Core Supply & Demand Data Chinese Gold Market Q1-Q3 2016
Chinese gold demand is still going strong this year, albeit less than in 2015. The most likely reason for somewhat lower demand has been the strength in the price of gold in the first three quarters of this year, to which the Chinese reacted by subduing purchases. From 1 January until 30 September 2016, the gold price went up 24 % in US dollars per troy ounce, from $1,061.5 to $1,318.1; measured in renminbi the price went up 28 % over the same period.
Now I have proven the gold on Chinese commercial bank balance sheets has little to do with physical gold ownership of these banks, but mainly reflects back-to back leases and swaps, we can be positive that data on withdrawals from the vaults of the Shanghai Gold Exchange (SGE) roughly equals Chinese wholesale demand. For now that is, as future developments can always alter our metrics.
Below is a chart showing withdrawals from the vaults of the SGE and the price of gold in yuan per gram. The most significant trends of recent years are still in effect; in the short term, when the gold price is falling Chinese demand increases (2013 and 2015), when the gold price is rising Chinese demand declines (2016). This trend is supported by SGE premiums that have an inverse correlation with the price of gold, when the price of gold declines, SGE premiums escalate and vice versa – I will show charts below. Furthermore, in the long term we can observe consistent growth in Chinese gold demand due to the opening up and development of the domestic market.
SGE withdrawals in the first three quarters of 2016 accounted for 1,406 tonnes – still impressive – down 29 % from 1,986 tonnes in 2015, which was a record year. Annualized SGE withdrawals are set to hit 1,877 tonnes in 2016.
Notable, “known net import” by China is relatively strong compared to SGE withdrawals in 2016. Total net import in the first three quarters of this year has aggregated to 905 tonnes – annualized 1,206 tonnes – or 64 % of SGE withdrawals, versus an import/withdrawals ratio of 53 % in 2015. As mine supply to the SGE is fairly constant, recycled gold through the SGE must be lower this year than last year. As a rule of thumb, we use the equation:
The largest net exporter to China is still Hong Kong, having transhipped 608 tonnes to the mainland from January until September 2016, up 5 % compared to 2015. The volume Hong Kong exports to the mainland has been quite constant since 2014, while in 2013 China’s special administrative region was a substantial larger supplier.
(There have been rumors that Hong Kong ’s export to China is overstated in the official data by the Hong Kong Census & Statistics Department, caused by fake exports. In the chart below you can see that the share of exports relative to re-exports from Hong Kong to China this year has increased from previous years. Potentially this signals fake exports, as it’s easier to over invoice an export than re-export, though I haven’t found hard evidence for this scheme. When I do I will report accordingly.)
The second largest exporter to China is Switzerland, having supplied a net 229 tonnes so far this year, which is 22 % more than last year. Clearly, direct shipments from Switzerland to China have replaced shipments via Hong Kong.
Direct net exports by the UK to China mainland have collapsed by 92 % this year compared to 2015, from 210 tonnes to a mere 18 tonnes. The reason being, the UK has been the largest net importer globally this year, which is related to the strength in the gold price early this year. UK net gold trade is a proxy for Western institutional supply and demand.
Australia’s direct export to China is down this year as well (in the first eight months, data for September has not yet been released). I’ve computed the data as described in my post Australia Customs Department Confirms BullionStar’s Analysis On Gold Export To China. Following this method, the land of down under has sent 50 tonnes of gold directly to China during the first eight months of this year, down 23 % from 65 tonnes in 2015.
Despite press releases suggesting Russian gold enterprises are strengthening ties with the SGE, I have identified only one shipment of 30 Kg by the Russian Federation directly to China in 2016. In 2013 the Russians directly net exported 50 Kg to China.
Data on gold export from South Africa to China is not publicly available.
Since 2014, when the Shanghai International Gold Exchange (SGEI) was erected, there is a possibility “SGE withdrawals” are inflated by withdrawals from vaults in the Shanghai Free Trade Zone; gold that is allowed to be exported abroad – the free trade zone is not part of the domestic market. But as far as I know any activity on the SGEI lacks foreign enterprises that buy gold to withdraw and export. A couple of months ago a source at a large Chinese bank told me the SGEI is mainly used by Chinese banks to import gold into Chinese domestic market. In addition, I haven’t bumped into any large importers from China. Occasionally India imports a few hundred Kg, but that’s it.
The emblematic difference between “Chinese gold demand as disclosed by GFMS” and SGE withdrawals – displayed in exhibit 7 – is due to GFMS’ incomplete metrics. For decades this consultancy firm has been denying the existence of institutional supply and demand in above ground gold, which is far more important to price formation than retail sales and mine supply, the predominant flows published by GFMS. The essence of this swindle can be read in my blog post The Great Physical Gold Supply & Demand Illusion. I also have a few more blog posts in the pipeline that discuss GFMS’ most recent gold supply and demand data.
I expect November to be a very strong month for SGE withdrawals. Mentioned in the introduction segment of this post, there is a trend in Chinese wholesale gold demand in relation to the gold price. Whenever, the gold price is climbing, Chinese demand is subdued, accompanied by low SGE premiums; when the gold price is decreasing, SGE withdrawals and premiums in China shoot up. The relationship between the gold price and SGE withdrawals can be viewed in exhibit 1. Below in exhibit 8 & 9, readers can see the relationship between “SGE end of day prices and premiums”.
Note, the gold price on the SGE and the premium have an inverse correlation.
I already mentioned that SGE withdrawals in the first nine months of 2016 have been subdued due to a rally in the gold price. However, high premiums at the SGE in November forecast elevated withdrawals for the month. Since Trump got elected on November 9, and price of gold started tumbling, SGE premiums have broken a three-year record. This signals strong demand.
In the next chart from Goldchartsrus.com we can see the premium on the SGE’s most traded physical contract Au99.99 has risen since November 9 and reached 3 % by 24 November. Levels not seen since 2013 (exhibit 8).
Although the relationship between the gold price and SGE premiums has been in place for years, Reuters reports the high premiums in November are caused by worries on import restrictions. From Reuters:
Gold premiums in top consumer China jumped to the highest in nearly three years this week on worries over a supply shortage that traders said were due to Beijing’s efforts to restrict import licenses.
“While we don’t have the exact numbers, we hear that they (Chinese government) have limited the number of importers,” said Dick Poon, general manager at Heraeus Precious Metals in Hong Kong.
To me this statement doesn’t make sense. At this moment that are 15 banks approved by the PBOC to import gold. Limiting the number of importers would cause less importers to import more gold in order to balance the domestic market (supply gold from abroad when necessary). In the Measures for the Import and Export of Gold and Gold Productsdrafted by the PBOC in March 2015 it states:
… An applicant for the import … of gold … shall have corporate status, … it is a financial institution member or a market maker on a gold exchange [SGE] approved by the State Council.
… The main market players with the qualifications for the import … of gold shall assume the liability of balancing the supply and demand of material objects on the domestic gold market. 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.
The Chinese government could lower imports by distributing less “import licences” to approved banks. As, every approved bank still needs to submit for a license for every gold import batch. Logically, lowering imports would be done by the PBOC through handing out less licences.
Gold supply and demand data published by all primary consultancy firms is incomplete and misleading. The data falsely presents gold to be more of a commodity than a currency, having caused deep misconceptions with respect to the metal’s trading characteristics and price formation.
Numerous consultancy firms around the world, for example Thomson Reuters GFMS, Metals Focus, the World Gold Council and CPM Group, provide physical gold supply and demand statistics, accompanied by an analysis of these statistics in relation to the price of gold. As part of their analysis the firms present supply and demand balances that show how much gold is sold and bought globally, subdivided in several categories. It’s widely assumed these balances cover total physical supply and demand, which is incorrect as the most important category is excluded. The firms though, prefer not to share the subtle truth or their business models would be severely damaged.
The supply and demand balances by the firms portray gold to be more of a commodity than a currency, as the gist of the balances reflect how much metal is produced versus consumed – put differently, the firms mainly focus on how much gold is mined versus how much is sold in newly fabricated products. However, in reality gold is everlasting and cannot be consumed (used up), all that has ever been mined is still above ground carefully preserved in the form of bars, coins, jewelry, artifacts and industrial products. Partly because of this property the free market has chosen gold to be money thousands of years ago, and as money the majority of gold trade is conducted in above ground reserves. Indisputably, total gold supply and demand is far in excess of mine production and retail demand.
As most individual investors, fund managers, journalists, academics and precious metals analysts consider the balances by the firms to be complete, the global misconception regarding gold supply and demand is one of epic proportions. Physical gold is a profound anchor in our global financial system and thus it’s of utmost importance we understand the fine details of its trading characteristics.
Supply & Demand Metrics By The Firms
The firms can argue that the difference between what they present as supply and demand (S&D), as opposed to what I deem to be a more unadulterated approach of S&D is due to contrasting metrics. Accordingly, we’ll discuss their metrics to reveal their infirmity. In a nutshell, the firms only count the physical gold S&D flows that are easy to measure, while leaving out the most important part: institutional supply and demand.
Although the firms all have slightly different methodologies to measure S&D, from comparisons the numbers appear to be quite similar. For our further investigation we’ll spotlight the metrics and models by GFMS. The reason being, GFMS has been the only firm that was willing to share a full description of their methodology for publication – to be viewed here. Metals Focus (MF) provided a partial methodology, the World Gold Council and CPM Group declined to comment.
Let’s have a look at GFMS its S&D categories. On the supply side is included:
Mine supply (newly mined gold)
Scrap supply (gold sourced from old fabricated products)
On the demand side is include:
Jewelry demand (gold content used in newly manufactured jewelry products bought locally at retail level, adjusted by jewelry exported and imported).
Industrial demand (the volume of gold used in industrial applications, for example bonding wire, products used in semiconductors/electronics and dental alloys).
Retail bar investment (the net volume of bars that are purchased by individual investors through retail channels).
Coin investment (a combination of published data from mints and also a proprietary survey conducted by GFMS detailing where coins are sold).
The above four demand categories summed up are often referred to as “consumer demand” by the firms.
Furthermore GFMS includes:
Net hedging (change in physical market impact of mining companies’ gold loans, forwards, and options positions)
Net official sector (total central bank selling or buying)
ETF inventory build (change in ETF inventory)
Exchange inventory build (change in exchange inventory)
The last four categories can be either supply or demand. In example, when central banks (the official sector) in total are net sellers this will be listed as a negative demand figure, as is shown in the S&D balance by GFMS below from 2006 until 2009, when central banks in total are net buyers this will be listed as a positive demand figure, as is shown in the balance from 2010 until 2015. For a clear overview of the GFMS S&D balance please have a look at all line items below.
According to GFMS Supply consists of Mine production, Scrap and Net Hedging. In turn, Demand consists of Jewelry, Industrial Fabrication, Retail Investment, and Net Official Sector. After balancing Supply and Demand this results in a Physical Surplus/Deficit. Then, ETF Inventory Build and Exchange Inventory Build are added/subtracted from the Physical Surplus/Deficit to come to a Net Balance.
GFMS likes to pretend their balance is complete and occasionally articulates any surplus or deficit arising from it is positively correlated to the price of gold, which is anything but true, as I will demonstrate step by step.
The Firms Exclude Majority Gold Supply & Demand
Most important what’s excluded from the balance is what we’ll refer to as institutional supply and demand, which can be defined as trade in bullion among high net worth individuals and institutions. Usually the bullion in question comes in 400-ounce (12.5 Kg) London Good Delivery (GD) bars having a fineness of no less than 995, or smaller 1 Kg bars having a fineness of no less than 9999. In addition, bullion bars can weigh 100-ounce or 3 Kg, among other less popular sizes, generally having a fineness of no less than 995. Bullion can be traded without changing in weight or fineness, but it can be refined and/or recast for transactions as well, in example from GD bars into 1 Kg bars. In some cases institutional supply and demand involves cross-border trade, when bullion is sold in country A to a buyer in country B, in other cases the bullion changes ownership without moving across borders.
Provided are two exemplifications of institutional S&D:
An (institutional) investor orders 400 Kg of gold in its allocated account at a bullion bank in Switzerland – which would be purchased in the Swiss wholesale market most likely in GD bars. This type of S&D will not be recorded by GFMS.
A Chinese (institutional) investor buys 100 Kg of gold directly at the Shanghai Gold Exchange (SGE), the Chinese wholesale market, in 1 Kg 9999 bars and withdraws the metal from the vaults. Neither this transaction will be registered by GFMS – or any other firm.
These examples show the S&D balances by GFMS are incomplete.
For illustrational purposes, below is a chart based on all S&D numbers by GFMS from 2013, supplemented by my conservative estimate of institutional S&D. Including institutional transactions total S&D in 2013 must have reached well over 6,600 tonnes.
GFMS Covers The Tracks With Help From The LBMA
Although GFMS intermittently admits their number are incomplete (they have to), at the same time they’ve been battling for years to eclipse apparent institutional S&D for its audience.Dauntless tactics were needed when in 2013 institutional demand in China reached roughly 1,000 tonnes and over 500 tonnes in Hong Kong. Institutional demand in the East was predominantly sourced through GD bars from the London Bullion Market, which were refined into 1 Kg 9999 bars that are more popular in Asia. For the cover up GFMS went to great lengths to refute the volumes of gold withdrawn from SGE vaults, and accordingly have the London Bullion Market Association (LBMA) adjust statistics on total refined gold by its member refineries. Remarkably, the LBMA cooperated. Allow me to share my analysis in detail.
In 2013 something unusual happened in the global gold market as Chinese institutional demand exploded for the first time in history. Hundreds of tonnes of institutional supply from London in the form of GD bars were mainly shipped to Switzerland to be refined in 1 Kg 9999 bars, subsequently to be exported via Hong Kong to meet institutional demand in China. From customs data by the UK, Switzerland and Hong Kong the institutional S&D trail was clearly visible. From 2013 until 2015 there was even a strong correlation between the UK’s net gold export and SGE withdrawals. Demonstrated in the chart below.
Stunningly, since 2013 GFMS has tried to convince its readers through numerous arguments why SGE withdrawals crossed 2,000 tonnes for three years in a row, while Chinese consumer demand reached roughly half of this. Yet the arguments have failed miserably to explain the difference – they rationalize only a fraction, read this post for more information.
And GFMS did more to eclipse apparent institutional S&D. They colluded with the LBMA.
To be clear, I cannot exactly measure global institutional S&D. However, let me make an estimate of apparent institutional demand for 2013. Notable, in 2013 a flood of gold crossed the globe from West to East. Chinese institutional demand accounted for 914 tonnes and Hong Kong net imported 579 tonnes – the latter we’ll use as a proxy for additional Asian institutional demand, as Hong Kong is the predominant gold trading hub in the region.
In total apparent institutional demand in 2013 accounted for (914 + 579) 1,493 tonnes. If we add all other demand categories by GFMS shown in exhibit 1, total demand in 2013 was at least 6,619 tonnes. Be aware, this excludes non-apparent institutional demand.
Because nearly all wholesale gold demand in Hong Kong and China is for 1 Kg 9999 bars, the global refining industry was working overtime in 2013, mainly to refine institutional and ETF supply in GD bars coming from London. In December 2013 I interviewed Alex Stanczyk of the Physical Gold Fund who just before had spoken to the head of a Swiss refinery. At the time Stanczyk told me [brackets added by me]:
They put on three shifts, they’re working 24 hours a day and originally he [the head of the refinery] thought that would wind down at some point. Well, they’ve been doing it all year . Every time he thinks it’s going to slow down, he gets more orders, more orders, more orders. They have expanded the plant to where it almost doubles their capacity. 70 % of their kilobar fabrication is going to China, at apace of 10 tonnes a week. That’s from one refinery, now remember there are 4 of these big ones [refineries] in Switzerland.
As a consequence, statistics on “total refined gold production” in 2013 by “LBMA accredited gold refiners who are on the Good Delivery List”, which the four large refineries in Switzerland are part off, capture the immense flows of institutional S&D – next to annual mine output and scrap refining. On May 1, 2015, the LBMA disclosed total refined gold production by its members at 6,601 tonnes for 2013 in a document titled A guide to The London Bullion Market Association. It’s no coincidence this number is very close to my estimate on total demand (6,619 tonnes), as apparent institutional demand in Asia was all refined from GD into 1 Kg bars.
Here’s exhibit 2 from another angle.
In the table below we can see the LBMA refining statistics for 2013 at 6,601 tonnes.
After this publication GFMS was trapped; these refining statistics revealed a significant share of the institutional S&D flows they had been trying to conceal. What happened next – I assume – was that GFMS kindly asked the LBMA to adjust downward their refining statistics. First and painstakingly exposed by my colleague Ronan Manly in multiple in-depth posts, the LBMA kneeled and altered its refining statistics to keep the charade in the gold market going.
On August 5, 2015, the LBMA had edited the aforementioned document, now showing 4,600 tonnes in total refined gold production. (Click here to view the original LBMA document from the BullionStar server, and here to view the altered version from the BullionStar server.) Have a look.
In the altered version it says:
Total refined gold production by the refiners on the List was estimated to be 4,600 tonnes in 2013, owing to recycling of scrap material, above world mine production of 3,061 tonnes (source Thomson Reuters GFMS).
A few important notes:
In the altered version the LBMA mentions “an estimate” for “total refined gold production”, while it doesn’t need to make an estimate as all LBMA accredited gold refiners who are on the Good Delivery List are required to provide exact data to its parent body. The exact data was disclosed in the first version of A guide to The London Bullion Market Association, and it stated, “total refined gold production by the refiners on the List was 6,601 tonnes”.
In the altered version the LBMA states the refining statistics were sourced from Thomson Reuters GFMS, but the LBMA doesn’t need GFMS for these statistics. The fact they mention GFMS, though, suggests a coordinated cover up of institutional S&D. Not only the firms, also the LBMA publishes incomplete and misleading data.
The altered version stated refining production totaled 4,600 tonnes, which is a round number and obviously quickly made up. A few weeks after the numbers were adjusted, the LBMA adjusted the numbers again, this time into 4,579 tonnes (click here to view from the BullionStar server).Clearly, on several occasions there has been consultation with the LBMA to get the statistics in line with GFMS.
In the original document the LBMA states, “Total refined gold production by the refiners on the List was 6,601 tonnes in 2013, more than double world mine production of 3,061 tonnes”, while in the altered version they state, “Total refined gold production by the refiners on the List was estimated to be 4,600 tonnes in 2013, owing to recycling of scrap material, above world mine production of 3,061 tonnes”. Notable, GFMS prefers to have total supply focused around mine and scrap production, instead of including institutional supply.
The original refining statistics (6,601 tonnes) are still disclosed in the LBMA magazine The Alchemist (#78 on page 24), to be viewed from the LBMA server here.
And so nothing is spared in trying to uphold the illusion of the GFMS S&D balance to be complete. In another example GFMS excluded gold purchases by the central bank of China from its S&D balance. In June 2015 the People’s Bank Of China (PBOC) increased its official gold reserves by 604 tonnes, from 1,054 tonnes to 1,658 tonnes. During that quarter (Q2 2015) all other central banks worldwide were net buyers at 45 tonnes. Thus, in total the Official Sector was a net buyer at 649 tonnes. Now, let’s have a look at GFMS’ S&D balance for Q2 2015:
Net Official Sector purchases are disclosed ay 45 tonnes. GFMS decided not to include the 604 tonnes increment by the PBOC simply because it didn’t fit their balance model. A 604 tonnes increment in would have set the “net balance” at -480 tonnes. Readers would have questioned the balance from this outlier, and so GFMS decided not to include the tonnage.
According to my sources PBOC purchases were sourced from institutional supply (from abroad and not through the SGE), which is a supply category not disclosed by GFMS and therefore the tonnage was a problem. (Note, GFMS disclosed the PBOC increment in text, but not in their balance.) For more information read my post PBOC Gold Purchases: Separating Facts from Speculation.
Gold Is More A Currency Than A Commodity
The biggest flaw of the balance model by GFMS is that it depicts gold to be more of a commodity than a currency. It’s focused on mine output and gold recovered from old fabricated products on the supply side, versus retail sales of newly fabricated products on the demand side. In parlance of the firms, how much is produced (supply) versus consumed (demand). Official sector, ETF and exchange inventory changes are then added to the balance. This commodity S&D balance approach by GFMS has caused deeply rooted misconceptions about the essence of gold and its price formation.
The price of a perishable commodity is mainly determined by how much is annually produced versus how much is consumed (used up). However, gold is everlasting, it cannot be used up and its exchange value is mainly based on its monetary applications, from being a currency, or money if you will. Logically the best part of its trading is conducted in above ground reserves. From my perspective the impact of global mine supply, which increases above ground stocks by roughly 1.5 % annually, and retail sales have less to do with gold’s price formation than is widely assumed.
Back to GFMS. Have a look at the picture below that shows their S&D flows for 2015.
GFMS pretends total supply is mine production plus some scrap, which is then met by jewelry demand in addition to retail investment, industrial fabrication and official sector purchases. The way they present it is misleading. These S&D flows are incomplete; they suggest gold is traded like any other commodity. But what about institutional S&D in above ground bullion? Trades that define gold as an international currency.
Let’s do another comparison; this time between what GFMS calls Identifiable Investment demand, consisting of…
Retail bar & coin
…versus my what I deem to be a more unadulterated approach of investment demand, consisting of…
Total [global] Identifiable Investment, … posted a modest 5 % increase in 2015, to reach 990 tonnes.
That’s quite a tonnage between global Identifiable Investment by GFMS at 990 tonnes and apparent Chinese institutional demand at 1,400 tonnes. We should also take into account non-apparent institutional demand, gold that changes hands in trading hubs like Switzerland. Unfortunately we can’t always measure institutional S&D, but that doesn’t justify denying its subsistence.
Have a look at the chart below that shows the large discrepancy. In the next chapter we’ll specifically discuss the significance of investment demand in relation to the price of gold.
My point being: what many gold market participants and observers think is total supply and demand is just the tip of the iceberg.This truly is a staggering misconception created by the firms.
When observing the GFMS balance in exhibit 1 its incompleteness is self-evident. At the bottom we can see the line item “net balance”, which reflects the difference between total supply and total demand. According to GFMS, if the “net balance” is a positive figure there was a surplus in the global gold market, and if “net balance” is a negative figure the market has been in deficit. In the real world this figure is irrelevant. Gold supply and demand are by definition always equal. One cannot sell gold without a buyer, and one cannot buy gold without a seller. Furthermore the gold market is deep and liquid. So how come there is a difference between total supply and total demand in the GFMS balance? As I’ve demonstrated before, because GFMS doesn’t include institutional S&D that in reality makes up for the difference and far beyond. In all its simplicity the “net balance” item reveals their data is incomplete.
Let’s have another stab at this. How can “net balance” exist in the real world, for example in 2009? According to GFMS the gold market had a 394 tonnes surplus in 2009. But how? Were miners left with 394 tonnes they couldn’t sell? Or some supranational entity decided to soak up the surplus to balance the market? Naturally, this is not what happens. Total supply and total demand are always equal, but GFMS doesn’t record all trades.
Moreover, in my opinion the words “surplus” and “deficit” do not apply to gold. There can be no deficit in gold; there will always be supply. At the right price that is. Sometimes Keynesian economists claim there is not enough gold in the world for it to serve as the global reserve currency. Austrian economists then respond by saying that there will always be enough gold at the right price. I agree with the Austrians and their argument also validates why there can be no deficit in gold.
There is more proof the “net balance” item presented by GFMS is meaningless. Although according to GFMS the market had a 394 tonnes “surplus” in 2009 the price went up by 25 % during that year. This makes no economic sense. A surplus suggests a declining price, not the other way around. Tellingly, S&D forces presented in GFMS balances are often negatively correlated to the gold price, as was the case in 2005, 2006, 2009, 2010 and 2014 (exhibit 1). In conclusion, GFMS S&D balances are not only incomplete, the resulting “net balance” items are misleading with respect to the price. Below are a few charts that demonstrate this conclusion.
If we plot “net balance” versus the end of year price of gold we can see the correlation is often negative. Have a look below. Green “net balance” chart bars show a positive correlation to the gold price, red chart bars show a negative correlation (note, the left axis is inverted for a more clear overview between any “deficit/surplus” and the price of gold). As you can see nearly half of the “net balance” chart bars are negatively correlated to the price of gold.
Mind you, although the “net balance” item is often negatively correlated to the gold price, in the Gold Survey 2016 GFMS states on page 9:
In terms of the Net Balance, 2015 marked the third year in which the gold market remained in surplus, and therefore it is not surprising that the bear market continued.
And on page 14:
The forecast reduction in global mine output and a gradual recovery in demand will see the physical surplus narrow in 2016, providing support to the gold price and laying the foundation for better prospects.
GFMS likes to pretend any “surplus” or “deficit” arising from their balance is correlated to the price, but the facts reveal this is not true.
Let us plot the “physical surplus/deficit” line item by GFMS (exhibit 1) versus the gold price. This results in even more negative correlations.
This exercise reveals that a positive correlation between either a “surplus” or “deficit” arising from a GFMS balance and the price of gold is just a coincidence. No surprise when one is aware their S&D data is incomplete.
Remarkably, the last chart was also published in the Gold Survey 2016, but GFMS chose not to invert the left axis and doesn’t disclose what we see is a surplus or deficit. As a result the largest surpluses (2006, 2007, 2009, 2010) seem to correlate with a rising price, though in reality they did the opposite. Compare the chart below with the one above.
GFMS also publishes S&D balances for silver (a monetary metal that is comparable to gold). For silver the presented correlations by GFMS between a “surplus” or “deficit” in relation to the price are even weaker.
According to GFMS the silver market is always in deficit, but the price goes up and down. Obviously GFMS neglects to measure institutional S&D for silver.
In my opinion, when Gold Fields Mineral Services (GFMS) was erected many decades ago they made a mistake to adopt a commodity S&D balance approach.Surely with the best intentions they gather intelligence and retrieve data from the market. But we must be aware this is not the full picture. The most significant data is not disclosed by GFMS.
When it comes to what drives the price of gold GFMS and I agree it’s determined by gold’s role as a currency in the global economy. When reading the chapter PRICE AND MARKET OUTLOOK in the Gold Survey 2016, GFMS shares its insights with respect to the gold price. Factors mentioned are:
Turmoil in global stock markets
A Chinese hard landing
Geopolitical tensions in the Middle-East
Central bank stimulus (QE)
Global economic weakness
Interest rates policy by central banks
Low risk asset / safe haven demand
So if these factors drive the gold price, in what S&D category would this materialize? Would (large) investors buy and sell jewelry? Or bullion bars? I think the latter. According to my analysis the price of gold is largely determined by institutional demand, and to a lesser extent ETF and retail bar & coin demand.
Let’s do an exercise to see what physical gold S&D trends correlate to the price. The majority of supply on the GFMS balance consists of mine output and the majority of demand on the GFMS balance consists of jewelry consumption. But if we plot these volumes versus the price of gold in a chart, there is no push and pull correlation. For example, when the gold price surged from 2002 until 2011 jewelry consumption was not rising. Neither was it outpacing mine supply. The opposite happened, to be seen in the graph below. This is because jewelry demand is price sensitive – when the price goes up jewelry demand goes down, and vice versa. Jewelry demand is not driving the price of gold.
I also added retail bar & coin demand. Interesting to see is that retail bar & coin demand is on one hand a price driver, moving up and down in sync with the gold price, on the other hand it can be price sensitive having brief spikes when the price of gold declines.
The best correlation between physical S&D in relation to the gold price can be seen in institutional and ETF S&D. One of the largest gold trading hubs in the West is the UK, home of the London Bullion Market that also vaults the largest ETF named GLD. The UK has no domestic mine production, no refineries and national gold demand is neglectable in the greater scheme of things. Therefore, by measuring the net flow of the UK (import minus export) we can get a sense of Western institutional and ETF demand and supply. For example, if the UK is a net importer – import demand being greater than export supply – that signals a net pull on above ground stocks. Approximately one third of the UK’s net flow corresponds to ETF inventory changes, the other two thirds reflect pure institutional S&D.
In the charts above we can observe a remarkable solid correlation between the UK’s net flow and the gold price. The UK is a net importer on a rising price and net exporters on declining price. The shown correlation can’t be a coincidence, though there’s no guarantee it will prevail in the future.
The two charts above show the gold price is mostly determined by institutional supply and demand in above ground reserves. Effectively, GFMS is hiding the most important part of global physical gold flows.
When I asked an analyst at one of the leading firms why his company doesn’t measure institutional S&D he told me candidly, “becauseit’s extremely difficult to accurately estimate it”. And it is. As I wrote previously, I can’t exactly measure global institutional S&D either. However, very often publicly available information gives us a valuable peek at it, and it shows to be more relevant to the gold price than what the firms keep staring at. Not knowing exactly what institutional S&D accounts for doesn’t mean GFMS shouldn’t pay attention to it.
But the firms keep trying to uphold the illusion the data they’ve been selling for decades is complete. For if they would plainly confess it was incomplete, future business could be severely damaged.
What I blame these firms is that they’ve created a meme that the gold market is as large as annual mine supply. This has caused all sorts of misconceptions. Often I read analyses based on a comparison between quantitative demand and mine output. Such analyses are likely to jump erroneous conclusions.
On a firmly rising gold price the UK is one of the largest net importers of gold in 2016. The gold price went up 25 % from $1,061.5 dollars per troy ounce on January 1 to $1,325.8 on June 31. Over this period the UK net imported 583 tonnes and GLD inventory mushroomed by 308 tonnes.
In the month of June the UK gross imported 154.2 tonnes, up 22 % from May, and gross export was 1.9 tonnes, down 37 % from the previous month. Net import into the UK resulted in a robust 152.3 tonnes, up 23 % month on month.
Gross import by the UK from Switzerland remained resilient at 68.5 tonnes, up 11 % from May, while gross export to Switzerland was nix.
The most noteworthy gold exporters to the UK in June 2016 were:
Notable, the UK net imported a record amount from China mainland at 3.2 tonnes. This is very exceptional and has never happened in recent history, as far as I know.
The establishment and development of China’s gold market marks the basic completion of the construction of a market for major financial products in China, which will provide better micro grounds for China’s macro economic adjustment. For further development, China’s gold market should gradually realize three transformations: from commodity trade to financial product trade, from spot transactions to futures transactions, and from a domestic market to integration with the international market.
…. gold still has a strong financial nature and remains an indispensable investment tool. In major financial centers in the world, the gold market – together with the money, securities and FX market – constitutes the main part of the financial market.
China’s gold market must integrate into the global market. …. China should actively create conditions for its gold market to become an important part of the international gold market.
… gold still bears the marked nature of money under the modern financial system.
This enables us to better execute on our strategy to become one of the largest Chinese banks in the precious metals market.
Is it a coincidence that China is suddenly exporting gold to the UK while ICBC Standard Bank was recently accepted as clearing member of the LPMCL and utilizes a gold vault in London? Likely the gold export to the UK is connected to the new clearing and vaulting activities by ICBC Standard Bank. Next to China’s strategy to develop the SGEI for gold trading in renminbi along the Silk Road, they’re actively increasing presence in the London Bullion Market.
However, I don’t think the majority of gold imports into the UK this year – aside from the import from China – are connected to ICBC Standard Bank, the imports mainly reflect Western institutional demand. Net gold flows through London have been correlated to the price of gold long before the Chinese entered the international precious metals construction.
So, although the 3.2 tonnes exported from China to the UK are exceptional, the UK manifesting itself as a net importer while the price is rising is quite normal.
The Gold Price And Global Flows
Here’s a theory hopefully sparking fruitful debate: the gold price is set by physical supply and demand in the West.
Since 2013 when the price of gold declined significantly in all major currencies, we’ve witnessed a massive exodus of physical gold from West to East. In 2013 the UK, housing the London Bullion market, net exported 1,424 tonnes, the highest amount since 1997 when 2,473 tonnes were net exported (source James Turk).
In the 2014 and 2015 the UK continued to be a net exporter. Large wholesale 400-ounce London Good Delivery bars were mainly transported to Switzerland, where being recast into 1 Kg 9999 fine bars for the Asian market. From international merchandise trade statistics we could clearly track the gold flowing from the UK, to Switzerland, to Hong Kong, finally reaching China mainland. We could even see a correlation between UK net export and SGE withdrawals from early 2013 up until December 2015.
Currently China is still buying gold, albeit less than in recent years, but the West has turned into a net buyer as well, pressuring supply and forcefully driving up the price.
Some commentators in the gold space deemed it impossible China was importing 1,400 tonnes on average in the past three years while the price was going down. The price was set purely in the paper markets, so they concluded. According to my analysis China was able to buy the tonnages they did by the willingness of the West to supply the metal – exactly who in the West was so eager to supply is another story.
The falling gold price from 2013 until 2015 and the exceptional tonnages China was importing were caused by strong physical supply from the West. Simplified, if 1,400 tonnes are imported into China, one can observe strong demand, but the corresponding supply had to be at least equally strong (or stronger) on a declining price. The nominal volumes of supply and demand are always equal, the difference in strength between both is what sets the price. In my logic, that is. What happened in the past years was that the Chinese were merely buying the physical supply coming from the West, buying as much as they could. A once in a lifetime opportunity.
Remember, if you see 1,400 tonnes being moved into China, that’s a lot of demand, but it’s a lot of supply as well
As stated in a previous post I think the price of gold can be, and is, easily manipulated through derivatives in the short term. Through leveraged futures contracts or derivatives in the highly opaque OTC market the price of gold can be efficiently managed for short periods. But in the long term the price can only be decided by physical supply and demand. If any entity for example desires to suppress the gold price in the long term then physical metal has to be supplied into the open market or an undeniably vivacious spread will appear between the paper and physical price.
What I’m seeing is that physical gold flows across the globe are highly correlated with the gold price. Have a look at the chart below showing the gold price versus the net flow through the UK (and GLD inventory change). There’s a clear correlation.
The same correlation can be seen in net gold flows through Switzerland – which can be considered as a proxy for Western demand just like net flows through the UK.
In general, every time the West starts hoarding in the UK and Switzerland the price goes up, and when they sell the price declines. I think these charts show that there is more correlation between the gold price and physical supply and demand than is widely assumed in the gold space.
Take this last chart for example. The UK net importing huge amounts of physical gold coincides with the price going up, and exactly when they turn to net exporting the price goes down. So then how can the price have nothing to do physical supply and demand?
On a small side note. I find it remarkable that research (by Ronan Manly, BullionStar, and Nick Laird, Goldchartsrus.com) pointed out that the physical float in London was nearly running out in late 2015 and shortly after the UK starts net importing and the price goes up. When in December 2015 the UK net exported 184 tonnes of gold, which was the third highest amount on record, I wrote In February 2016 [brackets added by me]:
When there is no more gold left in London to export, the gold price is likely to go higher on strong global demand induced by economic headwind.
How much gold is left in London? We can make a rough estimate, ….Research by Ronan Manly … and Nick Laird … pointed out there were roughly 6,256 tonnes of gold in London in June 2015. However, of this total at least 3,779 tonnes was monetary gold owned by central banks around the world stored at the Bank Of England (BOE), which is [presumably] not for sale. The remaining 2,477 tonnes in non-monetary gold were potentially for sale. [Note, this number included 1,116 tonnes in ETF gold outside BOE vaults and 1,355 tonnes stored within BOE vaults, leaving 6 tonnes in the LBMA system outside the BOE]
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 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 genuine 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 Chinese gold market you like to study. For example, Chinese gold demand metrics, the Shanghai Gold Exchange (SGE) system, Chinese cross-border gold trade rules, 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 Chinese Gold Market Essentials. Whenever the mechanics of the Chinese gold market develop all Chinese Gold Market Essentials will be updated or new ones will be published, as to remain a comprehensive knowledge base on the largest physical gold market in the world at all times. All Chinese Gold Market Essentials have been recently rewritten and the post on PBOC gold purchasescontains many very important new insights.
Topical data such as monthly Chinese gold import numbers will not be updated in the Chinese Gold Market Essentials, however, this data will be published in new blog posts appearing on my BullionStar Blogs homepage, accompanied with a link to this webpage to be complete.
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 email@example.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 weekly 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 World Gold Council, which has aggregated to at least 2,500 tonnes from 2007 until 2015. For whatever reason, the World Gold Council and its affiliates continuously present feeble arguments that should explain the difference. The Chinese Gold Market Essentials debunk these arguments where necessary, back up by facts, and reveal genuine 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 Rules.
When 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 gold trading hub in Asia. Related is SGE Withdrawals In Perspective that discusses how trading activity on the Shanghai International Gold Exchange (SGEI) can potentially blur our view on Chinese wholesale gold demand when measured by SGE withdrawals.
Finally, please read PBOC Gold Purchases: Separating Facts from Speculationfor 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).This post has collected many new contributions in recent months, a must read!
As part of the wide analysis of the Chinese domestic gold market I would like to share that since the seventies there is a special army in China dedicated to gold. It’s called The Gold Armed Police – if you can read Chinese have a look at this Wikipedia page.
It’s no coincidence this army came into existence in 1979, eight year after the US left the gold standard and when China started opening up under the guidance of Deng Xiaoping. As, this was the moment the Chinese slowly started to reform their economy and made the first preparations in their gold market. They knew, among others, the global dollar standard wouldn’t last forever.
On 29 October 1976 representatives of the Chinese central bank and the Federal Reserve (US, Arthur Burns) met in China and discussed international economics. From Wikileaks:
IN INTERNATIONAL ECONOMICS, THE DISCUSSION CONSISTED MAINLY OF QUESTIONS BY THE CHINESE AND ANSWERS BY DR. BURNS, ALTHOUGH THE CHINESE VIEW THAT INFLATION IS A SYMPTOM OF ECONOMIC WEAKNESS CAME THROUGH CLEARLY. THE CHINESE ASKED ABOUT DR. BURNS’ VIEWS OF THE IMF CONFERENCE AND WERE PARTICULARLY INTERESTED IN THE IMF GOLD AUCTIONS, AND THE ISSUANCE OF SDR’S. THE CHINESE ASKED ABOUT THE PROBLEM OF CONTROLLING THE $200 BILLION IN EURODOLLARS, AND GAVE THE IMPRESSION THAT THEY CONSIDERED THE EURODOLLAR MARKET A THREAT TO EXCHANGE RATE STABILITY, WHICH BY IMPLICATION THEY SEEMED TO FAVOR. THEY ALSO ASKED ABOUT COMPARATIVE GROWTH RATES AMONG THE OECD COUNTRIES. AGAIN, THE CHINESE BANKERS WERE WELL INFORMED AND HAD THEIR QUESTIONS WELL PREPARED.
In the quote from Wikileaks we can clearly read the Chinese were interested in gold. However, the Chinese economy was completely centrally planned at the time and they were not a member of the World Trade Organization or the giant exporter of goods they are now. Therefor, I suspect China had little resources to acquire gold – in the seventies China’s foreign exchange reserves were very small – while they urgently needed to increase their reserves.
Initially the Gold Armed Police was established to develop China’s domestic mining industry. China’s domestic mining output grew by an incredible 2,964 % from 1976 until 2014, according to data from the China Gold Association, and this was partially due to gold exploration by the Gold Armed Police.
Remember that before 2002 the PBOC had the monopoly on all gold trade in China. Mining output (and potential import) was transferred to the PBOC that set the domestic gold price and distributed the gold to a limited amount of designated jewelry shops or kept the metal for its official reserves. The Gold Armed Police and the PBOC must be closely associated.
Next to exploration the Gold Armed Police was also assigned to guard the mines and to do other tasks. And here is where it becomes interesting. Gold market insider James 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.
Although Rickards notes the convoy was lead by the People’s Liberation Army I think it’s very likely the Gold Armed Police was involved in this transport that contained monetary gold directed to PBOC vaults. We can speculate the Gold Armed Police is active in distributing the PBOC’s monetary gold into the mainland.
The other day I spoke to a gold market insider, that likes to remain anonymous, who told me “some central banks send their own airplanes to London to pick up monetary gold” when we were discussing purchases from China’s central bank in the UK. I’m quite sure the PBOC has bought a substantial amount of gold in London in recent years and I suspect the Gold Armed Police is distributing the monetary metal.
So how does the PBOC buy gold in London? Through which proxy do they do they purchase the metal? Well, that’s hard to say. But, if I may freely speculate the Bank Of China is part of this. If we read the Chinese Wikipedia page about the Foreign Exchange Reserves of the People’s Republic of China (not the English page) it states:
The FX reserves of the Chinese mainland are State-owned assets and managed by SAFE and the PBOC, the actual business operations are carried out by the Bank of China.
The Bank Of China is a commercial state-owned bank and LBMA member that can be one of the proxies for the PBOC’s monetary gold purchases around the globe. So, possibly the Bank Of China buys gold in the London OTC market, which is then transported by the Gold Armed Police to PBOC vaults in Beijing.
Below is an article I found on The China Times about the Gold Armed Police:
China has a military unit dedicated to gold exploration, this unit is the only one of its kind in the world.
The gold exploration unit was established in the beginning of China’s reform and opening up, when the country urgently needed to increase its gold reserves. The unit has found more than 1800 tons of gold so far, helping China become the world’s largest gold-producing country.
China’s annual gold production was merely 4 tons when PRC was founded. After the gold exploration unit of the Chinese People’s Liberation Army was established in 1979, 12 detachments were sent to all over China. The picture shows soldiers from the 7th detachment of the gold exploration unit singing songs on their way in March 2006.
Gold reserves are usually located in remote and inaccessible areas. The picture shows soldiers from the 8th detachment of the gold exploration unit fighting sandstorm in Lop Nur in August 2002.
In 1995, China’s gold production for the first time exceeded one hundred tons, taking the 8th place in the world. More than half of the gold reserves were found by the gold exploration unit. Eight years later, China’s annual gold production exceeded 200 tons. The picture shows a soldiers from the 8th detachment of the gold exploration unit carrying out explosion works in August 2002.
July 2000, soldiers from the 8th detachment panning alluvial gold in Xinjiang. In 30 years, the gold exploration unit has found many large-scale gold deposits, in total found more than 1800 tons of proven gold reserves.
Lop Nur, August 2002, soldiers from the 8th detachment cooking meals in tent, two days later, the tent was swept away by flood.
Lop Nur, August 2002, soldiers from the 8th detachment having lunch together.
April 2011, about 100 soldiers from the 7th detachment carrying out geology and resources survey tasks in Xinjiang.
May 2011, soldiers from the 6th detachment taking a break after long-hours hard work in Qilian Mountain, Qinghai.
Natural gold nugget found by the gold exploration unit in 1983, it contains 1114 grams of pure gold.
A seminar about gold supporting the internationalization of the renminbi and China’s financial strength was held in Beijing on 18 September 2015. One of the keynote speakers was Song Xin, President of the China Gold Association (CGA), Chairman of the Board of China International Resources Corporation, President of China National Gold Group Corporation and Party Secretary, who believes China’s economic power must be serviced by appropriate gold reserves to support the renminbi. An article written by Song published on Sina Finance in 2014 stated (translation by BullionStar):
For China the strategic mission of gold lies in the support of renminbi internationalization. Gold … forms the base for a currency moving up in the international arena.
If the renminbi wants to achieve international status, it must have popular acceptance and a stable value. To this end… it is very important to have enough gold as the foundation and raising the ‘gold content’ of the renminbi. Therefore, to China, the meaning and mission of gold is to support the renminbi to become an internationally accepted currency and make China an economic powerhouse.
That’s why, in order for gold to fulfill its destined mission, we must raise our gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.
President of the CGA before Song was Sun Zhaoxue, who shared many of the viewpoints of his successor. In 2012 a famous article from Sun was published in Qiushi magazine, the main academic journal of the Chinese Communist Party’s Central Committee, wherein he plead for stimulating the Chinese citizenry to buy gold next to increasing China’s official gold reserves (translation by BullionStar):
Currently, there are more and more people recognizing that the ‘gold is useless’ story contains too many lies. Gold now suffers from a ‘smokescreen’ designed by the US, which stores 74% of global official gold reserves, to put down other currencies and maintain the US Dollar hegemony. Effectively, the rise of the US dollar … and later the euro currency, from a single country currency to a global or regional currency was supported by their huge gold reserves.
Individual investment demand is an important component of China’s gold reserve system, we should encourage individual investment demand for gold. Practice shows that gold possession by citizens is an effective supplement to national reserves and is very important to national financial security.
Regular readers of this blog will know what Sun wrote in 2012 regarding ‘individual gold investment’ is exactly what has unfolded; through the Shanghai Gold Exchange (SGE) we could see thousands of tonnes of gold moving into the mainland in recent years. According to my estimates Chinese privates gold holdings have reached 12,000 tonnes – next to the People’s Bank Of China’s (PBOC) gold buying program.
Since my last extensive blog post (20 May 2015) on PBOC gold purchases I’ve been able to collect more clues related to the amount of gold China’s central bank has harvested in exchange for its lopsided US dollar holdings. Last week I spoke to an insider with connections at Western bullion banks. This gentleman confirmed proxies of the PBOC purchase gold directly in the London OTC gold market that is shipped to Beijing. Implying much of the 1,750 tonnes that have mysteriously vanished from the London Bullion Market (left London without being disclosed in UK customs statistics) in between 2011 and early 2015 went to China. This supports the analysis the PBOC is buying at a pace of 500 tonnes a year in the international OTC market (not through the SGE) and owns approximately 4,000 tonnes by now.
Furthermore, it seems the writings from Song and Sun correspond with China’s real undertakings in the gold market, which influences our valuation of their words. There are no transcripts from the seminar in September, but I found an article (in Chinese) that summarizes what Song and others have said. Please read the gripping translation below.
On 18 September 2015 the “Renminbi Internationalization and China’s Gold Strategy Seminar” was smoothly held in Beijing. The seminar was guided by the China Gold Association and jointly held by the Chinese Gold Research Center of Capital University of Economics and Business and Beijing Gold Economic Development Research Center. It was supported by Zhao Jin Futures, Shandong Zhaojin Investment Co., Ltd., Shenzhen Jinmingzhu Jewelry Co., Ltd. and Chifeng Jilong Mining Industry Co., Ltd.
Over 130 representatives from the governments, banks, gold mining industry, gold investment organizations, jewelry companies and educational institutions attended the seminar. Wang Wenju, Vice President of Capital University of Economics and Business announced to rename the Chinese Gold Market Research Center of Capital University of Economics and Business on the seminar site.
Wang Jiaqiong, President of Capital University of Economics and Business, Song Xin, President of Chinese Gold Association & General Manager and Secretary of the Party Committee of China National Gold Group Corporation, Wang Xiaomei, Deputy Party Secretary of China National Gold Group Corporation, Wei Benhua, Former Director of the State Administration of Foreign Exchange and Former General Representative of Chinese International Monetary Fund, and other leaders and representatives attended the seminar. 13 experts from China Gold Association, Shanghai Gold Exchange, Renmin University of China, Chinese Social Science, Capital University of Economics and Business, China Center for International Economic Exchanges, China Forex Investment Research Institute, Gold Economic Research Center, ICBC, China Construction Bank, Shandong Gold Group and Shandong Zhao Jin Group delivered splendid speeches.
President Wang Jiaqiong delivered a speech. In his speech, Wang Jiaqiong pointed out, RMB internationalization is a struggling process in need of strategic research. In the seminar, many experts, scholars and entrepreneurs were discussing renminbi internationalization and Chinese gold strategies. They would propose wise ideas and good policy suggestions after brainstorming, playing as a think tank in the development of China. The research team led by Professor Zhu Heliang from our university spent years studying Chinese gold strategy problems and some research results obtained the central affirmation and recognition. All of your arrival can better support our in-depth research on relevant topics and construction of related disciplines.
In the opening ceremony, Wang Wenju announced the renaming of the Chinese Gold Market Research Center of Capital University of Economics and Business, which focuses on the current gold market, to Chinese Gold Research Center of Capital University of Economics and Business with the purposes of better studying gold problems comprehensively, displaying the function of gold in national economy and society, boosting renminbi internationalization and keeping pace with the times. The school would offer vigorous support and hope that the new research center can strengthen team building and display think tank functions.
In his speech, Song Xin mentioned that the Chinese gold industry has achieved a great-leap-forward development since the new century. In 2014, Chinese gold yield had turned China into the biggest gold producing country in the world for eight consecutive years and the biggest gold consumption country again.Whether in the past, present or future, gold plays a crucial role in the development of human society. Renminbi internationalization has boosted China’s march towards an economic power from an economic giant. The new age has endowed gold with more important missions. Gold has shouldered a heavy responsibility of “increasing credit” for renminbi internationalization and increased the “gold content” for renminbi internationalization.
Recently, the Central Bank announced to increase gold reserves to the public many times in succession. In fact, it’s the strategic layout and major move for laying the renminbi’s international credit foundation.We always suggest formulating and boosting national gold strategies in pace with national financial strategies positively, further improving the quantity and proportion of gold in national foreign exchange reserves, developing occupancy volume of gold production and increased gold resources.We further suggest perfecting the gold market, promoting foreign currency in individuals, boosting Chinese and western wealth flowing, improving our control power of global gold wealth flowing, accelerating renminbi internationalization, helping the renminbi enter special drawing rights currency basket, rebuilding international currency system, balancing American hegemony process, and positively displaying the due function of gold and the gold industry. Leaders from Capital University of Economics and Business have supported the research on gold problems for a long time. The team led by Professor Zhu Heliang has persistently pursued basic research on gold with outstanding viewpoints. They have obtained relevant departments’ high attention for long. I hope that Capital University of Economics and Business can further display its gathering advantages of majors and talents, and strengthen the cooperation with Chinese Gold Research Center, China National Gold Group Corporation and its subordinate companies.
In the seminar, experts thoroughly analyzed the essence and inherent laws of renminbi internationalization, new positioning and functions of gold in the non-gold standard currency system.They discussed the strategic significance of gold in renminbi internationalization from historical and actual perspectives and Chinese gold strategies in the new age. Experts unanimously regarded gold as playing an irreplaceable role in currency internationalization progress. The important element of gold shouldn’t be ignored during renminbi internationalization. The country should attach great importance to the development of the gold industry and market and increase gold reserve from a strategic height.
The seminar is the “prelude” of the first renminbi internationalization and Chinese Gold Strategy Research Project jointly carried out by Chinese Gold Research Center of Capital University of Economics and Business and Beijing Gold Economic Development Research Center. After the seminar, key viewpoints were to be collected and submitted to related departments. Chinese Gold News will set up a special column and publish solicited articles about “renminbi Internationalization and Chinese Gold Strategies”. Meanwhile, two organizations will organize special research teams, focus on the topic research of “renminbi internationalization and Chinese Gold Strategies”, and open the research results for publication. With national major strategy research as their own duty, the two organizations have formed a strategic alliance in terms of promoting renminbi internationalization and adjusted research directions of Chinese gold strategies in order to make effort and contribution to the prosperous cause of China.
This post is part one 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 this gigantic physical gold market.
The largest physical gold market globally is presently the Chinese domestic gold market. At the core of this market is the Shanghai Gold Exchange.
China is the largest gold importer and mine producer globally, and because nearly all of these supply channels in the domestic market flow through the center bourse, as a consequence the infamous Shanghai Gold Exchange (SGE) is the largest physical gold exchange currently in existence. The yearly amount of physical gold withdrawn from the SGE vaults has exceeded 2,100 tonnes since 2013.
Whilst Western consultancy firms like the World Gold Council and Thomson Reuters GFMS report annual Chinese gold demand is roughly 900 tonnes, we can read in reports by inter alia the China Gold Association (CGA) that annual Chinese gold demand equals SGE withdrawals and is thus more that twice as much as is portrayed in the West.The difference (between GFMS demand and SGE withdrawals) canonly in part can be explained by contrasting metrics.
In this post we’ll examine 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 the level of true Chinese gold demand.
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 teh PBOC to monitor the gold traded in the Chinese market, and (iiii) keep track of the amount of physical gold added to Chinese (non-government) gold 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 and develop the Chinese gold market in order to support China’s internationalization.
For this 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)
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.
All the English reports were available on the SGE website until 2014, but now have been taken offline. Nowadays most information is only published in Chinese print.
Prior to 2002 the Chinese gold market was practically non-existent. Back then the PBOC had the monopoly in trading gold in China and Chinese 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 direct interference of the PBOC in 2007. In the CGA Gold Yearbook 2007 we can read:
In 2007, the amount of gold withdrawn from the warehouses of the Shanghai Gold Exchange, the total gold demand of that year, was 363.194 tonnes of gold, …
From 2002 until 2007 Chinese 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 total Chinese gold demand, according to the metrics used by the CGA used in the Gold Yearbooks published in Chinese. From 2012 until present SGE withdrawals roughly match total Chinese gold demand.
There are a few basic rules with respect to the Chinese domestic gold market that determine why SGE withdrawals equal Chinese (wholesale) gold demand, these rules compound to the mechanics of this market. The first we’ll discuss are import rules.
Chinese Cross-Border Gold Trade Rules
Gold bullion import into the Chinese domestic gold market can be done by banks that enjoy approval by the PBOC, though for every shipment anew approval must be submitted at the Chinese central bank. Bullion export from the Chinese domestic gold market is prohibited as far as is publicly know. At this stage there are fifteen banks that have been approved by the PBOC (in random order):
Shenzhen Development Bank / Ping An Bank
Industrial and Commercial Bank of China
Shanghai Pudong Development Bank
Agricultural Bank of China
China Construction Bank
Bank of Communications
China Merchants Bank
China Minsheng Bank
Bank of Shanghai
Bank of China
All bullion imported into the Chinese domestic gold market by one of the fifteen banks is required to be standard goldand sold first through the SGE. Standard gold in China is bullion casted by an LBMA or SGE approved refinery in bars of 50g, 100g, 1Kg, 3Kg or 12.5Kg, with a fineness of 9999, 9995, 999 or 995. Solely standard gold is allowed into SGE designated vaults to be traded through the SGE system. The Chinese gold trade rule book states [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.
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 apply. For import of doré, ore and jewelry into the domestic market different rules apply than for standard gold; in this form other entities than banks can import the metal, if approved by the PBOC, though export is prohibited.
The Chinese Mint has an exception to export golden Panda coins from the Chinese domestic gold market and to my knowledge there are also a few jewelry companies that are allowed to trade gold products in and out of the Chinese domestic market, but the tonnage is insignificant.
Individuals can officially import and export 50 gram when traveling abroad. However, this rule isn’t very stringent on the import side. Many mainland tourists visit Hong Kong to buy jewelry and bring as much bracelets as they like across the border when they return home.
At the LBMA forum in Rome September 30, 2013, Vincent Chow (Chow Sang Sang Jewelry, Hong Kong) showed some interesting slides.
Chinese Gold Mining
China has the largest domestic gold mine production in the world with an output of roughly 450 tonnes in 2015. The vast majority of this output is sold first through the SGE. All Chinese gold miners are required to sell their standard gold over the SGE. The next quote is from China Gold International Resources Corp. Ltd. [page 15, brackets added]:
On October 30, 2002, the Shanghai Gold Exchange commenced operation under the supervision of the State Council. Thereafter, the PBOC ceased its gold allocation and gold purchase operations. All PRC [People’s Republic of China] gold producers are now required to sell their standard gold bullion through the Shanghai Gold Exchange, and prices of gold on the Shanghai Gold Exchange are determined by market demand and supply, which essentially converge with the price of gold in the international market.
Because the SGE has the best liquidity in China, gold mining companies are incentivized to cast their output in standard gold bars and sell it through the SGE. However, in theory miners can sell non-standard gold off-SGE. For example China National Gold Group (China Gold) is a miner that also has its own physical stores to sell bars and ornaments.
Chinese Scrap And Disinvestment Supply
Scrap supply in the Chinese domestic gold market, as defined by old jewelry or industrial products sold, has a strong incentive to flow through the SGE as well because of the VAT rules regarding standard gold. Scrap is not required to be sold through the SGE, yet many refineries cast standard gold, which are the most commonly traded bars and the only bars allowed in the SGE system. Because standard gold traded off-SGE enjoys VAT and the SGE is the most liquid exchange in China most refinery bar production finds its way to the SGE. Below is a picture of a 100 gram standard gold bar:
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 Number.
Because in economics total supply and total demand are exactly equal – one cannot sell gold without a buyer or buy gold without a seller – consequently we can also gauge demand by measuring supply. With this knowledge we’ll have a more precise look at scrap supply. Important for understanding the metrics used by the CGA and GFSM to measure Chinese gold demand, there are three kinds of secondary supply (scrap, disinvestment, recycled) gold flows that enter the SGE. Although both the CGA and GFMS label their
The first is genuine scrap, as defined above, which is old gold products (jewelry or industrial) sold for cash and therefor true supply having an effect on the gold price. These scrap flows are included by both the CGA and GFMS in their “scrap” numbers.
The second is disinvestment. Individual and institutional investors in China buy gold directly at the SGE. If later in time the bars are sold back they can be send directly through a refinery and then making their 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 material, more likely he will approach a refinery. Disinvestment (in my nomenclature) are included by the CGA in their “scrap” numbers, but not by GFMS.
The third kind is recycled gold (again, this is my nomenclature). Recycled gold can be for example process scrap, which is metal spill over from jewelry or industrial fabrication. 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 being sold back from the jewelry manufacturer to a refinery making its way back to the SGE. Effectively the 200 Kg have been recycled through the SGE, being both demand and supply, having no net effect on the price. Process scrap is not included in GFMS data. Next to process scrap there can be other forms of gold being recycled through the SGE, which we’ll all label as distortion (distortion is recycled gold).
In the (CGA) Chinese annual gold reports mentioned at the beginning of this post, scrap, disinvestment and distortion flows are all counted in one category, labelled by the CGA as “scrap supply”. In contrast, GFMS only measures scrap and not disinvestment . This partially explains the difference in Chinese gold demand.
As supply and demand are always equal, when CGA metrics measure more supply, logically they measure more demand as well. When, later on, we’ll estimate true Chinese gold demand, we should subtract distortion from SGE withdrawals.
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 the SGE vaults they leave the chain of integrity. To prevent fraud, hereafter, these bars are not allowed to re-enter the SGE vaults. The only way they re-enter the SGE is if they’re recast into new bars by an SGE approved refinery. From the SGE’s Detailed Rules for Physical Delivery of the Shanghai Gold Exchange we can read:
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. Read point 2 of a considerations segment from an ICBC gold product:
This rule is essential for comprehending the mechanics of the Chinese domestic gold market.
SGE Withdrawals Equal Chinese Wholesale Gold Demand
Let us use some equations to clear our view of this market. If we put together the rules mentioned above we can understand the basic formula for the Chinese domestic gold market:
SGE withdrawals = Chinese Wholesale Gold Demand
As import + mine + scrap + disinvestment + distortion is total physical supply to the SGE and everything that is withdrawn is total demand, therefor:
Chinese Wholesale Gold Demand = True Chinese gold demand + Distortion
Please note, in the supply and demand balance shown above, and in our further investigation, two elements are left out. On the supply side I left out stock carry over in SGE vaults from previous years, as this information is not publicly available. On the demand side I left out gold bought at the SGE that was not withdrawn from the vaults, as this information is also unknown.
The formula is supported by reports from the CGA and SGE since 2007, as every year SGE withdrawals equal total (wholesale) gold demand in these documents. Let’s have a look at CGA demand data and SGE withdrawals since 2007:
2007: SGE Withdrawals 363.2 Tonnes
2008: SGE Withdrawals 543.2 Tonnes
2010: SGE Withdrawals 837.2 Tonnes
2013: SGE Withdrawals 2197 Tonnes
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
Chinese wholesale gold demand as disclosed in Chinese reports by the CGA is the widest measure of demand. Western consultancy firms like GFMS use different metrics, resulting in lower supply and demand figures. Though, contrasting metrics can not explain the full difference, which has aggregated to 5,030 tonnes from 2007 until 2015. In this post we’ll briefly discuss contrasting metrics, which explain the difference in part, a succeeding post is dedicated to an extensive study on these metrics and how we can measure genuine Chinese gold demand.
In the supply and demand tables above we could see the difference was labeled as net investment (in the CGA Gold Yearbook 2013 at 1,022.44 tonnes), which is calculated by the CGA as a residual between what is withdrawn from the SGE vaults and gold sold at retail level (jewelry shops and banks). GFMS does not include net investment on its demand balance, but merely includes the gold sold at retail level.Net investment, which roughly equals the difference, is caused by direct purchases from individual and institutional customers at the SGE that withdraw their metal (also see chart 3 below).
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.
The quote above clearly states that in 2010 direct purchases at the SGE by individual clients (266 tonnes) already exceeded retail bar investment (142 tonnes).
Purchasing gold directly at the SGE is fairly simple in China. Every Chinese citizen can buy gold or trade derivatives at the SGE through a commercial bank. For 50 RMB a client can open an SGE account at his local commercial bank branch. Subsequently, he or she receives a unique 10-digit trading number that gives access to one SGE account, consisting of a Bullion Account and a Margin Account. The 10-digit trading number will stay with an individual forever, even if he or she switches banks. The process is illustrated in the picture below:
When a physical SGE gold contract is exchanged the full amount of funds is transferred from the buyer’s Margin Account to seller’s Margin Account, the gold 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.
Since early 2016 there is even an SGE smartphone application called “Yijintong” that allows anyone with an internet connection to open an SGE account and trade directly on the SGE wholesale platform enjoying the lowest spreads in China.
Any individual can buy bullion directly at the SGE, the only reason he or she would buy gold in a jewelry shop is because these bars are decorated and come in all sorts of shapes and sizes. Obviously, large investors would not buy retail gold but prefer relatively cheaper SGE bars.
I should mention, the CGA discloses Chinese gold demand for the English speaking world excluding net investment, to make it appear demand is far lower than it is in reality. From Reuters on Chinese gold demand 2013:
Gold consumption in China grew to 1,176.40 tonnes last year, with jewellery demand climbing 43 percent to 716.50 tonnes and bullion demand soaring 57 percent to 375.73 tonnes, the China Gold Association said on its website.
Jewelry and bar demand is exactly the same as in the screen shot from the CGA Gold Yearbook 2013 above, but net investment is excluded. Why the widest measure of the Chinese gold market is hidden from the English speaking world is left for speculation.
I shall give another example that confirms 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 by me]:
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.”
…when we asked why the China Gold Association’s number is so low [demand disclosed without net investment], 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.”
Needless to say, the people that run the SGE, CGA, PBOC and SHFE are all related. Depending on the occasion these people choose to disclose net investment, and thus the true size of the Chinese gold market.
Let us briefly have a look at the compositions of the difference. In the chart below we can see apparent Chinese gold supply (import + mine + GFMS scrap = center column) versus SGE withdrawals and GFMS demand. Obviously, what is being supplied in the Chinese gold market is far more than what the GFMS reports as demand.
The gap between the height of the centre columns (apparent supply) and the red columns (SGE withdrawals) is something that will be discussed ina following post.
A legitimate reason that explains part of the difference (SGE withdrawals – GFMS demand) is stock inventory change. There is always gold in transit from being withdrawn from SGE vaults by jewelry and industrial fabricators to being sold at retail level. This is wholesale stock inventory is not being counted by GFMS as demand as this is likely hedged in the futures market and thus has no net effect on the gold price. Stock inventory change can’t make up the full difference between SGE withdrawals and consumer gold demand, but is part of distortion.
In 2013 GFMS wrote me net investment is solely stock inventory change. Of course this can’t be true. When confronting them with all the evidence I had collected they wrote me:
We have checked with our Data Specialist and confirmed that we use a different methodology. Total Chinese demand used by Thomson Reuters GFMS only include 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.
So according to you net investment 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!)
That’s correct based on the resolution provided by our data specialist.
The World Gold Council (WGC) has tried to explain the difference in two reports released in 2014 dedicated to the Chinese gold market, which both contained fallacious and self-contradictory statements. Up until now the WGC and GFMS have presented very weak arguments that should explain the difference.
For this post we’ll wrap it up. In short, there are several metrics to measure Chinese gold demand:
Gold sold at retail level = GFMS gold demand
Import + mine = net gold added to Chinese (non-government) reserves
Import + mine + scrap = the lowest measure of Chinese gold demand
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.
Typically, Xu likes to measure import + mine as Chinese gold demand as this is the amount of gold added to Chinese (non-government) reserves. I prefer to consider all metrics to have the best understanding of the Chinese domestic gold market and keep track by how much Chinese reserves are increasing.
The SGEI facilitates gold trading in the Shanghai Free Trade Zone (FTZ). Physical gold trading in the FTZ is completely separated form the Chinese domestic gold market, which is a closed market; bullion exports are prohibited and only 15 banks are licensed to import bullion. The banks that enjoy a PBOC bullion import license are:
Shenzhen Development Bank / Ping An Bank
Industrial and Commercial Bank of China
Shanghai Pudong Development Bank
Agricultural Bank of China
Bank of Communications
China Construction Bank
China Merchants Bank
China Minsheng Bank
Bank of Shanghai
Bank of China
The gold traded on the SGEI can be withdrawn from the vaults in the FTZ by foreign enterprises and shipped abroad, these SGEI withdrawals are captured in the total SGE withdrawals (only aggregated withdrawals are disclosed) and thus distorting our view on Chinese wholesale demand.
Would we get our clear view back if SGE and SGEI withdrawals would be disclosed separately? No. This is because Chinese domestic banks are also trading on the SGEI, when they withdrawal from the vaults in the FTZ they can import this gold into the mainland without it being required to be sold (again) through the SGE.
The trading volume/purchases on the SGEI (contracts iAu100g, iAu99.99 and iAu99.5) can be:
Not withdrawn at all and thus not distorting our view on Chinese wholesale demand.
Withdrawn by foreign traders and thus distorting Chinese wholesale demand. If we knew how much these withdrawals accounted for we could subtract them from total SGE withdrawals to have a clear view on Chinese wholesale demand. Unfortunately we don’t know these numbers.
Withdrawn by Chinese domestic banks to be imported into the mainland and thus being part of Chinese wholesale demand.
This is what we (I) know at this stage. Concluding weekly Chinese wholesale gold demand is at most total SGE withdrawals, at least total SGE withdrawals minus SGEI trading volume.
For example, in week 50 total SGE withdrawals accounted for 50,027.5 Kg. Total SGEI trading volume accounted for 6,159 Kg. Meaning Chinese wholesale gold demand was somewhere in between 50,027.5 Kg and 43,868.5 Kg (50,027.5 – 6,159). Year to date Chinese wholesale gold demand is somewhere in between 1,911,230 Kg and 1,955,090 Kg (at least 1,911 tonnes).
Needless to say, if more information is disclosed by the SGE I will report about it as soon as possible.
Furthermore; Chinese wholesale gold demand is supplied by import, mine and scrap. The amount of mine supply we know from numbers of the China Gold Association (CGA), in 2014 it will be approximately 451 tonnes. The composition of the other two supply flows is not known, for this we have to make estimates based on numbers from previous years. In 2012 scrap (through the SGE) was 232 tonnes, in 2013 it was 247 tonnes. This year scrap is likely to be substantially higher. How come? By way of measuring Chinese wholesale gold demand as described above, it was at least 1,841 tonnes in the first eleven months of this year. The Chairman of the SGE said on a conference import was (approximately) 1,100 tonnes over this period and mining had to be 416 tonnes, setting scrap at 325 tonnes.
Nevertheless, China will import far more than 1,100 tonnes in 2014, added to 451 tonnes of domestically mined gold, the Chinese people will add about 1,700 tonnes to their reserves. Assuming the PBOC doesn’t buy gold through the SGE.
Will Chinese Gold Demand End 2014 With A Boom?
Seasonally December and January are strong months for Chinese gold demand, but will they be this year? To answer this question let’s have look at the next chart.
We can see elevated withdrawals every December and January. Additionally, it’s clear the Chinese rather buy gold when the price is declining than when it’s rising, unlike Western gold investors. This thesis is also supported by the fact SGE premiums often move inverted from the price of gold.
Now let’s zoom in on the former chart.
Though withdrawals are strong, in my opinion demand is somewhat held back by a rising price of gold in the past few weeks. How withdrawals/demand will develop around New Year is (of course) partially determined by the direction of the price of gold. If the price of gold continues to rise in renminbi I expect it will further dampen Chinese demand around New Year and Lunar Year.
Chinese Gold Trading Volumes
Worth mentioning is that SGE gold trading volume is going up exponentially since a couple of weeks. The biggest drivers are the Au(T+N1) and Au(T+N2) deferred contracts. On November 3, 2014, the SGE adjusted the specifications of these contracts – that hadn’t been traded at all since October 2013, after which volumes skyrocketed. In week 50 the volume of these contracts combined accounted for 95 tonnes, which is 20 % of the total SGE gold volume traded (474 tonnes).
Total gold volume traded on the SGE combined with the total gold volume traded on the Shanghai Futures Exchange (SHFE) accounted for 1,309 tonnes in week 50. This amount was more than half the gold volume traded on the COMEX in the same period (2,507 tonnes). I don’t see a trend of declining volumes on the COMEX, but I do see a trend of surging volumes in China, that are now starting to near COMEX volumes.
On December 9, 2014, Albert Cheng, Managing Director Far East of the World Gold Council, was interviewed by the China Gold Network. The interview was published in Chinese only.
The Gold Demand Trends published each quarter by the World Gold Council (WGC), show aggregated Chinese consumer demand Q1 – Q3 2014 was 638.4 tonnes. But, in the interview Cheng notes that the chairman of the Shanghai Gold Exchange (SGE), Xu Luode, has stated the SGE was supplied by 1,100 tonnes of gold import in the first eleven months of 2014 and this number may reach 1,250 tonnes by year end. Supplemented by 450 tonnes of domestic mine production this year “total demand should reach about 1700 tonnes”, said Cheng.
I have been long disputing Chinese gold demand numbers from the WGC, as total supply (Chinese net import, domestic mining and scrap) persistently has been transcending the WGC numbers. The WGC has never been able to elucidate the difference between massive supply and their demand numbers. The aggregated difference from 2007 until present is about 3,000 tonnes.
The total supply can be tracked on a weekly basis by SGE withdrawals, which have proven to be the best proxy. Though the import (and scrap) composition of SGE withdrawals can only be estimated until confirmed by the SGE or China Gold Association.
And so I was surprised Cheng openly (in Chinese) elaborated on the SGE model and instead of solely talking about how much gold was sold at retail level, also expanded on how much gold is actually added to Chinese (non-government) gold reserves, measuringimport and domestic mine production, that are prohibited from being exported from the mainland.
The next quote is translated by LK, gold investor from Hong Kong (who we all should be very thankful for his work!):
The China Gold Network: The recently published Q3 Gold Demand Trends report says that China’s gold demand is down year-on-year. How do you interpret this?
Albert Cheng: This year, the Q3 gold demand figure that we publish is down because last year’s gold demand was a special case. Given that last year compared to 2012 same time was up 40%, there really is nothing strange. However, if we compare this year’s Q3 figure to the average of the last 5 years at this time, we still find positive growth, and still up slightly compared to 2012.
Using the numbers supplied by Xu Luode, they in fact show that China imported about 1100 tonnes of gold in the first 11 months this year through the SGE, and may reach 1200 to 1300 tonnes by year end. Adding together domestic production, total demand should reach about 1700 tonnes. So, the energy of the China gold market hasn’t diminished; compared to last year, the development is still healthy.
For clarity: the translator is a native Chinese speaker and a financial expert. The translation has been confirmed by a second native Chinese speaker and financial expert, which severely limits the probability of the Chinese text being misinterpreted.
As my regular readers know I often make estimates of Chinese net import using SGE withdrawals as a proxy. Last week I estimated China in the first 11 months of 2014 imported 1,200 tonnes, we now know now I probably overestimated gold import by 9 % (1,200 tonnes vs 1,100 tonnes).
In hindsight it’s always more easy to analyze. I think what happened is that in mid 2014 (March and June) a part of the SGE withdrawals supply composition shifted from import to scrap. If scrap went up, import went down, as:
In the chart above we can see premiums going negative in March and June while withdrawals staying relatively strong. This means domestic supply (scrap) was increasing relative to import, hence the gold in China became cheaper than in London. The reason the discount isn’t immediately arbitraged is because gold in China is prohibited from being exported.
The dip in Chinese gold import was also reflected in export from Hong Kong to China mainland.
Because scrap apparently was more than I calculated in my model, I can now adjust the model. If from January until November import was 1,100 tonnes and mining was 413 tonnes, than scrap had to be 328 tonnes, as withdrawals were at least 1,841 tonnes in the mainland.
Additionally, elevated scrap means quite some Chinese have been selling physical gold that found its way to the SGE. Perhaps some were expecting the price to rise sooner. I don’t think elevated scrap signals leases were unwound; if a lease expires the lessee is most likely to buy gold on the SGE, it would not make sense for him to buy gold in the domestic market to bring to the SGE in order the repay the loan.
SGE withdrawals in week 49 have dropped by a whopping 28 % w/w, to 38 tonnes. Year to date withdrawals stand at 1,905 tonnes.
However, when corrected by SGEI trading volume withdrawals in week 49 could have been as low as 27 tonnes, which was not expected for the seasonally strong December month. Year to date withdrawals corrected for SGEI volume is 1867 tonnes.
Let’s wait what next week will bring to see if China will reach the 1,700 tonnes.
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 the largest physical gold market globally.
“This event is a major milestone in China’s opening of its financial market to foreign investors. The Shanghai International Gold Exchange will bolster China’s gold market toward greater trading volume and further highlight the price discovery function of the gold market”, Zhou Xiaochuan, governor of the People’s Bank Of China, at the opening ceremony of the Shanghai International Gold Exchange September 18, 2014.
The one with the biggest smile, just left of the center, is PBOC governor Zhou.
An Introduction To The Shanghai International Gold Exchange
On 18 September 2014 the Shanghai Gold Exchange (SGE) launched it’s subsidiary the Shanghai International Gold Exchange (SGEI) located in the Shanghai Free Trade Zone. In this post we will investigate how the new gold exchange operates and how can international investors can participate in the Chinese gold market.
I’ve written many posts on the structure of the Chinese domestic gold market, with the SGE at its core, and how gold trade between China mainland and foreign countries is regulated. Has all this suddenly changed now the Chinese gold market is fully opened to the rest of the world? No, the structure of the Chinese domestic gold market and Chinese gold trade policy has not been altered. The SGE and SGEI are technically separate exchanges. This is because a Free Trade Zone (FTZ) in terms of trade is a separate country (region) from China mainland. FTZ’s enjoy different trade rules; one can not freely import goods from a FTZ into the mainland. Hence, gold imported into a FTZ is not imported into China’s domestic gold market. However, with the SGEI there is a fashion conceived that links the Chinese domestic gold market with the international gold market.
The launch of the SGEI is a very important step in China’s process of liberalization, opening up, going out and internationalizing the renminbi to bolster economic strength and become a dominant player on the world stage of geo-politics. Developments in the Chinese economy are rapidly accelerating and in their gold market it’s no different.
Prior to the launch of the SGEI, which is also referred to as the International Board (IB), no less than 16 English rulebooks were released on the website of the SGE on September 16, 2014. Because the structure of the Main Board (MB) had already been documented in Chinese, I think these existing documents have been translated in English and supplemented by new rulebooks about the principles of the IB – and will additionally be supplemented if the IB or MB develop. This would explain the large amount of rulebooks. A welcome incidental of the SGE English rulebooks is that it provides nomenclature on everything related to the SGE and the SGEI, or the Exchange. In the past there has been much confusion on terms like physical delivery on the SGE in the gold space, these misconceptions will hopefully be a thing of the past. From now on I will use the exact same nomenclature used in the rulebooks of the Exchange with regard to the Chinese gold market.
In this post I will expand on the most important changes that took place on 18 September 2014, perhaps at first it may seem a bit confusing, in the end it will all make sense. Note, all my analyzes of the Exchange are by definition simplified.
New Physical Gold Products Offered To International Investors Through The IB
The International Board has launched three new physical products international customers (SGEI members) can buy and sell:
iAu100g physical product 100 gram gold bar fineness 999.9
iAu99.99 physical product 1 kg gold ingot fineness 999.9
iAu99.5 physical product 12.5 kg gold ingot fineness 995.0
According to the rulebooks of the Exchange gold bars weigh 0.05 kg, 0.1 kg and gold ingots 1 kg, 3 kg, 12.5 kg.
Before we can go into detail on physical products and how international investors can trade these, we must first learn a bit more about the trading structure on the Exchange.
When you become a customer of the Exchange you will receive a trading code that is connected to your identity (or company) until infinity, no matter if you switch broker twice a week this code will stick with you until death does you part (article 17). Subsequently, you will be attributed two accounts:
1) The first is your Bullion Account; each customer’s physical deliveries, load-in and load-out amounts shall be recorded in its Bullion Account. Note, physical deliveries are not withdrawals from the vaults. As we can read from Article 85 of the Spot Trading Rules of the Shanghai Gold Exchange:
The term “Physical Delivery” refers to the act of transferring the ownership of the precious metals traded by the Exchange for the performance of the terms of a trade.
By physical delivery the Exchange transfers precious metals from one Bullion Account to another.
Funds in a Margin Account are composed of Trading Margin and Clearing Deposit. The Trading Margin recorded in the Exchange’s system is the margin that is tied to current day’s trades and the Clearing Deposit is the sum of all other funds on the margin account that is not part of the Trading Margin.
The most basic way of trading bullion on the Exchange is through physical products (which do not enjoy any leverage or fractional backing). After submitting a buying order of the respective product a buyer wishes to purchase on the Exchange, that order has to be matched with a seller’s order before a deal can be executed. When a deal is closed physical products are settled the same day. The amount of yuan in full is transferred from the buyer’s Margin Account to the seller’s Margin Account and the corresponding amount of bullion is transferred from the seller’s Bullion Account to the buyer’s Bullion Account. The buyer is now the owner of physical gold (located in an SGE(I) Certified Vault) and is free to process the bullion to its discretion. From the Spot Trading Rules of the Shanghai Gold Exchange:
To trade in a physical product, a buyer must possess funds of an amount equaling the total transaction value of the product when placing the order; and a seller must have the corresponding full amount of physical bullions in its trading account when placing an order. After an order is placed, the funds or physical bullions covered by the order will be frozen immediately.
After an order on physical gold product is filled, the buyer may re-sell the purchased gold on or after the current trading day, or may request to withdraw the gold.
Any gold bullion withdrawn by a member or customer shall not be loaded into any Certified Vault in the future.
Gold Products Offered To International Investors By The MB
Next to the three new physical products offered by the International Board, the Main Board offers 8 of its existing products to international customers, divided in two types; 4 physical products and 4 deferred products.
Au100g physical product 100 gram gold bar fineness 999.9
Au99.99 physical product 1 kg gold ingot fineness 999.9
Au99.95 physical product 3 kg gold ingot fineness 999.5
Au99.5 physical product 12.5 kg gold ingot fineness 995.0
Au(T+D) deferred product 1 kg gold ingot fineness 999.5
Au(T+N1) deferred product 1 kg gold ingot fineness 999.5
Au(T+N2) deferred product 1 kg gold ingot fineness 999.5
mAu(T+D) deferred product 100 gram bar fineness 999.9
As mentioned before the IB and its vault are located in the Shanghai FTZ. From the SGE website we know the IB Certified Vault is owned by the Bank Of Communications. According to China’s state TV network CCTV this vault has a capacity of 1,000 tonnes.
These are the details of the vault as disclosed by the SGE:
Malca-Amit, a global gold vaulting and transportation company, opened a 2,000 tonnes gold vault, their biggest vault on the planet, in the Shanghai FTZ in November 2013.
It could very well be this vault will also become an IB Certified Vault. If not, it would still be able to store 2,000 tones of gold in the Shanghai FTZ in addition to the 1,000 tonnes Vault of the Bank Of Communications. These huge amounts of vaulting capacity signal the threat of the Chinese gold market to the London Bullion Market that historically has been the global center of precious metals trading, but saw a large share of its physical bullion transported to China in recent years.
The Workings Of The Shanghai International Gold Exchange
Now we have a little bit more background information it’s time to put the pieces of the puzzle together. This is how the Exchange operates since 18 September 2014:
(Domestic) SGE customers can trade 12 gold products: 9 domestic gold products offered by the MB: Au50g, Au100g, Au99.99, Au99.95, Au99.5, Au(T+D), mAu(T+D), Au(T+N1), Au(T+N2) – and 3 international gold products offered by the IB: iAu100g, iAu99.99, iAu99.5. Some of these domestic customers, the ones blessed with a PBOC import license, can buy international physical products and have the bullion withdrawn from an IB Certified Vault to import the gold into the mainland. Or, the gold is directly transferred (imported) from an IB Certified Vault to an MB Certified Vault. For domestic customers without a PBOC import license it’s prohibited to withdrawal gold purchased through IB physical products. Note, (domestic) SGE members/customers are allowed to use onshore renminbi to buy physical products on the IB.
(International) SGEI customers are allowed to trade 11 contracts: 8 domestic gold products offered by the MB: Au100g, Au99.99, Au99.95, Au99.5, Au(T+D), mAu(T+D), Au(T+N1), Au(T+N2) – and 3 international gold products offered by the IB: iAu100g, iAu99.99, iAu99.5. However, international customers can only deposit and withdrawal gold into and from IB Certified Vaults. Consequently, international banks or investors trading IB physical products can not export physical gold from the Chinese domestic gold market. When international customers withdrawal gold from the IB Certified Vault they are only allowed to store the gold elsewhere in the Shanghai FTZ or export the gold abroad, they are not allowed to export the gold into the mainland.
The next quote is from an announcement published on the Chinese SGE website on September 16, one of my dear friends in the mainland was so kind to translate it:
No 3. The products that international members and international customers can trade include 3 International Board products and 8 Main Board products (Au99.99, Au99.95, Au100g, Au99.5, Au(T+D), mAu(T+D), Au(T+N1), Au(T+N2). However, they can only deposit and withdraw on the international products.
No 4. Domestic members and domestic customers can participate in trading all the International Board products, but can’t deposit and withdraw on the International Board products (the members with import and export qualifications excluded).
A Domestic Member or Domestic Customer may deposit physical bullions deliverable on the Main Board into a Main Board Certified Vault (“MB Certified Vault” for short); the member or customer is not permitted to deposit physical bullions deliverable on the International Board into any MB Certified Vault, nor may the member or customer deposit any physical bullions into any International Board Certified Vault (“IB Certified Vault” for short).
An International Member or International Customer who has obtained an approval from the Exchange may deposit physical bullions deliverable on the International Board into an IB Certified Vault. Furthermore, an International Member or International Customer who has obtained an approval may deposit, within its permitted quota, physical bullions deliverable on the Main Board into an IB Certified Vault. An International Member or International Customer is not permitted to deposit bullions into an MB Certified Vault.
Each Domestic Member and Domestic Customer may withdraw physical bullions deliverable on the Main Board from an MB Certified Vault, but is not permitted to withdraw physical bullions deliverable on the International Board from an MB Certified Vault. Except for those members and customers qualified to import and export gold, no Domestic Member or Domestic Customer is permitted to withdraw bullions from an IB Certified Vault. Any Domestic Member or Domestic Customer that has gold import and export qualifications may withdraw physical bullions deliverable on the International Board from an IB Certified Vault.
To deposit bullions into Transaction Vaults, an International Member or International Customer must apply to the Exchange for Good Delivery accreditation. An accredited International Member or International Customer may then deposit physical bullions deliverable on the International Board into an IB Certified Vault. Furthermore, an International Member or International Customer whose application is approved may, within the permitted quota, deposit physical bullions deliverable on the Main Board into an IB Certified Vault.
Any approved International Member or International Customer that sells physical bullions deliverable on the Main Board must engage a member which has the gold import/export qualification to carry out the import procedures on its behalf, and pay import agent fees for the fulfillment of such import procedures. The Exchange will issue a separate notice providing for the rate schedule and terms of payment of such fees.
Domestic members can trade on the IB. Where physical bullions are delivered and transported into the customs and deposited into a Main Board Certified Vault, the Exchange will further issue a SGE Execution Statement to the Domestic Member or the customer qualified to import gold for customs declaration purposes.
It can be more Chinese gold imports henceforth will enter through the newly launched SGEI, as more sellers of gold would like RMB in exchange – if the sellers prefer to receive USD the gold can still flow though the FTZ. The role of Hong Kong as the main conduit to China can be diminished by the latest developments.
In the financial section of the biggest newspaper in The Netherlands, De Telegraaf, an article was published on March 22 about a growing Dutch population investing in physical gold; a young generation is becoming more aware of finance and is acting accordingly. This generation no longer chooses to save in saving accounts, but prefers to buy physical gold. “They see their parents don’t receive their promised pension and they expect themselves to get even less. They spent each month, for example, €200 or €300 euros on physical gold.”
More and more young people are buying gold coins and bars to ensure their retirement. According to a Dutch gold dealer: “The number of these customers has tripled in 2013.”
According to Marleen Evertsz of GoldRepublic, an online trading platform for physical gold, the young gold investors have little to none confidence in traditional pension funds. They prefer something tangible. “It’s the new generation that can’t get a mortgage but do have a student loan. They see their parents don’t receive their promised pension and they expect themselves to get even less. They spent each month, for example, €200 or €300 euros on physical gold.”
I notice the same developments in my surroundings (I’m young and Dutch). It’s the generation who reads news from the internet instead of the mainstream media, vividly spreading awareness about economics, that is changing its views about prudent saving from pension funds to hard assets such as physical gold and silver.
“These are often young entrepreneurs who can just afford to invest a little in gold”, says Jaap Raijmans, gold dealer at Goudstandaard, of this growing group. “Saving like their parents did hasn’t been smart for years. They prefer to put some physical gold in the vault.”
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