22 compartments) to 4,585 tonnes (stored in 13 compartments). In an attempt to reassure the American people not all gold was gone a new audit was scheduled.

From several sources we know for the visual inspection by the press and congressmen only one compartment was opened, in which 368.2 tonnes was stored. I edited a small video clip from a History Channel documentary for us to take a look inside Fort Knox.

Whether one or multiple compartments were opened is actually irrelevant, unqualified people looking at a wall of yellow bricks and weighing a few bars will not pass as an audit.

The director of the Mint in 1974, Mary Brooks, did a remarkable confession when the press asked if there is a tunnel to the vault. She showed a narrow tunnel, the size of a sewer pipe, which could only be opened from inside the vault in case someone was trapped – no pictures were allowed to be taken from the tunnel. The escape could only be made outside the vault, not the building itself, she said. There are thus three connections to the vault, the front door, the back door and the tunnel.

The real audit started the day after, on September 24, 1974. This audit was performed by “a committee including auditors from GAO and from Treasury’s Office of the Secretary, Bureau of Government Financial Operations (BGFO), U.S. Customs Service, and Bureau of the Mint. The committee also included Bureau of the Mint technicians trained in assaying and weighing gold bullion”. No external auditor was hired; the US Mint, a department of the US government, can audit the gold in cooperation with thousands of other government departments, only an external auditing party can ensure the integrity of an audit.

Again three random compartments were opened (theoretically one or two could have been the same compartments that were opened as in 1953 as no compartment numbers have been disclosed in the audit reports). From the official audit report published in 1975 (download here):  

Mint regulations require that a special settlement committee be established to inventory and maintain physical control over the gold as it is being inventoried, weighed, and sampled. We selected the compartments to be audited, and we did not disclose this information until the inventory began. The committee opened 3 compartments and counted and inspected 91,604 bars representing about 31.1 million fine troy ounces [967 tonnes] of gold valued at about $1.3 billion, or approximately 21 per cent of the gold stored at the depository. From a random sample of all melts in the 3 compartments, the committee weighed 95 melts to the 100th part of a troy ounce. The committee also compared the weights and physical characteristics of all gold … inventoried to inventory records.

To verify the gold’s fineness, a bar from each melt weighed was assayed. Gold samples were obtained by taking a tetrahedron-shaped chip, weighing about four-tenths of an ounce, from both the top and the bottom of the representative gold bar. We assigned control numbers to the sample chips, because the assayer could possibly determine, without assay, the gold’s fineness if he knew the value or melt number from which the chips came. The New York assay office assayed the gold and gave us the results for comparison with inventory records. We observed the assaying of the first samples. The results of the assays indicated that the recorded finenesses were within the tolerances the Mint established.

No assay report was included.

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Note the irony in the “bottom line”: Keep Freedom in Your Future With U.S. Savings Bonds

In 1975 a Committee was appointed for the Treasury’s continuing audits of U.S.-owned gold stored at the Mint. The operation was designed to audit 10 % of the Treasury’s gold per annum. Inspector General (IG) Eric Thorson stated in 2011 during the hearing by Ron Paul:

In June 1975, the Treasury Secretary authorized and directed a continuing audit of U.S. Government-owned gold for which Treasury is accountable. Pursuant to that order, the Committee for Continuing Audit of the U.S. Government-owned Gold performed annual audits of Treasury’s gold reserves from 1975 to 1986, placing all inventoried gold that it observed and tested under an official joint seal.

The committee was made up of staff from Treasury, the Mint, and the Federal Reserve Bank of New York. The annual audits by the committee ended in 1986 after 97 per cent of the Government owned gold held by the Mint had been audited and placed under official joint seal.

These continuing audits would be the first to examine such a large share of the US official gold reserves, 97 % of all the gold held by the Mint equals to 7,485 tonnes, or 92 % of total US official gold reserves. At the same time, this is where the confusion starts. Let’s find out all there is to know about the continuing audits conducted from 1975 to 1986, as this should be what we’re after, the audit of nearly all US official gold reserves.

From the full report that came out of the congressional hearing in 2011, the US Treasury’s best defense I assume, these are the audit reports in existence since the early seventies:

Fort Knox US mint audit list published 2011 1

Fort Knox US mint audit list published 2011 2

We are not interested in the audits of financial statements of the Mint, but in audits of the physical inventory gold.

At first sight we can see that not from all years the continuing audits were supposedly performed (1975 to 1986) reports are listed. Only the following audit are disclosed:

  1. 1974 (released by the GAO 2/10/1975)
  2. 1977 (released by the GAO 5/5/1978)
  3. 1980 (released by the GAO 10/1981)
  4. 1985 (released by the OIG 4/25/1986)
  5. 1986 (released by the OIG 4/24/1987)

The continuing audits report of 1981 notes audits have been performed in 1975, 1976, 1978 and 1979, but no reference is made to audit reports. Only the amount of gold audited in each of those years is mentioned.

The list from 2011 is entitled “List of audits of US gold holdings” suggesting these are the only audits performed. If more audits were conducted they surely would have been disclosed on the 2011 list, right? Also the ones from 1981, 1982, 1983 and 1984. Or were audits conducted, but no reports drafted? More on this later, for now, we’ll focus on the content of the audit reports from the 2011 list:

The first audit report (1974) on the list we’ve discussed above, let’s have a look at the second from 5/5/1978 that covers the audit performed in 1977 (download here).

1977

Reading the report unveils a few problems:

  • No external auditor was present.
  • 11.7 % , or 536 tonnes, of the gold at Fort Knox was audited, but it’s not mentioned how many bars were counted, weighed and assayed.
  • The assay tests found irregularities. From the report:

Two sample melts showed the gold was below the fineness (5 parts per 10,000) permitted by the Bureau. Because of this problem, the vault had to be opened twice more in the presence of the Joint Sealing Committee and the gold reevaluated. This involved considerable time and expense, but was necessary because the fineness of gold must be precisely determined.

On July 29, 1977, bore samples, rather than chips, were taken from the questionable melts and sent to two assay offices for independent evaluations. Half of the samples reassayed were still unacceptable. The Bureau decided that the two melts from which the samples were taken had to be remelted and reassayed. This was done on November 16 and 17, 1977. This time, the gold was within the prescribed level of fineness but below the fineness listed on the inventory schedule. The difference in the original and revalued fineness resulted in a $158.77 adjustment to the records, which was considered insignificant. Previous discrepancies in fineness were attributed to improper melting and casting of the melts in 1920 and 1921. Bureau officials said the remelting process confirmed the validity and integrity of their audit procedures and assays.

  • We can ascertain the assay tests at Fort Knox in 1953 were done by drilling holes through the bars; in 1974 and 1977 the assay tests were changed totaking a tetrahedron-shaped chip, weighing about four-tenths of an ounce, from both the top and the bottom of the representative gold bar”. When this method ‘failed’ in 1977, the committee decided to drill holes, but why was the method of initial assaying changed from drilling holes through the bars, into taking chips from the top and bottom of the bars? When in 1977 the bore samples failed to proof the purity on the inventory list, both melts in question were remelted. But, who processed the remelting? How do we know the metal wasn’t refined/supplemented into higher purity gold? The report states that after the remelting, “This time, the gold was within the prescribed level of fineness but below the fineness listed on the inventory schedule. The difference in the original and revalued fineness resulted in a $158.77 adjustment to the records”. To me it’s not clear what this means. Some kind of adjustment was made and the auditors decided to move on? Didn’t this ring any alarm bells, if irregularities were found in two melts why wasn’t more gold assayed?
  • Apart from the negative assay test, the 1977 audit report is not reliable because it doesn’t disclose any information about how many bars were counted, weighed or assayed.

In the next part we’ll continue from the 1981 audit.

Federal Reserve New York Gold Withdrawal Numbers 2014 Don’t Match Dutch-German Repatriation Claims

From January to December 2014 the Federal Reserve Bank Of New York (FRBNY) has been drained from 176.81 tonnes of physical gold out of the foreign deposit accounts. A drop from 6,195.60 tonnes to 6,018.79 tonnes over 12 months, FRBNY data published on Friday showed. The FRBNY doesn’t disclose how much is withdrawn by which central bank.

FRBNY foreign gold deposits table 2014

FRBNY foreign gold deposits

These numbers do not match the claims made in Europe about gold repatriated from the US. This is bad news.

On November 21, 2014, the Dutch central bank, De Nederlandsche Bank (DNB), surprised the world by stating they had in utmost secret repatriated 122.5 tonnes from their gold deposit at the FRBNY. Although not specifically disclosed by DNB, all the gold must have been repatriated in 2014.

January 19, 2015, the German central bank, the Bundesbank, announced they had successfully repatriated 85 tonnes from New York and 35 tonnes from Paris in 2014. Of the 85 tonnes from the FRBNY 50 tonnes were recast according to the London Good Delivery (LGD) standard.

Some simple math: 122.5 tonnes plus 85 tonnes is 207.5 tonnes; this is the amount DNB and the Bundesbank claim to have withdrawn from the vaults in New York. The FRBNY states it only delivered 176.81 tonnes to their European allies across the pond. The gap accounts for 30.69 tonnes; this is “the problem” the three central banks are now facing.

“The problem” adds to a range of events that happened since 2011 and fueled speculation about whether the FRBNY can fulfill all their gold obligations to foreign depositors.

  1. Repatriating gold from New York in itself means the Europeans don’t trust the FRBNY as the custodian for their gold.
  2. Allegedly a delegation from the Bundesbank was obstructed by the FRBNY when they came to the New York vaults in 2011 to audit their gold.
  3. The Bundesbank refuses to publish a bar list of their official gold reserves. Just as the Netherlands, even after a Dutch FOIA request.
  4. In 2012 the Bundesbank presented a schedule to ship home 150 tonnes from the US in three years (ending in 2015). In 2013 the Bundesbank changed their schedule to repatriate 674 tonnes from New York (300) and Paris (374) over seven years. Why did they change their initial schedule and why would it take seven years to hire a few planes to ship the gold from New York to Germany?
  5. In 2013 the Bundesbank only received 5 tonnes from New York. That is very little gold given Germany should have safely stored more than 1,400 tonnes in nine compartments at the FRBNY. How hard can it be for the FRBNY to process a withdrawal request by a customer?
  6. The first batch from New York, the 5 tonnes, was said to be recast into LGD bars before stored in Frankfurt, but the Bundesbank refused to disclose why. In any case, the origin of newly cast bars can’t be traced, that makes it impossible to know if it came from New York or someplace else.
  7. During the recasting of the bars no independent external auditors were present.
  8. In 2014 DNB stated to have repatriated 122.5 tonnes from New York – presumably in less than 10 months. Why can’t the Bundesbank repatriate in this tempo?
  9. 50 of the 85 tonnes Germany repatriated from New York in 2014 were recast in LGD bars before stored in the vaults in Frankfurt. Again, no details were disclosed by the Bundesbank about bar numbers, nor was any independent party allowed to audit and assay the gold. For some reason the Bundesbank did mention the BIS was involved in an audit: “We also called on the expertise of the Bank for International Settlements for the spot checks that had to be carried out. As expected, there were no irregularities” 
  10. Late January 2015 the IMF published an update of the foreign exchange reserves of the Netherlands that showed DNB had bought 10 tonnes of gold in December 2014. A few hours later DNB denied it had bought any gold, without elaborating on how the IMF got the false numbers. Kind of adventitious given everything mentioned above. Perhaps DNB did buy gold in 2014 because there was something wrong with the gold they repatriated from the FRBNY or they wanted to repatriate more, but weren’t allowed? Of course, this had to be carefully covered up. Any problem that would have occurred from repatriating gold from the FRBNY can never be openly discussed for it would destabilize the international monetary order.

The list goes on and on. Perhaps the latest data released by the FRBNY is a typo, perhaps 30.69 tonnes was shipped to Germany early January 2015 and the Bundesbank counted this as repatriated in 2014 to make the tonnage shipped home in 2014 look less worrisome compared to the tonnage DNB got back, perhaps there is a explanation for the gap in tonnage reported by both sides of the Atlantic. I surely hope so. In any case it’s very alarming the three central banks didn’t even take the simple effort to make it seem all the numbers add up.

I will call and email all three central banks on Monday to confront them with the current situation, although I doubt either will change any of their numbers. In my opinion there can only be three causes for “the problem”:

  1. Someone is lying. That can be DNB, the FRBNY or the Bundesbank.
  2. There has been a gold swap between the FRBNY and some other central bank. This other central bank (or BIS) would than have delivered 30.69 tonnes to Germany, in return it got a claim on gold at the FRBNY. But why? Such a scenario wouldn’t lift any concerns regarding the FRBNY’s gold obligations, au contraire. Besides, both DNB and the Bundesbank specifically meant to repatriate gold from New York, where according to official sources their gold is supposed to be.
  3. UPDATE 8 PM GMT+1: Commenter “awgee” (read below) asked me if I failed to consider if a central bank, other than DNB or the Bundesbank, added gold to their stock at the FRBNY in 2014 which could explain the gap. The answer is I didn’t consider this, though it’s a very good point. If any central bank deposited approximately 31 tonnes in 2014 this would actually be the most obvious explanation for “the problem”. As far as my data goes back (1995), the last time a deposit was visibly made was in October 2011 (4 tonnes), and before that in February 1999 (3 tonnes). It doesn’t happen often, but it can happen. (as the FRBNY only discloses the total amount of gold in foreign accounts, we can only see deposits being made during a month with no withdrawals or during a month when deposits transcend withdrawals).  

To be continued…

Will Gold Be Part Of A New International Monetary System?

Anyone who has been paying attention to the global economy the past years can agree with me our central bankers have conducted miserable monetary policy and have taken insufficient measures to fight crises. All major economies have embarked in printing unprecedented quantities of money, but the only thing they bought was time. Quantitative easing on such a scale is like kicking the can determined to reach the end of the road. The future looks anything but sanguine.

Where is this going? Are our leaders truly gonna allow for the international monetary system to implode? Is there no plan B? And we are supposed to believe gold isn’t of any significance in economics?

In our current highly unstable economic environment the price of gold is relatively low, according to gold proponents like me. In addition, we can see immense flows of physical gold going from West to East that are guaranteed not to return in the foreseeable future. If the price of gold isn’t suppressed, my previous two observations can only be explained as physical supply outstripping demand since April 2013 – when the price of gold declined substantially to its current relative low levels. But perhaps there is more than meets the eye.

I would like to share a theoretical explanation for the observations just mentioned, supported by historic diplomatic documents that provide some guidance through the present fog.

Let’s start just before gold was removed from the system:

In the sixties France stepped out of the London Gold Pool, as it didn’t want to waste any more gold on the war the US was waging against Vietnam. The London Gold Pool was a joint effort by the US, the Netherlands, France, Germany, Italy, Belgium, Switzerland and the UK to peg the price of gold at $35 an ounce. But because the US was printing dollars to finance the war in Vietnam – this devalued US dollars – a lot of gold was required to be sold to maintain the price at $35. Shortly after France left the Pool it collapsed in March 1968. From the IMF:

While the total number of U.S. dollars circulating in the United States and abroad steadily grew, the U.S. gold reserves backing those dollars steadily dwindled. International financial leaders suspected that the United States would be forced either to devalue the dollar or stop redeeming dollars for gold.

The dollar problem was particularly troubling because of the mounting number of dollars held by foreign central banks and governments: In 1966, foreign central banks and governments held over 14 billion U.S. dollars. The United States had $13.2 billion in gold reserves, but only $3.2 billion of that was available to cover foreign dollar holdings. The rest was needed to cover domestic holdings. If governments and foreign central banks tried to convert even a quarter of their holdings at one time, the United States would not be able to honor its obligations.

The Incredible Shrinking Gold dollar IMF

And that is exactly what happened; in 1971 the US closed the gold window, no longer could foreign central banks convert dollars into gold (except on the open market). As I’ve written before: (i) Europe, most notably France was not amused and wanted to revalue gold, (ii) the US was very persistent to completely phase out gold from the monetary system in order to leverage the power of the US dollar hegemony.

I’ve found documents that connect the past with the present. On February 24, 1970, French President Pompidou met with US President Nixon in Washington DC. The oncoming quotes are from the US minutes of the meeting:

Turning to France, the President [Pompidou] said he wished to emphasize again that – as distinguished from the positions of some of his predecessors in this office – he would not comment on the independent French policy. He might have his own views but he felt that a strong independent France devoted to the same goals as we are is in the interest of the US. A strong Europe in the economic sense might seem not to be in the US interest, in the long term it was. What we need is a better balance in the West. It is not healthy to have just two superpowers; in such a situation there is more chance of a conflict than when there are more centers of power. Greater strength of the European economies, an independent French policy, and, in Asia, a stronger Japan, would eventually make for a more stable world. The position of the U. S. at the end of World War II was not healthy. Twenty-five years had passed and things were changed. This we regarded as a healthy development.

In the final analysis with three billion people on earth if civilization is to survive … this will be decided by the Soviet Union, by China, and eventually Japan, by Western Europe, by that he meant France, Britain and Germany and the United States. Africa is moving along, but it is a century away.

Latin America is also moving but it is fifty years or more away. In Asia, India and Pakistan will have enormous difficulty in simply keeping pace with their increase in population. We have a great responsibility to use the power we have to build the kind of a world that keeps the forces of expansion in check and thus give the forces of freedom a chance to grow in their own way and not like tin soldiers lined up behind the biggest one.

Pompidou’s idea was clearly to spread economic power across the globe for a more balanced, peaceful and prosperous world. We can also read the first signs of a unified Europe between the lines. Pompidou is one of the best forecasters I’ve ever read, what he said 45 years ago has more or less happened by now. However, Pompidou’s ideology could not coexist along the dollar hegemony. The US, therefor, embarked in divide and conquer, a notorious strategy to gain and maintain power. The next quotes are from a telephone conversation on March 14, 1973, between Henry Kissinger, National Security Advisor, and William Simon, Under Secretary of the Treasury: 

K: … I’ve just been called to the President. Let me tell you — Shultz has sent me a copy of the cable that Volker gave him – that Volker sent him about the interventions, and he has asked for my views. I basically have only one view right now which is to do as much as we can to prevent a united European position without showing our hand.

S: Okay. Well, I interpret that as less intervention, which is a good idea, and I think George will be very happy with that comment. Do as much as we can to prevent a unified European position.

K: I don’t think a unified European monetary system is in our interest. I don’t know what you think for technical reasons, but these guys are now helping to put it to us.

S: Yes, sir.

K: I don’t know whether that’s true in the short term, but I’m convinced that that’s true in the long.

S: I just agree with you a thousand percent.

K: So I’d rather play with them individually. You know, if it were a question of supporting an individual currency, I’d be much more inclined to do that.

S: Yes, such as the mark.

K: That’s right.

S: Yes, sir.

K: Does that make sense to you?

S: Yes it does.

K: You understand, my reason’s entirely political, but I got an intelligence report of the discussions in the German Cabinet and when it became clear to me that all our enemies were for the European solution that pretty well decided me.

S: Yes, sir. Well, I pass. I’m going to be talking to George on the telephone.

K: Be careful. Everything in Bonn is tapped.

S: I promise you I will.

Next, from Wikileaks, a report of a meeting held by all European Ministers of Finance about gold, written to the American Ministry Of Foreign Affairs on April 23, 1974 (Europe and the US were debating this issue for a few years):

MADE IN A WIDER INTERNATIONAL CONTEXT, WHAT CAME OUT OF ZEIST WAS A CONSENSUS ON CERTAIN SUBSTANTIVE PROPOSITIONS THAT ARE TO BE FURTHER EXPLORED BEFORE THEY ARE SUBMITTED TO A NEXT MEETING OF THE COUNCIL OF MINISTERS OF THE EEC [EU]. IF AT A LATER STAGE THE COUNCIL REACHES AGREEMENT ON A CERTAIN POSITION, THE FURTHER PROCEDURE COULD BE THAT THE EUROPEAN COMMUNITY FORMULATES A FORMAL PROPOSAL ON HOW TO DEAL WITH THE PROBLEM OF GOLD IN THE PERIOD BEFORE THE REFORM OF THE INTERNATIONAL MONETARY SYSTEM.

IN ZEIST, MINISTERS HAVE AGREED ON TWO GENERAL PROPOSITIONS. FIRST, THEY HAVE RE-ASSERTED THAT THE SDR SHOULD BECOME THE PRINCIPAL RESERVE ASSET IN THE FUTURE SYSTEM, AND THAT ARRANGEMENTS FOR GOLD IN THE INTERIM PERIOD SHOULD NOT BE INCONSISTENT WITH THAT GOAL. SECOND, THEY HAVE AGREED THAT SUCH INTERIM ARRANGEMENTS SHOULD ENABLE MONETARY AUTHORITIES TO EFFECTIVELY UTILIZE THE MONETARY GOLD STOCKS AS INSTRUMENTS OF INTERNATIONAL SETTLEMENT.

THERE WAS A CONSENSUS AMONG MINISTERS THAT AN INCREASE OF THE OFFICIAL GOLD PRICE, ALTHOUGH IT MIGHT SERVE THE SECOND OBJECTIVE, WOULD BE INCONSISTENT WITH THE FIRST. IN ORDER TO MOBILIZE MONETARY GOLD AS AN INTERNATIONAL RESERVE ASSET, THEY HAVE AGREED THAT:

1) MONETARY AUTHORITIES SHOULD BE PERMITTED TO BUY AND TO SELL GOLD BOTH AMONG THEMSELVES, AT A MARKED-RELATED PRICE, AND ON THE FREE MARKET. THE MONETARY AUTHORITIES WOULD HAVE COMPLETE FREEDOM TO BUY OR TO SELL GOLD, AND WOULD HAVE NO OBLIGATION WHATEVER TO ENTER INTO ANY PARTICULAR TRANSACTION.

2) CERTAIN DELEGATIONS ARE OF THE OPINION THAT GOLD TRANSACTIONS WITH THE FREE MARKET SHOULD NOT, OVER A CERTAIN PERIOD OF TIME, LEAD TO A NET INCREASE OF THE COMBINED OFFICIAL GOLD STOCKS.

3) IN ORDER TO APPLY THESE PRINCIPLES, VARIOUS PRACTICAL SOLUTIONS CAN BE ENVISAGED. TWO WERE MENTIONED IN PARTICULAR. ONE IS THAT MONETARY AUTHORITIES PERIODICALLY FIX A MINIMUM AND A MAXIMUM PRICE BELOW OR ABOVE WHICH THEY WOULD NOT SELL OR BUY ON THE MARKET. THE OTHER CONSISTS IN CREATING A BUFFER STOCK TO BE MANAGED BY AN AGENT WHO WOULD BE CHARGED BY THE MONETARY AUTHORITIES TO INTERVENE ON THE MARKET SUCH AS TO ENSURE ORDERLY CONDITIONS ON THE FREE MARKET FOR GOLD.

Now we know what Europe was planning in seventies, this explains a lot better what occurred later on. Remember the Washington Agreement On Gold? Just before the euro was introduced in 1999, all European central banks collaborated in a program called the Central Bank Gold Agreements (CBGA), or the Washington Agreement On Gold, to jointly manage gold sales. (note, Eurozone aggregated gold reserves currently still transcend US reserves)

Central Bank Largest Sellers

In 1991 the Dutch central bank (DNB) held 1,700 tonnes in official gold reserves, currently it holds 613 tonnes. When the Dutch Minister Of Finance, J.C. de Jager, was questioned about these sales in 2011 he answered:

Question 6:  Can you confirm that since 1991 DNB has sold 1,100 tonnes of the 1,700 tonnes it owned…

Answer 6: Since 1991 DNB sold 1,100 tonnes. At the time DNB determined that from an international perspective it owned a lot of gold proportionally. It decided to equalize its gold holdings relative to other important gold holding nations. 

Right, so since the seventies Europe wanted to spread economic power across the globe, replace the dollar as the world reserve currency and sold parts of its official gold reserves “to equalize its gold holdings relative to other important gold holding nations. These types of plans aren’t realized overnight; it can take decades, it can even take more decades than estimated. Who knows? We can be in the final stage right now.  

Not so long ago I published a Wikileaks cable from 1976 wherein China expresses its particular interest in gold and SDR’s. Of course this is all just a theory, but it seems as if the redistribution of the chips, physical gold flowing form West to East, is all part of orchestrated preparations for the next international monetary system, anchored by gold. This system would require gold to be spread among the major economic power-blocks proportionally. 

Chinese mining 1949-2014 x

Total Estimated Chinese Gold Reserves 1995 - 2014

Jean-Claude Trichet, former president of the European Central Bank, said on November 4, 2014:

The global economy and global finance is at the turning point in a way, …new rules have been discussed not only inside the advanced economies, but with all emerging economies, including the most important emerging economies, namely, China.

 

Gold world

 

(h/t Freegold)

historic documents:

1970 February 24, Washington DC, US. Pompidou and Nixon. 

1971, October 28. Phone call between Nixon and Kissinger on gold.

1971, December 13 & 14, Azores. Negotiations between Kissinger and Pompidou about the value of currencies and gold.

1973, March 14, Kissinger and Simon telephone conversation. 

1973, May 18, Paris, France. Meeting Kissinger And Pompidou on value of gold.

1974, March 6, Washington, US. Note From the Deputy Assistant Secretary of State for International Finance and Development (Weintraub) to the Under Secretary of the Treasury for Monetary Affairs (Volcker): GOLD AND THE MONETARY SYSTEM: POTENTIAL US–EU CONFLICT.

1974, April 22 & 23, Zeist, The Netherlands. Meeting European Ministers Of Finance On Gold.

1974, April 25. Minutes of Secretary of State Kissinger’s Principals and Regionals Staff Meeting on gold.