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!
I was interviewed by Lars Schall on behalf of Matterhorn Asset Management, 4 November 2015. Please listen to the podcast below, or you can read the transcript provided with links for further reference. Wa talked about PBOC gold purchases, the London Bullion Market, The Shanghai Gold Exchange, the Silk Road Economic Project and much more!
China is playing the gold game very carefully
Lars: My first question would be, during this year, the Chinese Central Bank announced its new gold position. How much does China possess now and do you think those numbers are accurate?
KJ: Well, they state they have about 1,700 tons right now. I do not think those numbers are accurate. I think the numbers they disclose now every month since June, they are increasing their reserves a little bit, just like Russia does, and I think this is a strategy maybe communicated between Russia and China even to slowly push for a new monetary system, international monetary system. So, if they would’ve disclosed they have 3,000 tons or 4,000, whatever they have or see fit to disclose, they would really rock the boat in the international sphere. So, they are very careful in playing this game and they also want to be included into the SDR to internationalize the Renminbi. That is of great importance for them, so they are finding ways to internationalize and the Renminbi being included into the SDR is one of them, to be a reserve currency, and so they don’t want to make too many enemies. So, they’re playing it really careful. They stated in, I believe it was June or July, they increased official gold reserves by 600 tons from 1,054 to about 1,700 and they’re increasing reserves now by, you know, 15 tons a month more or less. I think it’s a strategy to slowly push for a new international monetary system in which the Renminbi will have a much greater role. So, I don’t believe the 1,700 number. I think they have a little bit more, between 2,000 or 4,000 tons. I did a study once about this but it’s kind of difficult because it’s really one of the best kept secrets on earth, but my study indicated that they do buy about 500 tons a year. There was a small segment in the paper from Deutsche Bank that said the PBOC is buying 500 tons a year. I stumbled upon a study from a guy from the China Gold Association who had written a report in 2011 and he advised the People’s Bank of China to increase its official gold reserves by 500 tons a year, so that would be about 3,500, 4,000 tons right now. Of course, this gentleman from the China Gold Association is not a policymaker but I collected a lot of hints from various places that the People’s Bank of China is buying about 500 tons a year. Now, we can’t prove it but it sure suggests they have more than 1,700 tons and then indirectly it suggests that the 1,700 tons they state they have is just strategy.
Lars: Yeah, but the Chinese can buy gold covertly? I mean, your company, for example, has done a study that a huge amount of gold went off the radar in London. How can that be?
KJ: Yes, that’s correct. That started with an investigation from Ronan Manly from BullionStar and Nick Laird from Sharelynx, and Bron Sucheki and I also helped a little bit. In the first instance, it was a study about the London bullion market and how much gold was left in London. Now, they found that in 2011, there were 9,000 tons in London in the LBMA system, let’s say, within the London Ring way so that includes LBMA vaults, it includes the vault of the Bank of England, foreign central bank it’s called, and then in 2015, that number dropped from 9,000 to 6,250. So, it means that 2,750 tons were removed or had left London since 2011. Now, official foreign trade statistics indicate that the UK over this period only net exported about 1,000 tons, so that means that 1,750 tons is missing from London, let’s say. So, that can be possible because what we see in international merchandise trade statistics, I should say that’s the official name for goods and services crossing the border, only non-monetary gold is disclosed. So, what I do and a few colleagues of mine is we track all merchandise trade statistics from the UK, Switzerland, Hong Kong, all the gold trading hubs, also some mining nations such as Russia or nations in Africa. But all of those numbers only include non-monetary gold because the rules are that non-monetary gold must be disclosed in these reports but monetary gold is exempt from being disclosed in foreign trade statistics. So, in this way, for example, the People’s Bank of China can buy gold in London, non-monetary gold from whatever seller and they can monetize it in London and then covertly ship it home without it having to be declared at the customs department. They can do this all around the world. They can do it in Africa, they can do it in Switzerland, and they can do it in Hong Kong. Just to illustrate, Hong Kong net imported 600 tons of gold in 2013. That’s a lot of gold but I think it’s possible that the People’s Bank of China bought a part of that gold in Hong Kong once it was imported as non-monetary gold in Hong Kong. Probably a part of it was monetized in Hong Kong and then shipped to the mainland for the official gold reserves of the People’s Bank of China.
Lars: Yes, but when it comes to gold buying as a covert operation, so to say, does the PBOC buy gold directly or is this buying through proxies?
KJ: I think they buy through proxies because what they buy is kind of a good kept secret, and they are very secretive about it. So, to avoid any risk of leaking, I think they buy through proxies. In any case, they buy through SAFE and maybe through CIC which are sovereign wealth funds, but even maybe through Chinese commercial banks, I don’t know, but I assume they buy through other proxies.
Lars: And does this buying take place via the Shanghai Gold Exchange?
KJ: No. This is the whole thing. This is what I like to talk about because a lot of analysts look at China and they count how much China is mining every year and they count how much non-monetary gold imports into China is every year. China doesn’t disclose how much they import in non-monetary gold but from looking at other nations, for example, Hong Kong and Switzerland and the UK, we know how much they export to China so we can more or less figure out what they import. But that is all non-monetary gold and all the non-monetary gold which is imported into China is required to be sold through the Shanghai Gold Exchange. So, the question then is, does the People’s Bank of China buy gold through the Shanghai Gold Exchange. Now, I don’t think they do. There are a number of reasons. One reason, for example, is that I think the People’s Bank of China likes to buy London Good Delivery Bars, which are 400 ounce or 12.5kg in the metric system, because the gold in those bars is cheaper. If you buy a ton of gold in coins, it’s more expensive than in London Good Delivery Bars. So, I think they buy London Good Delivery Bars but these bars are not being sold through the Shanghai Gold Exchange. They can be sold but if I look at all the trade data from the Shanghai Gold Exchange, only I think, if I recall correctly, three tons have been sold in London Good Delivery Bars in 12.5kg bars through the Shanghai Gold Exchange in recent years. So, that will mean that either the People’s Bank of China is not buying London Good Delivery Bars or they are not buying through the Shanghai Gold Exchange. For example, all gold on the Shanghai Gold Exchange is denominated in Renminbi and I think the People’s Bank of China wants to diversify its foreign exchange reserves, which are predominantly in US dollars for gold. So, they want to sell their US dollars and buy gold. That is not done through the Shanghai Gold Exchange. So, I made a whole list, I wrote an article about this once, about all the reasons why the People’s Bank of China may or may not buy gold through the Shanghai Gold Exchange and it’s kind of obvious they would not buy gold through the Shanghai Gold Exchange, also because it would be done in clear sight. If they buy a few tons every week in the Shanghai Gold Exchange, everybody would see it, you know, and again, they would then buy all these 1kg bars. So, I think given the fact they are so secretive about it and all the reasons I think they will never buy gold through the Shanghai Gold Exchange. I do think they are able to intervene in the Chinese domestic gold market but as a main hypothesis, I’d say the People’s Bank of China would not buy gold through the Shanghai Gold Exchange and from there, I try to analyze.
Lars: Okay, but where do the Chinese try to sell their dollars and get gold in return?
KJ: Well, London is an example. Most gold across the world is paid for in US dollars so they can buy it anywhere. Also, Singapore, Hong Kong, Australia, maybe they have some deals with mining companies in Africa or Australia that they covertly ship some to China mainland but it’s not difficult of course to sell your dollars and buy gold in the international market.
Lars: Yeah, and talking about gold mining projects, well the ‘One road, One belt’ project in Eurasia driven by the Chinese is connected already to gold. Can you talk a little bit about how this is connected to gold?
KJ: On the Eurasian continent, there are a lot of clubs cooperating at the moment and that is kind of interesting. Maybe the biggest club is the ‘Silk Road Economic Project’ also called the ‘One Belt, One Road’ project initiated by the Chinese President – I believe it was in 2012 but in the last year, it gathered steam. There are about 60 countries along this Silk Road and his intention is to have more cooperation on the political and economic fields now. The Silk Road is a big project and there’s also a Silk Road fund but underneath this Silk Road project, we have the Asian Infrastructure Investment Bank which has 57 founding members among which a lot of western countries, a lot of European countries. There is also the Eurasian Economic Union which consists of Russia, Belarus, and Kazakhstan. That is not officially a part of the Silk Road project yet but these are clubs that are all gaining ground on the Eurasian continent. You then have the Shanghai Cooperation Organisation and all these clubs are also starting to cooperate a little bit. There’s also President Putin who said already that his Eurasian Economic Union will cooperate with the Silk Road Economic Project so that is one. And now this year, the Chinese have disclosed that there also will be a Silk Road Gold Fund which is led by the SGE and is meant for more cooperation on the Eurasian continent obviously in mining exploration, gold trading, and things like that. So, that is a really significant development and the SGE also said that it will facilitate gold buying for foreign central banks. So, I can imagine countries like Kazakhstan, for example, buying gold through the Shanghai Gold Exchange, Shanghai International Gold Exchange, I should say, in the future. So, this is the intention of the Silk Road Gold Fund. We also saw some little signs of cooperation earlier this year. Russia’s biggest mining company, Polyus Group, started a cooperation with China’s biggest mining company, China National Gold Group. I just wrote an article about this, Polyus sells most of its gold so it outputs through VTB Bank which is a Russian bank and VTB Bank also became a member of the Shanghai Gold Exchange last week. So, likely more gold from Polyus will be sold through VTB Bank on the Shanghai Gold Exchange. The volume of the Shanghai International Gold Exchange is still very low and the Shanghai International Gold Exchange is really meant for the world to sell its gold in Renminbi to other countries. The volume is very low at the moment so we can say it has failed up until now but who knows what the future will hold.
Lars: Isn’t it interesting, you’ve mentioned the Shanghai Cooperation Organisation which was launched in the summer of 2001 that many of the members are buying gold actively, that many of the countries that are intended to be members of the SCO one day that they are also buying gold, for example, Turkey, and that many of those countries, they have the majority of all the gold that is in the ground, in the soil still to produce?
KJ: Yes, I should write a new article about this because I think the system is exactly the same now or being launched now in India. The Indian Central Bank also has said that the Indian commercial banks can use the gold in deposit from the citizens as a reserve requirement. So, I don’t know if they’re going to count that gold also as official gold reserves but it’s very worth watching. So, the next question was about the Shanghai Cooperation Organisation, yeah. Of course, those nations are buying gold and I see a lot of gold in the wider Silk Road region. If we look at Asia and Europe, for example, a lot of countries in Asia are buying gold and then we have, for example, in India, the people are buying a lot of gold, about 900-1,000 tons a year. In other Asian countries, the central banks are buying gold which is very significant because that is like, you know, we are diversifying away from the US dollar. I don’t need to tell our listeners this; a lot of buying is happening on the Asian continent. On the European continent, these central banks already have a lot of gold but what they’re doing is they’re repatriating their gold from the UK, from the Bank of England, and from the Federal Reserve Bank of New York in the US. So, I think both continents, Europe and Asia are focused on gold and slowly moving away from the US dollar, albeit that the Europeans are not yet buying. They’re repatriating because they have already significant amounts of gold. The Asians are buying.
Lars: Recently, Peter Mooslechner, an official of the Central Bank of Austria said that the Asians are more active in the gold market now and that they use their gold to influence the price or actually he said to intervene in the market. Do you have something to say on those statements that he made?
KJ: Yeah. Well, actually I found his interview very interesting. I don’t really know what he meant by intervening because he also said that, you know, we gold analysts immediately think about gold price manipulation. I don’t know if all those countries he mentioned are manipulating gold price because he also mentioned the euro system and the ECB are intervening into the gold markets, just like the Asian countries. I’m not sure what he meant by that.
Lars: Yes, but you know that I’ve asked him some specific questions.
KJ: Yes, I know.
Lars: It’s their policy not to provide answers to any questions that relate to their strategy with gold or other central banks strategy with gold.
KJ: Yes, of course, if you ask a central banker about gold, he will never answer you. I’ve found that all across the world which is a signal in itself we can think, but I didn’t really focus on the comments of Mooslechner on the intervening parts which he said. I found more interesting what he said about repatriating gold and about Europe maybe even buying gold if the Chinese economy is going down. The world is entering a recession again. I found that very interesting and also because at one point he said that European countries, more and more European countries are repatriating because of economic nationalism which is a contradiction to what he said a minute before and that was that the Austrian Central Bank was repatriating because of a concentration risk at the Bank of England. So, clearly this contradiction indicates that he is not repatriating because of a concentration risk at the Bank of England but because of other reasons. Now, also this year, the General Court of Auditors in Austria, they released a report in which they disclosed that the Austrian auditors were not allowed to audit their gold in England in the past years in between 2009 and 2013. That is of course one of the real reasons why Austria is repatriating is because the gold is not safe at the Bank of England or, you know, for other countries like the Netherlands. The gold is not safe in New York. That’s why they are repatriating and so that was my takeaway from the interview with Mooslechner.
Lars: Yes, and is it your perception related to the German case that the Bundesbank is following a policy of economic nationalism. Don’t you think that it is very reluctant and that it does what it does only because there was public pressure?
KJ: That’s a good question. Of course, it also has to do with public pressure but I don’t think the Bundesbank is only repatriating because of public pressure. I think they do it because of their own interests, bearing in mind, I believe it was in 2001, the Bundesbank repatriated about 1,000 tons from the Bank of England in secret. Nobody knew about it so there was no public pressure at the time and they repatriated the gold even still from the Bank of England. The same goes for the Netherlands. They repatriated. The Dutch Central Bank repatriated not really because of public pressure. I mean, there was some, you know, I submitted a freedom of information act (FOIA) request once and there were some talks in politics. Of course, that happened after the economic crisis, you know, chatter about gold was started but I don’t think it was public pressure in the Netherlands or in Germany that led them to repatriate the gold. I think it’s their own interest. The second question of course is, so why do they take so long and why don’t they repatriate all the gold. Now, just like I said previously about Asia, I think they do this so slowly because it’s such a sensitive subject. Maybe the gold indeed is not all there anymore so that’s why they have to do it very gently. We can also imagine that if, for example, the Netherlands, Austria and Germany were to repatriate all their gold all at once then it would of course lead to instant shock in financial systems. So, I think it’s on purpose that they do it slowly but it’s speculation.
Lars: However, the Germans intend to leave roughly half of their gold position in New York and London, and they are saying, this is now the official position of the Bundesbank that they want to leave it there so they are able to react to a currency crisis if it appears or a curse. Do you have to have the gold in London and in New York for such a purpose?
KJ: I would say no. I mean, if there would be a currency crisis, people would rush to gold and your gold would become more valuable and you would like to have it at home, not in England or New York. Only if there was a crisis and you want to sell gold, you would like to have gold in London, but how I look at it, I think it’s better with economic turmoil up ahead to have your gold at home than in England.
Lars: Yes, and the IMF says that gold, monetary gold, physical bullion gold is the only financial asset with no counterpart risk.
Lars: Yes, but in order to be such a financial asset, you really have it in your own possession, on your own soil, right?
KJ: Right, right. Oh, sorry, you were referring to the previous question. – You’re absolutely right. If you talk about gold and gold is the only asset with no counterparty risk, you’d need it at home and of course it does have a counterparty risk if it’s in London or in New York. It’s as simple as that. Yeah, you’re right.
Lars: Now, another question would be that China is a big producer of gold but the production doesn’t leave the country. Where does it go to?
KJ: I think to the private sector in China. Before 2002 when the Shanghai Gold Exchange was launched, the People’s Bank of China had the monopoly in the Chinese domestic gold market. So, all the domestic mining output was sold to the People’s Bank of China and then it was distributed to a few designated jewelry shops or to maybe the coffers of the PBOC. So, before 2002, all the gold that was mined in China flowed through the People’s Bank of China but since the Shanghai Gold Exchange was launched in 2002, most of the gold, I would say 99% of the gold mined in China is being sold through the Shanghai Gold Exchange, and then what I just spoke about in one of my previous answers is that I think the private sector are the buyers on the Shanghai Gold Exchange in China. So, it does not really go to the People’s Bank of China, maybe still a little bit is going to the People’s Bank of China because maybe they still have some covert mines operating in China but actually most of the conventional output is being sold through the Shanghai Gold Exchange.
Lars: Koos, thank you very much for this interesting conversation.
I couldn’t resist translating this must read from 1993 in Dutch newspaper NRC Handelsblad (h/t @frankknopers) about the gold sales by the Dutch central Bank (DNB). Presumably, “a part” of the 400 tonnes sold at the time through the Bank For International Settlements went to the Chinese central bank. Although we don’t know for sure what the Chinese central bank did with the gold – at the time the People’s Bank Of China was the primary dealer in the Chinese domestic gold market and in theory could have sold the gold to Chinese jewelry fabricators – we may assume it was kept for its official reserves.
The other week I published an article about the Chinese Gold Army that was established in 1979 to develop domestic gold mining and exploration. This signifies the People’s Bank Of China (PBOC) was laying the foundation for the Chinese gold market in the seventies. Later on, in 2002 the PBOC started to liberalize the gold market by launching the Shanghai Gold Exchange that took over gold allocation and the pricing mechanism from the central bank. Many of us thought that the PBOC only became active in the international OTC gold market to diversify its lopsided US dollar reserves after, say, 2009. But we were wrong, the PBOC was buying gold in London as early as 1992. No, we don’t know exactly how much or what they did with the gold, though for sure the PBOC has been designing its gold strategy decades ago along side its opening up policy.
Remarkably, the article from NRC noted that the Dutch central bank sold gold “to equalize its holdings relative to other important gold holding nations” and “it’s known China is working to increase its gold reserves to bring it more in line relative to its GDP”. One of the theories about our current international monetary system – that was detached from gold in 1971 – is that it can only shift to a new gold anchored system when the power blocks have equalized the chips (Jim Rickards). In other words, if the US, Europe, Russia and China all have an equal ratio of official gold reserves to their GDP, the international monetary system could make a transition towards gold.
Within the aforementioned theory China should have about 6,000 tonnes to come to the gold/GDP ratio the EU and Russia have (the US has a little less gold proportionally). Although it’s impossible to know how much the PBOC really holds, it’s certainly more than what they disclose at the moment, which is 1,743 tonnes. In a forthcoming post we will discuss the most recent ins and outs regarding PBOC official gold reserves. For now, enjoy the full article.
Note, at the time the article was published DNB held 1,090 tonnes of gold.
Last summer the President of the Dutch Central Bank, W. Duisenberg, persuaded the Minister Of Finance, W. Kok, of the need to sell a quarter of the Dutch gold reserves: “The time is right”. Part of the Dutch gold was probably sold at the end of last year to the People’s Republic Of China. The multi billion operation that has taking place in utmost secret is producing the state an annual 400 million guilders in extra benefits since 1994. “Part of the sale was handled outside the market.”
van Ewijk and L.J.R. Scholten: The profitability of De Nederlandsche Bank, in: ESB 1-7-1992. In ESB 19-8-1992 there was a sequel and in ESB 20-1-1993 both authors went on about the gold sales.
March 27, 1993
No. The gold of De Nederlandsche Bank [DNB] was not secretly loaded into a Chinese cargo plane at Schiphol and flown to Beijing. The gold of the Dutch Central Bank remained where it was, in the vaults of the Bank of England where it has been for years. Only the signs with the name of the owner of the gold bars were changed. A new name: for traders in the international gold market there is no doubt that the People’s Bank Of China (PBOC) has bought a part of the 400 tonnes of gold, a quarter of the Dutch gold reserves, which DNB has sold late last year in utmost secrecy.
“With 99 percent certainty we know that the People’s Bank of China has been one of the buyers of the Dutch gold”, said Philip Klapwijk from Goldfields Mining Services, an institute in London affiliated with the South African gold mines that specializes in research into the gold market. Also other London bullion dealers have a strong suspicion that China was involved in the gold sales of DNB. “We have noted that the Chinese central bank has bought gold in recent months”, said John Coley of the London bullion dealer Sharp Pixley and spokesman of the London Bullion Market Association.
At the Ministry of Finance in The Hague and at DNB in Amsterdam they know the story of the Chinese connection, but they remain tight lipped. “Everything is sold locally in London”, said the spokesman of DNB, JH du Marchie Sarvaas. The central bank is silent on the question of who was engaged in the sale and who the buyers were. “It is not in our interest to make announcements about it”, he said. Servaas will only tell us that the transactions have been set up in different ways and that DNB has not entered the market directly itself.
The spokesman of the Ministry of Finance, Dr. RP Florisson, stated not to know where the gold that was sold has gone. Some things, he added, you would rather not know. Members Of The House have neither any idea in what way the gold was sold. With the letter from 12 January by Kok that notified the Members Of the House about the gold sale came an attachment, though in it the ‘technical details’ from the original correspondence between Duisenberg and Kok were omitted. This was a crucial passage, which disclosed the name of the mediator in the gold sales, the Bank for International Settlements, the central bank of central banks.
Perhaps the phrase “silence is golden” finds its origin in the world of central banks. Like is the case in Operation Gold. In April 1992 DNB developed the intention to sell part of its gold stock and add the proceeds to its foreign exchange reserves. The Board Of Governors of the central bank, consisting of President Dr. WF Duisenberg and three other Directors, approved the plan. Only a few other employees were notified. In June Duisenberg shared his plan with Kok during one of their weekly lunch meetings. Kok hesitated at first because he feared he would be remembered as The Seller of the national gold.
Duisenberg explained that it was the sound fiscal policies from Kok and the strong position of the guilder that made the gold sales possible. Kok was persuaded. At the Ministry Of Finance the Deputy Comptroller General and the Director were informed. On 29 September Duisenberg sent a letter to Kok in which he explained that the sale was intended ”to equalize our gold holdings relative to other important gold holding nations”. The sale should not lead to loss of confidence in the guilder, not serve to fill the state coffers and not lead to disruption of the gold market. “Therefore, a high degree of secrecy is warranted”, Duisenberg wrote. If unexpected complications would arise DNB would waive the operation.
Kok agreed on 2 October and in the fall several sales transaction followed in the London forwards market. In addition, the Bank has for International Settlements (BIS) was involved as an intermediary. The BIS, which is based in Basel and was established in 1930 to administer the German reparations, is as closed as the Swiss banking secrecy. Who calls the BIS can enjoy the long version of Eine kleine Nachtmusik as on-hold music, to finally be told the BIS never releases any information.
Duisenberg expanded on the gold sales at a meeting of the BIS on 12 January 1993. The sale had already taken place, only the gold had yet to be delivered. Not all members of the BIS welcomed the Dutch move, nor were they consulted for its decision. That same day DNB published the news. A team from a TV news network was – under the pledge of secrecy –flown to Basel for an interview with Duisenberg. “The time is right” for the sale of part of the Dutch gold reserves, the President said.
The news dropped like a bomb. Rumors were circulating in the gold market late last year about possible Dutch gold sales, based on these rumors a reporter from news agency Reuters asked DNB for a response in November. It replied no announcements were ever made on market transactions. Gold traders were particularly surprised by the volume of sales: “It was very well done. I never knew that the market could absorb such an amount in such a short time without drastic price distortions”, said one gold dealer.
It was a huge deal. Four hundred tonnes is nearly a quarter of the total annual gold mine production. It is the equivalent to 32,000 gold bars of 12.5 Kg [400-ounce] and 26 centimeters in length, which placed end to end form of line of 8.32 kilometers. That is almost as long as the symbol of our national pride, the Oosterscheldedam.
With the sale DNB earned 7.5 billion guilders in US dollars, D-marks and Japanese yen that have been added to the foreign exchange reserves of the central bank. As these foreign exchange earn interest – unlike gold – the profit starting from 1994 is an annual 400 million guilders which will flow to the state coffers. Recent pleas from Members Of The House to invest this money in infrastructure have been rejected by Kok, who agreed with DNB that this amount, like other profits of the central bank, flow to the Treasury.
Seldom a critical note is written about the policy of DNB. Coincidentally, last year, while Duisenberg was preparing the gold sales in secret, a remarkable article in the journal for economists, ESB, was published. Casper van Ewijk and Bert Scholten, both working at the economics department of the University of Amsterdam, questioned the profitability of DNB. They concluded that the central bank, with its relatively large reserves of gold and foreign exchange, yields an extremely poor result on its investments. With that, the annual profit payment to the Treasury is a lot lower than possible.
In a second article – after the gold sale – the two economists claimed that DNB had sold too little gold and had waited too long with the sale. Now the gold was sold for an average of 18,800 guilders per kilo, while ten years before it could have been twice that amount. In those ten years, the gold yielded not one cent and its value only declined. The addition of the gold to the foreign exchange reserves was in their opinion, “unnecessary and therefore undesirable”, as the Netherlands has more than enough foreign exchange reserves. And the revenue of the sale, according to Van Ewijk and Scholten, could be better used to reduce the national debt. That gives the government more financial benefit than an annual interest income.
The defense of DNB – as expressed in replies from the Minister Of Finance to questions by the parliament – is that a central bank is not a hedge fund. The gold and foreign exchange reserves are not intended to maximize returns but to conduct a proper exchange rate policy and to ensure confidence in the guilder. As a result, it is also necessary to hold currency that offers a low rate of return. The gold is not held for speculation, but is a cornerstone of the monetary policy of the Netherlands as a major gold holding nation. When deciding on the time at which it sold some of the gold, the gold price did not play any role whatsoever.
The suggestion to use the principal proceeds to flow to the treasury could no find grace: the change in the composition of reserves (gold was converted into US dollars, D-marks and yen) is not a reason to pour assets of the central bank into the hole of the national deficit. If DNB would give in to this temptation that would be a monetary sin: financing the government deficit by the central bank. That happens in South America, or in Italy, but not in countries that appreciate a hard currency.
Gold plays a vital role in finance since trade emerged. Late last century all European countries and the United States went on the classical gold standard. The direct link between the amount of money in circulation to gold reserves at central banks broke the economies of the industrialized countries in the economic depression of the thirties. The Netherlands held on to gold until 1936 as one of the last countries together with Switzerland and France.
After the Second World War the US dollar ruled. Under the Bretton Woods system, which was set up in 1944 under US-British leadership, all currencies were pegged to the US dollar. This provided stability and dynamics because the Americans constantly pumped new dollars into the world economy. The Bretton Woods system created unprecedented economic growth for a quarter of a century. The gold did not disappear completely. To increase the credibility of the system, the United States declared their readiness to ensure the conversion of dollars into gold at a fixed price of 35 dollars per troy ounce (31.1 grams). The Americans could easily make that offer, because in 1944 they were in possession of three quarters of all the gold reserves in the world.
The Dutch government in exile had largely spent its gold reserves during the war. During the reconstruction foreign exchange reserves piled up in the fifties and sixties and DNB happily took advantage of the opportunity to convert dollars that were earned through exports, for gold in the US. Together with France The Netherlands was in those years the largest gold accumulator. French President General Charles de Gaulle said, in a famous news conference on 4 February 1965, about the US dollar hegemony and gold, “Ah! Gold its nature never changes, not in any form, bars or coins. It has no nationality, it is held eternal and universal as the unchangeable and trustworthy value par excellence”. Also in The Netherlands gold was held as an article of faith.
During the sixties the US gold reserves in Fort Knox severely declined. Eventually, President Nixon decided in 1971 to temporarily suspend the convertibility of dollars into gold. The ‘gold window’ was closed; the world had spent well over twenty five years to tap into the US gold reserves.
Since 1971 the gold reserves of DNB hardly changed. The spectacular rise in gold price to $850 dollars per troy ounce in early 1980 led to a great gain in the books but that was all. However, politicians in the seventies had their greedy eyes on the gold stocks to use these for employment projects and other fun things for the people to finance. President of DNB at the time, Dr. Jelle Zijlstra, abhorred such ideas. Not a single gram of gold was sold from the vaults of DNB.
Zijlstra and his successor Duisenberg feared gold sales would affect the position of the guilder. Moreover, the government deficit was so huge in the eighties that sales would be interpreted by financial markets as weakness. Gold supported confidence in the guilder and provided an aura of invulnerability.
During 1991 the gold inventories were casually mentioned in a conversation between senior officials of the Ministry Of Finance and DNB during the preparations for the Economic and Monetary Union (EMU) – the plan for a European central bank and a common currency, which was clinched in the Maastricht Treaty. It was clear that the size of the Dutch gold stock was well above average in the EC. This would be disadvantageous if in a few years DNB must transfer part of its reserves to the European Central Bank (ECB).
As a rich gold country the Netherlands is at a disadvantage, because it participates for a relatively small amount in the ECB. The Netherlands threatens to get stuck in the monetary union with a huge amount of gold – that doesn’t yield – because according to ECB rules participating central banks may only purchase or sell gold and foreign exchange reserves with approval by the ECB. After ratification of the Maastricht Treaty, the freedom of DNB would be very limited. “The Netherlands has no interest in a large amount of gold”, said a source familiar with the matter.
The Netherlands receives a 4.7 percent share in the ECB based on the size of the Dutch population and the national economy. That’s less than the Dutch share of 7.3 percent in total international reserves (gold and foreign exchange) of all central banks in the EC and much less than the share of 11.7 percent in gold reserves. Even after the sale of 400 tonnes the Netherlands retains a stake in the EC gold reserves of 9.4 percent. DNB is expected to sell another 685 tonnes of gold to bring their gold share in line with that of the ECB. To reassure the gold market DNB states it will not sell any more gold, though financial experts expect that the gold reserves by EC central banks, including DNB, will be further adapted within the framework of the monetary union. “Last year the Belgian and Dutch central banks sold gold. That made gold sales by central banks respectable. Additional sales threaten the market”, said a London bullion dealer.
In the beginning of 1992, still in the fuddle of Maastricht and nine years after the traumatic devaluation of the guilder in 1983, the position of the guilder was very strong and the Dutch budget deficit was considerably reduced. In The Hague no one advocated to do any more fun things with the Dutch gold stocks. The time was right to proceed to sale.
It was not possible that DNB would enter the gold market itself, because that would be known immediately in the closed world of gold trading. The few remaining Dutch players in the gold market are tiny. In London, there are four major gold traders, Sharps Pixley, Samuel Montague, Mase Westpac and Rothschild. According to John Coley, spokesman of the London Bullion Market Association, it was obvious that DNB would use the BIS as an intermediary. Duisenberg is very well known in Basel because he was President Of The Board of the BIS from 1988 to 1990.
The advantage of the BIS is, as “central bank of central banks”, that it guarantees anonymity and direct access to the central banks of the member countries in Eastern and Western Europe as well as Australia, Canada, Japan and South Africa. A London trader suggested that DNB used the central bank of another member state of the BIS to bring the gold to the market. That could have been the central bank of South Africa, whose gold offers would not surprise any traders. South Africa is always very active in the London bullion market. The BIS could have acted as an intermediary between DNB and the South African central bank.
“Part of the sale was handled outside the market”, says Philip Klapwijk of Goldfield Mining Services. He says he came to this conclusion because the price of gold last year, although down slightly, it should have shown much greater fluctuations if 400 tonnes would have been sold – even if the supply would be split into small tranches.
The BIS probably made contact with the People’s Bank of China as the buyer. Why precisely the People’s Republic of China? Chinese love gold, says an expert, and he refers to the huge Taiwanese gold purchases in 1987. Second, China has large dollar surpluses as a result of the spectacular economic growth. And third, China announced that it is working to build up its reserves in order to bring it more in line with the size of the Chinese GDP.
The weekly table of DNB, which is published every Wednesday in the newspaper, we can see since February a decline in Dutch gold reserves. Presumably, the increase in the gold reserves of China will never be visible. The statistics produced by the International Monetary Fund for China record the same amount of gold for a decade, coincidentally about 400 tonnes. China experts, however, know that the People’s Bank has second secret gold reserves, which are held outside the statistics in “non-monetary gold”. If part of the gold reserves of DNB have been added to these, as many suspect, no one will ever officially know.
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.
Withdrawals from the vaults of the largest physical gold bourse globally, the Shanghai Gold Exchange (SGE), accounted for 54 tonnes (in week 45 / 16 until 20 November), up 10 % from last week. Year to date SGE withdrawals have reached 2,313 tonnes, which is an all time record.
Given elevated SGE withdrawals and continued weakness in the gold price it looks like the Chinese population is buying the dips. The Chinese central bank (PBOC) is likely doing the same, but not through the SGE. The PBOC does its monetary gold purchases in the international OTC gold market – for example, in London or Hong Kong.
According to Reuters China has imported 72 tonnes of (non-monetary) gold from Hong Kong in October – this gold is required to be sold first through the SGE, it’s not directed to the PBOC. Data from the Hong Kong Census & Statistics Department has not been released, but Reuters has a contract with the Department in order to obtain data a few days before the public release.
Known gold exports to China year to date: From January until October Hong Kong has exported 653 tonnes to China mainland, which is 784 tonnes annualized. Switzerland has exported 217 tonnes to China from January until October, annualized 260 tonnes. The UK shipped 210 tonnes to China in the first nine months of this year, annualized 280 tonnes. Australia net exported 49 tonnes in seven months, which is 84 tonnes annualized. So, without counting shipments from exporters such as South Africa and Singapore, China has imported 1,129 tonnes of gold year to date and is on track to import 1,408 tonnes of (non-monetary) gold in total this year. In addition, Chinese domestic mining output is set to reach 476 tonnes. Chinese apparent gold supply – without counting scrap – in 2015 will be 1,884 tonnes.
Using SGE withdrawals as a measure for Chinese gold demand canbe slightly deceiving for a number of reasons. For example, Chinese citizens can buy gold on the SGE but prefer not to withdraw this metal from the vault, or chose to withdraw next month/year. This way, wholesale demand would actually be higher than the amount of gold being withdrawn. On the other hand, since the inception of the Shanghai International Gold Exchange (SGEI) gold can be withdrawn from SGEI (IB) Certified Vaults in the Shanghai Free Trade Zone (SFTZ) and exported abroad. According to the accounting rules from the SGE, any SGEI withdrawal is included in SGE withdrawals. An export from the SFTZ would be included in SGE withdrawals. I’m always occupied with the details regarding SGE withdrawals, why we can use it as a measure for Chinese wholesale gold demand and why not. I think SGEI withdrawals can have been a cause for inflated SGE withdrawals this year.
Late 2014 and early 2015 I’ve written SGE withdrawals could have been distorted by withdrawals from the SGEI. For a while I corrected SGE withdrawals by SGEI trading volume to be conservative about Chinese wholesale gold demand. We simply didn’t know what happened to the SGEI gold that was traded – was it withdrawn from the vaults or not withdrawn. Then, in February 2015 SGE chairman Xu Luode published some figures in an article for Bullion Bulletin that pointed outmost of the SGEI trades that were withdrawn from the vault was imported into the Chinese domestic mainland. Meaning, SGEI trading volume could only have slightly distorted our measure of Chinese wholesale gold demand (SGE withdrawals).
After a run up in SGEI trading volume this year, from January until March, it appeared trading of iAu9999 (the most commonly traded SGEI contract – 1 Kg 9999) severely declined in recent months and I stopped subtracting SGEI trading volume from SGE withdrawals to measure Chinese wholesale gold demand. But, the other day I studied the Chinese SGE weekly reports. What I failed to see in recent months was that iAu9999 has been trading in the Chinese OTC market. Mea culpa. In the Chinese OTC market SGE contracts can be negotiated off-SGE, while settlement is done on-SGE.
In the Chinese weekly SGE reports we can see OTC trades on the first page. Below is a screen shot of the report, the OTC settlements are framed in red. Framed in blue is ‘this weeks’ trading, which was in week 45 (framed in green).
Some analysts, including myself, thought the SGEI was dead. But it isn’t.
First of all, the iAu9999 contract is traded increasingly in the OTC market. In the chart above the black line resembles OTC iAu9999 trading volume. In the OTC market volume has declined from a peak in May, but I wouldn’t say trading has ceased.
It certainly is possible the gold of these OTC iAu9999 trades can have been withdrawn from the vaults in the SFTZ and exported abroad and thus inflated SGE withdrawals. When acontract (iAu9999) at the SGEI is exchanged, four things can happen (in the context of this investigation):
The gold stays in the vault.
The gold is withdrawn and stored elsewhere in the SFTZ.
The gold is withdrawn and imported into the Chinese domestic gold market.
The gold is withdrawn and exported to, for example, India.
Option 2 and 4 would increase SGE withdrawals without increasing Chinese wholesale gold demand.
When looking at the numbers from the OTC iAu9999 trading we can see an interesting pattern.
Have a look at the data labels in the chart above. We can see that all weekly OTC iAu9999 volumes end on two zeros (blue bars) or three zeros (red bars). These volumes are the sum of all trades executed during the week. It’s safe to conclude these volumes are exchanged by large traders, as iAu9999 is changing hands in batches of one hundred (blue bars) or in some weeks one thousand (red bars) 1 Kg 9999 bars. For example, in the week that ended 3 July 2015 exactly 73,000 Kg’s were traded. In theory, 20,855 Kg’s were traded on Monday and 52,145 Kg’s on Thursday, aggregating at 73,000 Kg’s in total for the week. Though, this coincidence cannot have occurred each and every week. More likely the OTC iAu9999 traders buy and sell per 100 or 1000 Kg’s. No other SGE or SGEI contracts show this bulky trading pattern.
Did any foreign nations buy gold through the SGEI OTC market and export it from the SFTZ? Hard to say. The most obvious gold trading partner for China is India. Early this year the SGE chairman wrote about the SGEI [brackets added by me]:
… Using the International Board [SGEI] as a launch pad, China’s gold market will embrace greater openness and foster stronger ties with its neighbours and, together, elevate the trading and pricing influence of Asia in the world’s gold market.
As a perennial major consumer of gold and a close neighbor of China, India will undoubtedly become one of SGE’s most important partners in the coming years. SGE looks forward to forming close partnerships with the Indian market.
Imaginably, the iAu9999 purchases were withdrawn from the SGEI vaults in the SFTZ and exported to India. Though, India’s trade statistics can be tracked very precisely and only a small amount of gold has been exported from China to India since the SGEI was erected in September 2014.
In the table above we can see India imported 1.205 tonnes from China Since September last year. These imports into India can be processing trade from any Free Trade Zone in China (no SGEI involvement required), but can also be from purchases at the SGEI in the Shanghai Free Trade Zone. In the latter scenario these exports would have been captured in SGE withdrawals (the metal is bought at the SGEI, withdrawn from the IB Certified Vault and exported).
In any case India imported very little gold from China in the past year. The only other gold importer from China I could find was Thailand at 1.488 tonnes, which makes me think foreigners have not yet been very active on the SGEI. More likely, at this stage, is that SGEI withdrawals are imported into the Chinese domestic gold market. Another option, given the large round number volumes, is that OTC iAu9999 is trading in China’s foreign exchange market.
I should add, the customs departments from Switzerland and Hong Kong confirmed that when gold is exported from local soil to the Shanghai Free Trade Zone it’s disclosed in their data as an ‘export to China’. It is irrelevant if that gold is ever imported into the Chinese domestic gold market. No matter what happens to the gold in the SFTZ it is initially disclosed as an export to China.
In short, trading at the SGEI can have blurred SGE withdrawals this year. More research should point to what extent.
Because inaccurate information regarding the Chinese gold market keeps circulating in the international gold community BullionStar has decided to translate the Measures for the Import and Export of Gold and Gold Products drafted in March 2015 by the People’s Bank Of China (PBOC). The translation, which can be read below, will serve as a foundation to further expand on CCFDs and investigate the discrepancy between SGE withdrawals and Chinese consumer gold demand. In a forthcoming post I will expand in detail on the Measures for the Import and Export of Gold and Gold Products combined with additional Chinese trade laws,to elucidate how these rules relate to the physical gold flows involved in round tripping. A second succeeding post will be dedicated to the physical gold flows inside the Chinese domestic gold market – through the SGE – and how these relate to gold leasing.
You can download the original Chinese Measures for the Import and Export of Gold and Gold Products from the PBOC here. Be advised the Measures for the Import and Export of Gold and Gold Products can be confusing if not connected to Chinese trade rules in general.
In the translation below reference is being made to:
Annex 1, Import and Export License of the People’s Bank of China for Gold and Gold Products, ofwhich is a translation can be viewed here.
Annex 2, Application Form for Import and Export of Gold and Gold Product, of which a translation can be viewed here.
Catalogue for the Regulation of the Import and Export of Gold and Gold Products, of which a translation can be viewed here.
Measures for the Import and Export of Gold and Gold Products
Order of General Administration of Customs and People’s Bank of China
Order No. 1〔2015〕
Measures for the Import and Export of Gold and Gold Products is prepared by People’s Bank of China and General Administration of Customs based on Law of the People’s Republic of China on the People’s Bank of China, Customs Law of the People’s Republic of China and Decision of the State Council on Establishing Administrative License for the Administrative Examination and Approval Items Really Necessary to be Retained.
The Measured is issued hereby and shall take effect since April 1, 2015.
Measures for the Import and Export of Gold and Gold Products
Article 1 The Measure is prepared to regulate the imports and exports of gold and gold product and to enhance the import and export management of gold and gold product based on laws like Law of the People’s Republic of China on the People’s Bank of China, Customs Law of the People’s Republic of China and Decision of the State Council on Establishing Administrative License for the Administrative Examination and Approval Items Really Necessary to be Retained etc.
Article 2 For the purpose of these Measures, gold means gold unwrought and gold products mean semi-finished gold and finished products of gold.
Article 3 The People’s Bank of China, as the authority in charge of the import and export of gold and gold products, implements a permit system for the import and export of gold and gold products.
The People’s Bank of China, based on the needs of national macroeconomic regulation and control, may conduct restrictive approval for the import and export volume of gold and gold products.
For the import and export customs clearance of gold and gold products as included in the Catalogue for the Regulation of the Import and Export of Gold and Gold Products, the Import and Export License of the People’s Bank of China for Gold and Gold Products (Annex 1) issued by the People’s Bank of China or a People’s Bank of China branch shall be submitted to the Customs.
The People’s Bank of China shall, in conjunction with the General Administration of Customs, formulate, adjust, and issue the Catalogue for the Regulation of the Import and Export of Gold and Gold Products.
Article 4 A legal person or another organization importing and exporting gold and gold products by the following trade modes shall obtain an Import and Export License of the People’s Bank of China for Gold and Gold Products in accordance with these Measures:
(I) General trade;
(II) Processing trade for the domestic market and gold products exported under processing trade with gold raw materials purchased within the territory of China; and
(III) Import and export between areas under special customs supervision or supervised bonded places and overseas areas.
An individual, a legal person or any other organization donating imported gold and gold products for public interest undertakings shall obtain an Import and Export License of the People’s Bank of China for Gold and Gold Products in accordance with these Measures.
The provisions on the administration of individuals entering and leaving China with gold and gold products shall be formulated by the People’s Bank of China in conjunction with the General Administration of Customs.
Article 5 The import and export of the state gold reserves shall be handled by the People’s Bank of China.
The import and export of gold coins (including gold precious metal commemorative coins) shall be handled by institutions designated by the People’s Bank of China.
Article 6 The main market players with the qualifications for the import and export of gold shall assume the liability of balancing the supply and demand of material objects on the domestic gold market. Gold to be imported and exported shall be registered at a spot gold exchange approved by the State Council where the first trade shall be completed.
Article 7 Applications for the import and export of gold and the import of gold products donated for public interest undertakings shall be accepted and approved by the People’s Bank of China.
Applications for the import and export of gold products shall be accepted by the branches of the People’s Bank of China at or above the prefecture level and approved by the Shanghai Head Office of the People’s Bank of China, the branches and business management departments of the People’s Bank of China, or the central sub-branches of the People’s Bank of China in the capital cities of the provinces (autonomous regions), and the central sub-branch of the People’s Bank of China in Shenzhen.
Article 8 An applicant for the import and export of gold (except the import of gold for donation to public interest undertakings) shall have corporate status, have no record of violating laws and regulations within the recent two years, and satisfy one of the following conditions:
(I) It is a financial institution member or a market maker on a gold exchange approved by the State Council, with professionals of the gold business, a perfect gold business risk control system, and stable gold import and export channels, whose business carried out on the gold market complies with relevant policies or regulatory provisions, and whose spot trading of gold is active and the volume of transactions for its own account is among the highest in the two years before the application is filed;
(II) It is a comprehensive member of a gold exchange approved by the State Council, and a mining enterprise with annual gold production of 10 tons or more, pollutant emissions during the production process satisfying the environmental protection standards of the state, overseas gold mineral products investment scale exceeding USD 50 million, which has obtained mining rights of overseas gold mines or paragenetic and associated gold mines, which has formed mineral gold production capacity, whose business carried out complies with relevant policies or administration provisions, and whose spot trading of gold is active and volume of transactions for its own account is among the highest in the two years before the application is filed;
(III) It is a mining enterprise, with three consecutive years of domestic taxation records no less than RMB 200 million yuan and investment in overseas nonferrous metals exceeding USD 100 million, which has obtained mining rights of an overseas gold mine or paragenetic and associated gold mine and is ready to produce gold, and whose business carried out complies with the relevant policies or regulatory provisions;
(IV) It is a manufacturing enterprise that assumes the task of producing precious metal commemorative coins for the state;
(V) It is a gold importing and exporting refining enterprise which has become a certified brand on the international gold market.
Article 9 An applicant for the import and export of gold products (except the import of gold products for donation for public interest undertakings) shall have corporate status or the status of other organization, have no violation of laws and regulations within the recent two years, and satisfy one of the following conditions:
(I) For enterprise which produces, processes or uses relevant gold products, it shall possesses necessary production sites, equipment and facilities, discharge pollutant made in the production process based on national environment protection standards and keep a tax payment record that no less than RMB 1 million yuan has been paid each year for a successive 3 years;
(II) For foreign trade operation enterprise which applies to customs certification on enterprise management, it shall keep a tax payment record that no less than RMB 3 million yuan has been paid each year for a successive 3 years;
(III) Educational organizations, science study organizations and so on which need to use gold product for national research project and key subjects.
Article 10 Those which apply for import and export of gold shall submit the following materials to People’s Bank of China:
(I) Descriptions on business conditions including name, address (office place), enterprise profile, using of the imported and exported gold and planned amount etc. shall be noted on the written application;
(II) Application Form for Import and Export of Gold and Gold Product (Annex 2);
(III) Copies of officially sealed business certification of the enterprise legal person;
(IV) Gold import and export contracts and their copies;
(V) Officially sealed copies of Organization Code Certificate of the People’s Republic of China;
(VI) Explanatory materials on whether the applicant has illegal conducts in the past 2 years;
(VII) Financial organization of banking industry shall also offer relevant materials on internal gold business control system; those which apply for gold export shall submit real gold inventory amount certification of gold and commodities exchange approved by State Council;
(VIII) Gold mining enterprises shall also submit pollutant discharge permit certification and copies of annual qualification inspection report issued by provincial environment protection department, copies of relevant foreign investment approval document by the business department, copies of bank out-remittance certification, relevant certifications on exploiting gold in foreign countries or regions and tax payment record of the enterprise in the past 3 years; those which apply for exporting gold shall submit gold production capacity issued by the industry command department or self-discipline organization and registration certification of gold and commodities exchange approved by State Council.
Those which apply for gold import and export again and of which no materials of the aforesaid terms are changed shall only need to submit materials in Item II and Item IV; or shall apply and handle as the first application in case the other materials in the aforesaid terms are changed.
Article 11 Those which apply for import and export of gold product shall submit the following materials to the branch of People’s Bank of China above municipal level where the applicant lives:
(I) Descriptions on business conditions including name, address (office place), enterprise profile, using of the imported and exported gold and planned amount etc. of the applicant shall be noted on the written application;
(II) Application Form for Import and Export of Gold and Gold Product;
(III) Copies of officially sealed legal registration certificate including business certification of the enterprise legal person and legal certificate of public institutions;
(IV) Gold import and export contracts and their copies;
(V) Registration Form for the Archival Filing and Registration of Foreign Trade Operator or Certificate of Approval for Establishment of Enterprises with Foreign Investment in PRC which is sealed with archive filing seal.
(VI) Description materials on whether the applicant has illegal conducts in the past 2 years;
(VII) Enterprises which produce, process or use gold product shall also submit the enterprise tax payment record of the past 3 years, pollutant discharge permit certificate issued by municipal environment protection department and annual qualification inspection report as well as their copies;
(VIII) Enterprise of foreign trade operation shall also submit relevant enterprise management proving materials apply to customs certification and enterprise tax payment record of the past 3 years;
(IX) Education organizations and science research institutes shall also submit proving materials on conducting national research projects or key subjects;
(X) Enterprises which export gold products shall also submit proving materials including added-value tax invoice of gold raw materials obtained within China.
Those which apply for gold import and export again and of which no materials of the aforesaid terms are changed shall only need to submit materials in Item II and Item IV; besides, education organizations and science research institutes shall also submit materials in Item IX and enterprise which export gold products shall also submit relevant materials specified in Item X; or shall apply and handle as the first application in case the other materials in the aforesaid terms are changed.
Article 12 The application conditions specified in Item I, Article 9 of the Measure applies to gold product from processing trade for the domestic market, imported materials of products for domestic market within products listed in Catalogue for the Regulation of the Import and Export of Gold and Gold Products and gold products exported under processing trade with gold raw materials purchased within the territory of China.
For processing trade for the domestic market, the application materials shall be submitted and delivered in accordance with provisions in Article XI of the Measure; besides, materials explaining fair reasons for turning to domestic market, copies of processing trade business approval certificate and processing trade contracts and their copies etc.
For gold products exported under processing trade with gold raw materials purchased within the territory of China, the enterprise shall report the conditions of gold purchase within the territory of China when the processing trade manual is established (changed) and submit Import and Export License of the People’s Bank of China for Gold and Gold Products.
Article 13 As for imported gold and gold product donation made by individual, legal person or other organization for public welfare establishments, the following materials shall be submitted by the Donee to People’s Bank of China:
(I) Donation agreement that conforms to provision of Law of the People’s Republic of China on Donations for Public Welfare;
(II) Legal registration certificate and their copies including public institute legal person certificate or social group legal person registration certificate;
(III) Application Form for Import and Export of Gold and Gold Product
Article 14 People’s Bank of China shall make the administration permit decision within 20 work days since accepting the application for import and export of gold and gold products.
Article 15 Municipal branches of People’s Bank of China shall directly report the primary review opinions and all the application materials to the upper organization within 20 work days since accepting the application for import and export of gold and gold products. And the upper organization shall make the administration permit decision within 20 work days since receiving the primary review opinions and all the application materials.
Shanghai head office, all branches, business management department, central branches of provincial capitals (metropolis) and Shenzhen central branch of People’s Bank of China which directly handle application for import and export of gold products shall make the administration permit decision within 20 work days since acceptance.
Article 16 People’s Bank of China or its branches may review the applicant in case it is necessary to verify the real content of the application materials; the review shall be conducted by more than 2 working staff.
Article 17 The approved applicant shall handle relevant procedures at the customs by Import and Export License of the People’s Bank of China for Gold and Gold Products when handling cargo import and export of gold and gold products.
There shall be one Import and Export License of the People’s Bank of China for Gold and Gold Products for each batch of product and the License shall be used within 40 work days since the issuing date. The licensed party which need a postpone for reasonable reasons may apply for handling a delay procedure to the issuing organization with the original license 5 work days after the expiring of the license.
Article 18 People’s Bank of China and its branches are entitled to supervise and inspect the activities of administration permit items conducted by the Licensee shall be cooperative.
Article 19 The Licensee shall promptly report the implementation conditions of import and export of gold and gold products and provide relevant materials based on the provision of People’s Bank of China and its branches.
Article 20 Despite of the provisions in Article 4 of the Measure, gold and gold products imported and exported by the following means shall exempted from handling Import and Export License of the People’s Bank of China for Gold and Gold Products and shall be supervised by the customs instead:
(I) Imported or exported by processing trade;
(II) Imported or exported between customs special supervision region, tax-free supervision area and foreign territories;
(III) Imported or exported between customs special supervision region and tax-free supervision area;
(IV) Imported or exported by maintenance, shipment return and temporary in-and-out methods.
Article 21 Except for provisions in Article 4, 5 and 20 of the Measure, any individual, legal person or other organization shall not import and export gold and gold products by any other means. Except otherwise specified by the state.
Article 22 Individual, legal person or other organization shall abide by relevant national regulations on anti-money laundering and anti-terrorist financing when importing and exporting gold and gold products.
Article 23 Foreign exchange receipts and payments incurred when importing and exporting gold and gold products shall be handled in accordance to foreign exchange management rules.
Article 24 The Licensee shall not make the following conducts:
(I) Transfer or lend the import and export license for gold and gold products;
(II) Use fake or intentionally made import and export license for gold and gold products;
(III) Acquire the import and export license for gold and gold products by lying or other dishonest conducts;
(IV) Exceed the class, specification and amount scale permitted by the import and export administration;
(V) Make fake donations on imported and exported gold and gold products;
(VI) Fail to register and exchange the imported and exported gold at the gold and commodities exchange based on the provisions;
(VII) Maliciously manipulate gold exchange price by means like hoarding and profiteering, or other conducts which violate the rights and interests of the other investors like cheating;
(VIII) Violate relevant policies or management provision on gold market and gold derivatives exchange;
(IX) Refuse the supervision and inspection by People’s Bank of China and its branches or hide relevant conditions and provide fake materials during the supervision and inspection process.
In case the Licensee makes any of the conducts listed in former terms, People’s Bank of China and its branches is entitled to suspend the handling of its import and export application; those with vital situations shall be punished in accordance to Article 46 of Law of the People’s Republic of China on the People’s Bank of China.
Article 25 People’s Bank of China and its branches is entitled to withdraw the import and export license for gold and gold products of the Licensee by law.
Article 26 Illegal conducts including smuggling or violating customs supervision provisions resulting from importing and exporting gold and gold products by violating the Measure shall be disposed in accordance to laws and regulations including Customs Law of the People’s Republic of China and Regulation of the People’s Republic of China on the Implementation of Customs Administrative Punishment by the customs; or shall be investigated for its criminal liabilities by being transferred by the justice organization in case of crime.
Article 27 People’s Bank of China and General Administration of Customs are responsible for explaining the Measure.
Article 28 The Measure shall be implemented since April 1, 2015.
1. Import and Export License of the People’s Bank of China for Gold and Gold Products
2. Application Form for Import and Export of Gold and Gold Products
There are a few analyses making rounds on the internet about gold owned by the People’s Bank Of China (PBOC). I’m always interested in these analyses, as I like to be aware of all knowledge available on this subject, but I rarely agree with them.
The big questions that remain in the gold space are, (i) how much gold does the PBOC truly have, (ii) how and where is this gold stored, (iii) how much of the imported (non-monetary) gold ended up at the PBOC or at the private sector.
In previous posts I’ve shared my analyses: I think the PBOC buys most of its gold abroad where they monetize the metal after which it can be imported into China mainland without having to be disclosed in publicly available customs reports (these monetary gold flows would be invisible to us, therefor I don’t know how much gold the PBOC has). All the gold that is disclosed in publicly available customs reports as export to China is directed through the Shanghai Gold Exchange (SGE) where it’s bought by private investors and institutions, not the PBOC. That’s my main thesis, although I don’t rule out the PBOC is able to interfere in the domestic Chinese gold market and the SGE.
The problem we encounter is that there has been a lot more gold sold through the SGE than all consultancy firms (WGC/GFMS/CPM) disclose as Chinese gold demand. The difference, which is at least 2,000 tonnes, is thought to be PBOC gold accumulation. In addition, there are a lot of precious metals on the balance sheets of Chinese commercial banks, although it’s unknown what these precious metals truly represent. Is it gold, silver or platinum and who is the owner? Many analysts think the PBOC buys gold on the SGE through commercial banks and leave this on balance sheets of these banks before it can be flipped to the PBOC’s balance sheet.
The website Smaulgld published an article on 2 October 2015 that hints at the mechanism described in the previous paragraph. From Smaulgld:
Chinese President Xi Jinping recently confirmed the practice of moving the People’s Bank of China’s reserve assets to other entities in China [quote from Xi]: “some assets in foreign exchanges were transferred from the central bank to domestic banks, enterprises and individuals” This might explain where some of China’s gold hoard, that many suspect they posses but have not reported as reserves, may be located.
If indeed China holds gold with … any of the Chinese state owned banks, the PBOC could roll up that gold on to its own balance sheet in order to show more gold reserves quickly and easily in one month with a single entry.
In this post I would like to focus on the quote from Xi. It was copied from a written interview with the Wall Street Journal that was republished on iCross China. The original Chinese text was published on China network. In Chinese Xi said:
First, the ownership of part of the foreign exchange reserves was transferred from the central bank to institutions like domestic banks, enterprises and individuals. For example, the balance of the foreign exchange deposits of all kinds at domestic banks increased 56.9 billion USD, with a 27-billion increase in August alone.
I think this is what happened: in the original Chinese text it said 外汇存款, which means foreign exchange deposits, but the translator working for iCross China translated it into foreign exchanges, which was interpreted by Smaulgld as being foreign exchange reserves. The essential difference is that foreign exchange deposits are owned by the private sector (at domestic banks) and foreign exchange reserves are owned by the central bank.
What Xi meant was that the Chinese private sector (banks, enterprises and individuals) was exchanging yuan for US dollars at the Chinese central bank. In turn the PBOC used its foreign exchange reserves to supply US dollars to the private sector in exchange for yuan. Subsequently, foreign exchange deposits at domestic banks grew by $56.8 billion, reflected in a matching decline of $56.8 billion in the PBOC’s foreign exchange reserves. In short, yuan went from the private sector to the PBOC, US dollars went from the PBOC to the private sector.
Currently there is downward pressure on the renminbi and the PBOC is defending the value by selling its foreign exchange reserves and buying yuan. When the Chinese private sector wants to exchange yuan for US dollars, which eventually is done through the Chinese central bank, the PBOC would not buy US dollars in the international foreign exchange market for this purpose, as this would lead to a declining value of the renminbi. Instead, the PBOC exchanges its own foreign exchange reserves for yuan, which are then transferred to the private sector and deposited as foreign exchange deposits at domestic banks. Needless to say, the US dollars transferred from the PBOC’s foreign exchange reserves to domestic banks, as foreign exchange deposits, are no longer the PBOC’s foreign exchange reserves.
Concluding, there are no foreign exchange reserves transferred from commercial bank balance sheets to the PBOC’s balance sheet or vice versa, nor has any gold been transferred this way.
Another quote that popped up at several blogs, after it was published on Reuters, was the one from Fu Xuejun, strategist at Huarong Securities Co. When the Chinese stock market was collapsing in the beginning of July this year, Fu Xuejun said/wrote:
The government must rescue the market, not with empty words, but with real silver and gold…
In my opinion this was wrongly translated. Fu Xuejun probably wrote 真金白银, which is a phrase that means “real money” not “real silver and gold”. This is a common pitfall as in many languages the word for gold or silver is the same as for money. For example, money in French is argent, but silver in French is also argent.
I’ve been told Fu Xuejun is known in China purely as a stock trader with very little knowledge of gold and silver. Therefor, most likely, Fu Xuejun meant to say that the government needed to use money out of its own pockets to rescue the stock market instead of empty words. Fu Xuejun replied to my email:
I mean “real money”, not with physical gold and silver. “真金白银”is a idiom meaning a lot of real money.
I should add, gold on the balance sheets of Chines banks could be copied to the PBOC balance sheet IF the Chinese adopt the Turkish system, wherein gold savings by citizens deposited at commercial banks also show up on the balance sheet of the Turkish central bank, albeit double counted, as commercial banks in Turkey can use gold as part of their Reserve Requirement Ratio at their central bank.
Finally last Friday the People’s Bank Of China (PBOC) updated its official gold reserves, from 1,054 tonnes, a figure reported since 2009, to 1,658 tonnes. Most gold analysts expected a number substantially higher than what was just disclosed. In this post we’ll analyze the 1,658 tonnes figure.
Before diving into the analysis, I like to share that I think it’s possible the PBOC hasn’t been completely honest by stating their gold reserves have grown by only 604 tonnes since 2009. I think in reality they have more than 1,658 tonnes, but let’s discuss that later on. In my analysis, I always try to start with official data and work my way from there, instead of start with speculative data and work backwards. It’s very easy in the gold space to rebut all official data, mainly because there is so much speculation. Therefor, I would like to start with the figure just disclosed, then I’ll try to answer, why 1,658 tonnes?
PBOC Gold Reserves Increment Was Covertly Imported
With regard to the update in gold reserves, the PBOC has stated on its website (in Chinese):
Based on our assessment of the asset value of gold and analysis of price movements, on the condition of not impacting or influencing the market, through various domestic and international channels, we gradually accumulated this part of gold reserves. The major channels of accumulation include: purifying domestic gold scraps and gold of various grades [杂金 in Chinese usually means non-standard gold including scraps so I have to paraphrase it], direct purchase of production, transaction in domestic and foreign markets, etc.
The official narrative is that the PBOC has bought 604 tonnes of gold in the domestic and international market. From my perspective, however, I think the PBOC has mainly been buying gold in the international market, as that’s where superfluous US dollars can be exchanged for gold. In the Chinese domestic gold market, physical gold is settled in renminbi. Gold the PBOC potentially has obtained in the mainland would be from state owned mines that not sell their gold through the Shanghai Gold Exchange, but have the gold directly transported to central bank vaults.
The PBOC does not buy gold through the Shanghai Gold Exchange (SGE).
PBOC purchases/shipments are not disclosed in global customs reports.
As a consequence, everything we can see going into China (exports from other countries to China which are required to be sold through the SGE) and domestic mine supply (which is mainly sold through the SGE) are being added to private gold reserves and does not end up at PBOC vaults.
According to the China Gold Association (and global trade data), mainland net gold imports from 2010 until 2014 accounted for 3,967 tonnes and domestic mining output over this period totaled 1,979 tonnes; a combined 5,964 tonnes.
To summarize we know that:
(1) Laws and tax incentives direct Chinese gold import and gold mine supply to be sold through the Shanghai Gold Exchange
(2) Chinese private gold demand is all supplied through the SGE
(3) Physical gold at the SGE can only be settled in renminbi
4) The PBOC is likely to buy gold abroad with US dollars (not renminbi) to diversify their lopsided FX reserves and
(5) In 2014 an SGE official confirmed that the PBOC did not buy gold through the Shanghai gold bourse
With this knowledge, it’s easy to understand the PBOC did not buy the 5,964 tonnes of gold that was supplied to China 2010-2014 through import and mining. The 5,964 tonnes was consumed by private gold buyers at the Shanghai Gold Exchange. To repeat myself, PBOC gold purchases cannot be traced from global trade data or SGE withdrawals, as these occur in the realm of the private Chinese gold market.
One more reason why the gold exports to China we can see – for example in Hong Kong customs reports – are not addressed by the PBOC is that it can be observed that gold bullion is being declared as either non-monetary or monetary gold when studying customs data from any country. If the PBOC can choose how to declare their bullion, they’ll choose monetary. These are typically the options available when making a gold customs reporting:
Gold, for non-monetary purposes (HS code 71081100)
Gold, unwrought, for non-monetary purposes (HS code 71081200)
Gold, in semi-manufactured forms, for non-monetary purposes (HS code 71081300)
Monetary gold (HS code 71082000)
The essential difference between these four categories is that “monetary gold” is always blank; this category is never disclosed publicly! As we know, the PBOC prefers to buy gold in secret, so their gold transport surely is hidden in the eclipsed category “monetary gold”. It’s thus pointless to try to measure PBOC gold reserves from available customs data on gold, as this data doesn’t show gold monetary shipments. From trade data we can only see what’s entering China for private gold demand sold through the SGE.
From this perspective all official gold data presented above makes sense; all these thousands of tonnes of gold we could see entering China fell into the hands of private hoarders.
My supposition can be further strengthened if we re-read translations from Chinese gold industry officials I’ve published over the years. From Sun Zhaoxue, President of the China Gold Association in 2012:
We should advocate to ‘store gold among the people’ and guide a healthy positive development in this segment. In recent years, the domestic gold industry’s rapid growth provided good conditions for various uses of gold, as well as create space for this business to grow faster. China … has to catch the opportunity, while increasing its supply capacity, to push the ‘store gold among people’ strategy, actively extend the business value chain, increase gold investment types, encourage and promote individuals’ gold investment and consumption. Foremost, maximize the utilization of … gold retailers, increase sales channels, optimize sales network, strengthen branding and achieve to ‘store gold among the people’ and thus ‘store wealth among the people’. This is the objective under our gold strategy.
From an internal memo (only published in Chinese) from the PBOC on how to develop the gold market, 2012:
The tradition of gold investment and consumption is with our people/citizens. As the private sector grows at speed and living standard upgrades, private demands for gold jewelry, coins and investment gold are also growing quickly. A gold market with a rich diversity of products will help develop new investment channels, satisfy the varied demand, help investors make appropriate asset allocations, raise investment returns and protect our wealth assets.
There have been many clues the PBOC was buying gold as well, next to Chinese private demand, but for now we’re confirmed the gold we could see going into China over the years has been from the private sector.
Let’s make a new chart:
I’ve accumulated all domestic gold mining output and known gold imports isolated from “Official reserves” since 2009. The “Official reserves” increments in 2001 and 2003 are subtracted from “Cumulative domestic mining”, the “Official reserves” increments in 2009 and 2015 are not subtracted from “Cumulative domestic mining” or “Cumulative total import”, as my theory is that this was covertly imported. A detailed description of how I compiled this chart can be found in my previous post on this subject.
If I’m right in my analysis that the PBOC has mainly been buying gold abroad since 2009, there are currently 13,781 tonnes of gold in China, of which 1,658 tonnes are (confirmed) official gold reserves and 12,123 tonnes are private reserves. Needless to say, everything the PBOC potentially holds in addition to 1,658 tonnes official reserves must added to these estimates. (I do not rule out the PBOC is able to buy gold in the domestic market.)
PBOC Gold Reserve Increment Is A Strategic Move
The PBOC’s decision to disclose their official gold reserves at 1,658 tonnes cannot be viewed in isolation from global monetary affairs. Since the financial crisis in 2008, Europe and Asia have been very clear in their preference to gradually decrease the emphasis of the US dollar as reserve currency in the international monetary system. China’s strategy is to play multiple hands at the same time of which one is the SDR.
For the development of their economy, China aims to internationalize the renminbi. The composition of the SDR will be reviewed later this year. A requirement for a currency to be included in the SDR is that it’s freely usable. China will thus be required to disclose its reserves at least once yearly by groups of currencies. If we read the official statement on the gold reserves by the PBOC in Chinese, this is apparent from the part containing info about IMF’s Special Data Dissemination Standard (reserves disclosure).
With the US having the power to obstruct renminbi inclusion into the SDR, the Chinese have to play it safe. They are required to be transparent about their true gold reserves, but may not want to upset the US by disclosing an official gold reserve figure at 3,500 tonnes. The 1,658 tonnes figure, which is too little to rock the global financial order, though a sign that China assesses gold to be “an important element of international reserve diversification” may thus be an appropriate figure. It’s not in China’s interest to rush into a new international monetary system as they continue to diversify away from the US Dollar.
From the above chart, we can see China is not net selling US treasuries, but that they have stopped increasing their accumulated holdings since 2010. The Chinese aren’t ready for a major shift in the international monetary system yet. They are still working on further internationalization of the renminbi, the SDR inclusion, developing their financial markets and opening up their capital account. Only then will they unwind the US dollar. Until then, China will continue to adopt a slow step by step approach.
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.
The difference between SGE withdrawals and Chinese consumer gold demand as disclosed by the World Gold Council has aggregated to 3,193 tonnes from 2007 until 2014 (the period this article will focus on). Naturally, we’re here to get the finest understanding of Chinese gold demand. To explain how the difference is caused Western consultancy firms have presented several arguments in publications and lectures at conferences, though none of them can explain the difference in full. This post is an overview of all such arguments (supplemented by my own arguments).
Below we’ll examine to what degree the arguments can or cannot have caused the difference. Subsequently, we’ll discuss the details of all metrics that can be applied, to eventually be able to calculate our best estimates of genuine Chinese gold demand 2007 – 2014 within every metric.
This is the argument list so far in chronological order:
stock movement change
the Shanghai International Gold Exchange
In 2014 the World Gold Council (WGC) came out with two special reports about the Chinese gold market that should have shine a light on the difference (China’s Gold Market: Progress And Prospects form April 2015 and Understanding China’s Gold Market from August 2014). However, these reports contain many false statements and the segments on the difference fail miserably, as I’ve pointed out in several posts (one, two, three, four, five, six, seven, eight). Surprisingly, after the reports were published Western consultancy firms came up with new arguments that should explain the difference. I would like to direct your attention on this shift in arguments; when the old ones failed, the firms impudently moved on and came up with new ones. The fact this list of arguments is constantly changing confirms the weakness of all arguments it holds, and the apparent ‘ignorance’ of Western consultancy firms regarding the Chinese gold market.
First let’s go through all the arguments to investigate which ones make any sense, at the end of the post we’ll do some number crunching.
1) INDUSTRIAL DEMAND. The first argument ever presented to me was from the WGC. In August 2013 I’ve asked the Council what their explanation was for the difference between their Chinese gold demand and demand disclosed in the CGA Gold Yearbooks (co-written by the PBOC), which exactly equaled SGE withdrawals. They replied to me by email:
The data that we publish in Gold Demand Trends are collected for us by Thomson Reuters GFMS. Our data represent jewelry and bar & coin demand and do not incorporate any industrial demand or fabrication, which is included in the PBoC figures. As I am sure you will appreciate, data collection of this sort relies on a number of proprietary sources and these will not necessarily be the same for both GFMS and PBOC. It is, therefore, perhaps not surprising that the estimates of demand differ somewhat.
Not very credible the WGC identifies a gap of 3,193 tonnes of gold with industrial demand, but, although being small, industrial demand isn’t captured in WGC Chinese gold demand, for whatever reason, and thus partially explains the difference from a metrics point of view.
The reason I tend to compare SGE withdrawals to Chinese gold demand as disclosed by the WGC, and not by GFMS, Metals Focus or CPM Group, is because the WGC is globally the easily (free) accessible data source for investors. Usually investors and news agencies worldwide consult the WGC for supply and demand statistics, which make these the most important to test for their accuracy. Why the WGC doesn’t include industrial demand in their data is beyond me, but for our own investigation we’ll simply take notice.
Industrial demand is a legitimate argument and its volume will be taken into account for our own calculation of genuine Chinese gold demand at the end of this post.
2) STOCK MOVEMENT CHANGE. When I asked GFMS in August 2013 about net investment – which is how the difference was titled in the CGA Gold Yearbooks – they wrote me by email:
We have checked with our Data Specialist and confirmed that we use a different methodology. Total Chinese demand used by Thomson Reuters GFMS only includes jewelry, physical bullion bars/coins and all industrial demand. Any stock movement change (which is essentially the item 6 net investment) will not be included as underlying demand.
So according to you category six is “stock movement change”? This would be gold added to the stocks from jewelers, the mint, industrial companies, etc? (this is a few hundred tons each year!)
That’s correct based on the resolution provided by our data specialist.
Because SGE withdrawals capture wholesale demand the difference is partially what jewelry companies, refineries, industrial companies and the mint have purchased at the SGE, but not yet sold in retail. And so, stock movement change is a legitimate argument, though the amount of gold in stock can never explain the full difference of 3,354 tonnes.
According to an estimate by the WGC as much as 125 tonnes of gold can have been absorbed as inventory in the Chinese domestic gold market from 2009 until 2013:
… It is, however, indicative that as jewelers expanded, so too did their inventory levels and it is our judgment that across the industry between 75t to 125t may have been absorbed in the supply chain since 2009.
As the period we are investigating with respect to the difference spans wider, from 2007 until 2014, we’ll use an estimate of 200 tonnes for stock movement change.
Stock movement change is a legitimate argument and its volume will be taken into account for our calculation of genuine Chinese gold demand at the end of this post.
3) ROUND TRIPPING. In April 2014 the WGC published a report on China titled China’s Gold Market: Progress and Prospects. It certainly was not the first WGC report on China, in 2010 China Gold Report was released, but it was the first time the Council elaborated on the structure of the Chinese gold market, the Shanghai Gold Exchange and the ‘supply surplus’ in the Chinese gold market. Logically, the Council had some explaining to do, as it was clear China imported substantially more gold than what they disclosed as demand.
For the first time Chinese Commodity Financing Deals (CCFD) were introduced to the Council’s wide reader base. This type of financing is pursued to acquire cheap funds, it can be done trough round tripping or gold leasing. The Council wrote:
These operations fall into two broad categories, although there is some overlap between the two. Firstly, there is the use of gold via loans and through letters of credit (LCs) as a form of financing. Secondly, there is the use of gold for financial arbitrage operations that will also be based upon gold loans or LCs. In most cases the gold is quickly re-exported to Hong Kong, often as very crude jewellery or ornaments to get round tight controls on bullion exports. (This is the practise commonly referred to as ‘round-tripping’. Moreover, because nearly all gold flowing into China goes through the SGE, round-tripping can inflate the SGE delivery figures.) In other cases the metal is stockpiled in vaults in China or Hong Kong.
In particular the part in bold is not true, as we could read in my previous posts. Basically, round tripping gold flows are completely separated from the Chinese domestic gold market and the SGE system, therefor they can not inflate SGE delivery or withdrawals.
So, round tripping is not a legitimate argument. To my understanding the WGC has abandoned this argument all together, though GFMS still thinks round tripping inflates SGE withdrawals. In their Gold Survey 2015 it’s written (page 78):
…the round tripping flows between Hong Kong and the Chinese mainland, which also inflates the SGE turnover and withdrawal figures…
4) GOLD LEASING. The other CCFD is leasing. In the WGC report from April 2014 it’s stated:
No statistics are available on the outstanding amount of gold tied up in financial operations linked to shadow banking but Precious Metals Insights [PMI] believes it is feasible that by the end of 2013 this could have reached a cumulative 1,000t…
PMI insinuated 1,000 tonnes is tied up in CCFDs, but as I’ve clearly demonstrated in previous posts, this is not true. There is no need to go over this again – if you wish please read my previous posts for a detailed analysis.
5) OFFICIAL PURCHASES. Often it’s being thought in the gold space SGE withdrawals end up in the vaults from the People’s Bank Of China (PBOC). Early 2013 the WGC speculated the difference could be explained by official purchases, later that year the Council changed its mind. From the July 2014 WGC report on China, Understanding China’s Gold Market, we can read:
China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. But there are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBoC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.
In my post PBOC Gold Purchases: Separating Facts from Speculation I’ve analyzed why it doesn’t make sense for the PBOC to purchase gold through the SGE. The firms will agree the PBOC is not likely to buy gold through the SGE and thus official purchases cannot make up the difference we’re after.
6) RECYCLED GOLD. The most obvious argument to explain elevated SGE withdrawals, one would think, is recycled gold through the bourse counted over and over as withdrawn. Though, SGE rules command bars withdrawn are not permitted to re-enter the vaults before being remelted and assayed by an SGE approved refinery. Which is not say it doesn’t happen.
Arguments presented by the firms regarding recycled gold must be divided in subcategories. In Understanding China’s Gold Market the WGC was correct in pointing out there are two sorts of scrap flows going through the SGE; gold-for-cash and gold-for-gold.
Gold can be sold for cash, thereby increasing supply, while gold can also be sold for gold, increasing both supply and demand. Gold-for-gold supply does not affect the supply-demand balance, hence it’s not counted as supply in WGC metrics – nor is the matching demand side. I would say gold-for-gold cycles through the SGE are a legitimate argument that explain SGE withdrawals to inflate and therefor will be taken into account for our calculation of genuine Chinese gold demand at the end of this post.
Let’s have a look at examples of gold-for-gold:
6.1) Process scrap. This argument was first presented by CPM Group. In short, CPM states industrial companies produce 50 – 70 % scrap supply of the gold used in manufacturing. The scrap spillover flows back to the SGE. Process scrap thus inflates SGE supply and demand, because the gold was bought at the SGE (demand), but flows back for a significant part (supply). Although, it’s unknown how much of this gold actually flows back to the SGE or is brought to a refinery for toll refining (a refinery producing bars or wire from the process scrap for the industrial company in return for a fee).
Process scrap, described in detail by Jeffrey Christian at the very end of this post, is a form of gold-for-gold scrap supply.
6.2) Arbitrage refining. This argument was brought forward by GFMS on 17 February 2015 at the Reuters Global Gold Forum when Jan Harvey interviewed Samson Li (GFMS).
Some people see withdrawals on the Shanghai Gold Exchange as a proxy for Chinese demand. Do you think this is valid?
It depends on the methodology used. For example there are refiners that would, at times, withdraw 9995 gold bars from the SGE, refine it into 9999 bars whenever there is profitable opportunity, and then deposit it back into SGE vault……
Presumably there can be an arbitrage opportunity at the SGE if Au99.95 gold is an X percentage cheaper than Au99.99 gold. Such a spread would be a classic example of one of the contracts being under or overvalued relative to the other.
I’m not a trader, but I can imagine a way to close the arbitrage through gold leasing. This is my theory: if a spread occurs Au99.95 is bought, concurrently Au99.99 (LAu99.99) is borrowed and immediately sold. Then the Au99.95 is withdrawn, refined into Au99.99 and returned to the lender.
If the arbitrage described above can be closed inter alia depends on the speed to which a lease contract can be settled. If a spread occurs and the refiner has to wait 2 days before it can take delivery of Au9999, the arbitrage won’t fly. I’ve asked the ICBC gold lease desk what would be the fastest possibility to sign a lease contract. They told me usually it takes several days or weeks as the lessee’s credit rating must be determined. Though, for regular customers the lease ca be executed in one hour.
It’s hard for me to say if arbitrage refining is really possible according to the aforementioned theory, because it depends on many variables and the established relationship between lessor and lessee. In addition, why would anybody sell Au99.95 if it was undervalued? In my opinion the argument that arbitrage refining inflates SGE withdrawals can be doubted.
6.3) VAT schemes. This argument I found it myself, but is not yet fully worked out. On the South China Morning Post there was an article published wherein an illegal VAT scheme is described which I suspect can inflate SGE withdrawals. I will investigate this scheme as soon a possible, for now, this is all I have.
So how much is gold-for-gold in total (all aggregated process scrap and potential arbitrage refining and VAT schemes)? We can estimate total gold-for-gold supplyand I will tell you how. The advantage of calculating total gold-for-gold supply is that it doesn’t require us to know exactly how much all separate gold-for-gold volumes are.
Every year the Chinese publish the composition of total supply in the Chinese wholesale gold market in the CGA Gold Yearbooks. Have a look at the next chart (I’ve added GFMS scrap, which is gold-for-cash supply):
By knowing, (i) SGE withdrawals, (ii) Import, (iii), Mine output and (iiii) Gold-for-cash (labeled as GFMS scrap in the chart) we can calculate gold-for-gold scrap, because of the structure of the Chinese gold market:
It may be difficult to track process scrap and potential arbitrage refining directly, indirectly the Chinese disclose the volume of both flows as gold-for-gold. By knowing import and we can fill in the equation.
To come to a thorough understanding of Chinese gold supply/demand metrics gold-for-gold scrap flows are very much worth measuring. Especially, because since 2013 this supply category has grown.
7) EXPORT. This argument was brought forward by PMI. On a conference in London Phillip Klapwijk, Managing Director of Precious Metals Insights Limited (PMI), stated China exports about 1,000 tonnes a year (from the domestic gold market). However, at this stage the rules prohibit gold export from the Chinese domestic gold market. I’ve written an extensive analysis on Klapwijk’s presentation (click to read), no need to go over this again here. The export argument is not legitimate.
9) SMUGGLING. Naturally, smuggling can cause SGE withdrawals to be inflated. Although, we have no numbers on smuggling so I can’t take it into account for our calculation of genuine Chinese gold demand.
How much is genuine Chinese gold demand?
The difference between SGE withdrawals and WGC Chinese consumer gold demand from 2007 until 2014 accounts for 3,193 tonnes. By subtracting the volume of gold involved in legitimate arguments from the total difference we can calculate genuine Chinese gold demand. Let’s put to work the numbers and see what happens.
1) INDUSTRIAL DEMAND. Data on Chinese industrial demand wildly varies. Thereby, both the CGA and GFMS publish industrial demand including the use of scrap. Because the scrap produced by fabricators flows back to the SGE and must be subtracted from SGE withdrawals as gold-for-gold to compute genuine Chinese gold demand, we need to measure industrial demand excluding the use of scrap. We’ll use an estimate of 200 tonnes for Chinese industrial gold demand (excluding the use of scraps) from 2007 until 2014:
3,193 tonnes minus 200 tonnes = 2,993 tonnes
2) STOCK MOVEMENT CHANGE: For growth in wholesale inventory from 2007 until 2014 we’ll also use an estimate of 200 tonnes:
2,993 tonnes minus 200 tonnes = 2,793 tonnes
6) GOLD-FOR-GOLD. This type of recycled gold supply from 2007 until 2014 accounted for 903 tonnes:
2,793 tonnes minus 903 tonnes = 1,893 tonnes
When we subtract the tonnage from all legitimate arguments from total SGE withdrawals we’re still left with a difference of 1,893 tonnes of gold. Contrasting metrics can only explain the difference for 1,300 tonnes (3,193 – 1,893).
While, the 1,893 tonnes cannot be labeled as anything else than genuine gold demand (and many Chinese gold industry executives have publicly disclosed to wholeheartedly agree with me). To repeat myself, the residual difference can only be caused by direct purchases from individual and institutional customers at the SGE that withdraw their metal from the vaults.
In the chart above you can see the data I’ve used to write this post. Total SGE withdrawals from 2007 until 2014 accounted for 8,822 tonnes, while WGC demand accounted for 5,629 tonnes over this period. We can only correct the difference of 3,193 tonnes by1,300 tonnes when taken into account contrasting metrics, leaving a difference of 1,893 tonnes.
5,629 tonnes (WGC demand) + 1,893 tonnes = 7,522 tonnes, which is genuine (estimated) Chinese gold demand for 2007 until 2014.
I’ve found more detailed rules on the workings of the Chinese gold market regarding, (i) the use of onshore renminbi for contracts traded on the Shanghai International Gold Exchange (SGEI), (ii) gold sales of Chinese domestic gold mines. Previously I’ve written posts on these subjects that contained inaccurate information that I would like to correct. (My previous posts are already corrected.)
First, let’s have a quick look at the latest Shanghai Gold Exchange (SGE) withdrawal numbers. In week 22 (June 1 – 5) withdrawals came down 12 % from the week before at 32 metric tonnes. Year to date 1,015 tonnes have been withdrawn. The current downtrend is completely normal as seasonally the summer months are quiet in the Chinese gold market, as opposed to the months around new year.
SGE Customers Can Use Onshore Renminbi For SGEI Contracts
Chinese citizens in the mainland that have an SGE account are allowed to use onshore renminbi to buy physical gold contracts on the Shanghai International Gold Exchange (also referred to as the International Board or SGEI). On May 30, 2015, I published a post on the current status of trading rules at the SGEI regarding the use of onshore renminbi by domestic traders. From a source at the SGE I was told domestic SGE members (banks, refineries, etc) can trade SGEI contracts using onshore renminbi, but domestic SGE customers (citizens, corporations) cannot. Afterwards I came in contact with an employee of the SGEI who told me this is incorrect, in reality both SGE members and SGE customers can use onshore renminbi to trade International Board contracts. I checked with a source at ICBC and he confirmed SGE customers can use onshore renminbi to trade SGEI contracts.
Important to understand is that if SGE customers buy SGEI contracts they own gold stored in the Shanghai Free Trade Zone (offshore), but they’re not allowed to withdraw this gold and/or transport. Likewise if SGEI members purchase SGE contracts (in the mainland) they’re not allowed to withdrawal and/or transport.
This is the corrected segment from my post May 30, 2015:
Since September 2014 international traders can use offshore renminbi to trade all contracts on the International Board and most contracts on the Main Board (they can only withdraw gold from International Board contracts stored in the Shanghai FTZ). Domestic traders can trade all Main Board contracts and International Board contracts. Although, only a few Chinese banks – to my knowledge ICBC and China Industrial Bank – offer domestic clients SGEI brokerage to use onshore renminbi to trade International Board contracts.
Have a look at the next table for an overview. Kindly note, delivery is not the same as withdrawals (/load-out).
In my previous post I quoted Wang Lixing (also known as Roland Wang, Managing Director China for the World Gold Council) saying:
China’s domestic investors still cannot conveniently participate in trading on the International Board. Key reason is control on foreign exchange, which the International Board requires the use of the offshore renminbi.
Now I know SGE customers can also use onshore renminbi on the International Board I disagree with Wang even more.
Not All Chinese Domestic Mining Ouput Is Required To Be Sold Through The SGE
A few years ago I’ve written, “all output from Chinese mines is required to be sold though the SGE”, based on the rule:
All PRC [People’s Republic of China] gold producers are … required to sell their standard gold bullion through the Shanghai Gold Exchange…
Later I found out what standard gold bullion encompasses in the Chinese gold market; gold bars of 50g, 100g, 1Kg, 3Kg or 12.5Kg, with a purity of Au9999, Au9995, Au999 or Au995. Meaning, not all output from Chinese mines is required to be sold through the SGE, only when doré/ore is refined into standard gold bullion it’s required to be sold through the SGE.
In my opinion this rectification is not a game changer. Because the SGE has the best liquidity in the Chinese domestic gold market miners want to sell through the SGE, so they mostly cast standard gold bars to sell.
Mining output and scrap supply can be refined into standard gold bullion or non-standard god bullion, if standard gold is traded over the SGE or SHFE it’s exempt from VAT. Standard gold traded off-SGE is not exempt from VAT. Non-standard gold (for example jewelry) traded off-SGE is exempt from VAT (if there is value added, the value added would enjoy VAT), but many buyers and sellers like to trade standard gold bullion over the SGE for the liquidity and because this gold is granted of the highest quality.
Imported gold can be standard gold bullion or non-standard gold bullion (like doré). Imported standard gold is required to be sold though the SGE. I’m not sure at this stage what the rules are for imported doré/ore, though I know much of it is refined into standard gold and sold through the SGE. (It’s likely the rules for imported gold are the same for domestically mined gold.)
In short, there are many incentives that drive supply in the Chinese domestic gold market to be sold through the SGE. Hence, SGE withdrawals (the demand side) is such significant data.
The author of this post would like to have lunch some time with the architect of the Chinese domestic gold market, but doesn’t yet know who this person(s) is.
More false arguments – that should explain the difference between Shanghai Gold Exchange (SGE) withdrawals and Chinese gold demand as disclosed by the World Gold Council – are being spread in the gold space. The most recent argument is gold export from China.
Since 2013 I’ve been writing the World Gold Council (WGC) is grossly understating Chinese gold demand. The aggregated difference between SGE withdrawals and WGC demand from 2007 until 2014 is 3,354 tonnes. Though many arguments have been tested the Western consultancy firms have not been able to elucidate the difference – illustrated by the fact many new arguments keep appearing.
Chinese Gold Export Has Got Nothing To Do With SGE Withdrawals
Against all odds, the ‘export’ argument was presented by Phillip Klapwijk, former Executive Chairman of GFMS, currently Managing Director of Precious Metals Insights Limited (PMI), at the Bloomberg Intelligence Forum in London May 22, 2015, where Klapwijk talked specifically about the ‘supply surplus’ (the difference) in the Chinese gold market. I wouldn’t be writing this post if I would agree with Klapwijk. (PMI is nowadays the main data provider for WGC demand figures.)
In a previous post I’ve expanded on Chinese gold trade rules (click this link to read a detailed analysis). All we have to do now is refresh our memory and have a look at what Klapwijk said in London. There is no transcript of his speech, but Lawrie Williams from Mineweb.com has written an article about Klapwijk’s argument regarding gold export, I assume Williams has reported accurately or Klapwijk wouldn’t have tweeted a link to the article.
The slides from the presentation can be found on the PMI website.
Klapwijk’s argument: gold is exported from China mainland, which explains the difference between SGE withdrawals and WGC demand.
Chinese do export gold – to Hong Kong
…Indeed he [Klapwijk] asserts that this [gold export] has been happening in sufficient quantity to cover virtually all the imbalance between SGE figures and those of the Western analysts over the past two years.
I have a few reasons to believe this is not true:
1) Chinese gold export has got nothing to do with SGE withdrawals as gold is only allowed to be exported from Free Trade Zones, which are separated from the Chinese domestic gold market (the SGE system). It’s prohibited by the PBOC to export gold from the Chinese domestic gold market.
Gold export from China to Hong Kong is nothing new, in contrast to Williams’ headline. Since I’ve been publishing data and charts on gold trade between Hong Kong and China I’ve always included gross import and export.
Not only are these figures well known, it’s also well known gross gold trade between Hong Kong and China has got nothing to do with the Chinese domestic gold market and the SGE system. Gold can only flow in and out of the mainland through processing trade in Free Trade Zones, such as Shenzhen right across the border with Hong Kong. What is net imported into the mainland is done through general trade; this gold is required to be sold first through the SGE. The PBOC does not allow gold to be exported from the Chinese domestic gold market.
Gold that is exported from China is always processing trade from FTZs, it’s not gold from the SGE and therefor can’t have anything to do with the difference we’re after.
It’s pointless to measure total Chinese gold supply by Chinese gross import like Klapwijk does. Gross import has got nothing to do with the Chinese domestic gold market and Chinese gold demand.
Additionally,Round tripping inflates gross gold trade. Round tripping is always done through processing trade; speculators import and export gold from FTZs (usually between Hong Kong and Shenzhen). Because gold used in round tripping can make more than one round – the same batch of gold is imported and exported over and over again – Hong Kong/China gross trade data captures far more gold than is used for genuine processing trade (jewelry fabrication). For example, if 50 tonnes are round tripped 6 times, gross import and export are inflated by 300 tonnes, though nothing has been net imported into the Chinese domestic gold market.
2) Gold is smuggled from Hong Kong to China, not the other way around as Klapwijk states. From Williams’ article we can read:
…the China/Hong Kong border has been pretty porous, with very big movements of gold bullion, much in the form of very low mark-up jewellery and artefacts, from Mainland China into Hong Kong.
The low mark-up artefacts are just round trip products in my opinion. They certainly are not smuggled SGE bars.
Let me describe an example of how gold between Hong Kong and the mainland flows: gold bullion is exported from Hong Kong to Shenzhen, then the bullion is manufactured into jewelry and exported back to Hong Kong where thousands of jewelry shops are located (genuine processing trade). In Hong Kong consumer prices for jewelry are significantly lower than in the mainland because of tax rules, as we can see in the next slide from Chow Sang Sang Jewelry.
As a result, many mainland tourists visit Hong Kong to load up on jewelry and return home. It’s common knowledge mainland tourist can walk across the border without having to declare gold jewelry. Chinese customs at the airport is very stringent on the export side, not on the import side (into the mainland).
So, bullion flows from Hong Kong to the mainland, then back to Hong Kong as jewelry and then it’s ‘smuggled’ into the mainland by tourists. No doubt gold is also smuggled from China to abroad, but I have no data on this.
3) Klapwijk greatly overstates Chinese gold export numbers. Let us turn to another slide compiled by Klapwijk.
Although it has got nothing to do with SGE withdrawals, in the slide above it’s shown China exports 1,000 fine tonnes every year based on Hong Kong customs data. Needless to say, I fully disagree; let’s do some number crunching. If I check the numbers on bullion, jewelry and articles from the Hong Kong Census and Statistics Department in 2013 I get totally different results (source import data, source export data). The next chart is based on my calculations and estimates from looking at Klapwijk’s previous chart.
Quite some discrepancies. For the amount ‘gold bullion’ traded have a look at a screenshot from the Hong Kong Census report below. It’s disclosed Hong kong imported 337 tonnes of bullion from China in 2013 – the disclosed value matches this tonnage. I don’t see how Klapwijk can come up with 250 tonnes.
Moving on to jewelry. After scanning the customs reports there was only one item I could find that can be used: “ARTICLES OF JEWELLERY AND PARTS THEREOF, OF PRECIOUS METALS OR METALS CLAD WITH PRECIOUS METALS (G)”, code 89731. Below you can see a screenshot.
Because the weight is in GRAMS, not in KILOGRAMS as is ‘gold bullion’, the total tonnage is 209 metric tonnes. The total value is 39 billion Hong Kong dollars (HKD). The description of this category tells us the jewelries are made of ‘precious metals’, which can be gold, silver or platinum, it’s impossible to know exactly how much gold content is in the jewelry. Additionally, the total value includes gems and fabrication costs. If we deny silver, platinum, gems and fabrication costs and compute the total value to fine gold tonnes, the outcome is 104 tonnes (at a USDHKD exchange rate of 7.75 and a gold price of 1,500 USD). I don’t see how Klapwijk can come up with 450 tonnes.
Same story for articles, I get 1 tonne in contrast to his 300 tonnes. If someone can tell me what categories in the Hong Kong customs reports do capture a few hundred tonnes of fine gold I would be happy to change my numbers. Until then, China does not export 1,000 tonnes of gold to Hong Kong every year.
If the argument is, gold is smuggled out of China and doesn’t appear in Hong Kong trade statistics, that’s another story. In 2014 gold was trading at a small discount on the SGE relative to international prices for substantial periods, this could have triggered smuggling. But, in this scenario SGE bars (bullion) would have crossed the border with Hong Kong, not low mark-up jewelry and artefacts.
The New Silk Road initiatives, also known as the “One Belt, One Road” plan, proposed by President Xi Jinping in September 2013, have been joined by over 60 countries and will rebuild and amplify a network of land and sea routes from East Asia to the rest of Asia, Africa and Europe. The multiple projects aim to boost connectivity between Asia, Europe, the Middle East and Africa.
The initiatives include a cluster of finance approaches. Among others these are the Silk Road Investment Fund, Asian Infrastructure Investment Bank, Eurasian Economic Union, ASEAN Economic Community and Shanghai Cooperation Organization. Grounded on long-term finance capabilities, well-defined economic objectives, and the commitment of China and Russia, these projects and the Silk Road region overshadow multiple projects that share one common denominator and shake up the current lopsided global economy, creating a more multi-polar world.
For the Silk Road project to fly, financial endowments should equal ambition. Indeed, many ideas for large transnational infrastructure investment are floating around in the post-crisis, low-growth environment. The U.S. Central Asian economic and infrastructure integration program in 2011 and recently the Investment Plan for Europe, or the Juncker Plan, seeks ways for infrastructure investment to revive the economy.
Yet, these projects run risks related to their confusing objectives, and their puny and uncertain finance capabilities exist only on paper.
The Silk Road initiatives stand out for their strong financing backdrop, namely Asia’s large foreign exchange reserves. The emerging Asian holdings of forex, the outcome of over 30 years of policies aimed at promoting export growth, amount to about US$ 5.5 trillion.
The total currency reserves in emerging markets have fallen recently. The International Monetary Fund reported foreign reserves in emerging markets in aggregate fell US$ 114.5 billion on a year-over-year basis to US$ 7.74 trillion in 2014, down from their peak of over US$ 8 trillion in the second quarter of last year.
The shrinking forex pie is likely due to the sharp weakening of the euro, but this development should not put the region’s economies at risk because emerging Asia remains the primary creditor of the world.
China – holding nearly US$ 4 trillion in forex as of June 2014 – is eager to make better use of this huge pile. In a matter of months, it slashed its forex reserves to US$ 3.7 trillion by May. With the priority of seeking investment opportunities and providing monetary services through the Silk Road initiatives, the People’s Bank of China plans to inject US$ 62 billion of its forex reserves into two state-owned policy banks, the China Development Bank (CDB) and Export-Import Bank of China (EXIM), to support the projects.
The capital injection will provide long-term foreign currency for the banks and will be carried out through converting entrusted loans into stakes. The PBOC will become the second-largest shareholder of the CDB and the biggest shareholder of the EXIM bank.
Gold and the New Silk Road
Part of the Silk Road initiative is the Silk Road Gold Fund, which aims to raise 100 billion yuan (US$ 16 billion) within five to seven years to invest in gold-related business and mining companies in countries along the Silk Road.
China is the world’s largest producer of gold, and also a major importer and consumer. Among the 60 countries along the Silk Road, numerous Asian countries are identified as important reserve bases and consumers of gold.
Two top Chinese gold producers, Shandong Gold Group and Shaanxi Gold Group, will own 35 percent and 25 percent of the new financing source, respectively. The fund may also include an exchange-traded fund for gold and investments in miners of the precious metal.
The gold fund will be run by a new company, under the umbrella of the Shanghai Gold Exchange, to be established by gold producers and financial institutions, and is expected to facilitate central banks’ redeployment of forex reserves into gold. The fund is to increase gold trading in yuan, internationalizing the yuan and increasing China’s pricing power over gold.
The New Silk Road Investment Fund and the Silk Road Gold Fund are not just a new paradigm of infrastructure finance. Designed to fill the gap of finance infrastructure, these two facilities will enable central banks to diversify and redeploy their excess forex reserves. The gold fund is particularly important to this objective because it will ease gold purchases by central banks in the countries that are part of the New Silk Road development project. In this way, forex reserve managers will benefit from portfolio diversification, and at the same time, they can convert excess reserves into a nearby institution, which guarantees rapid availability to help cool off currency disorders.
The Dollar’s Retreat
The buildup of emerging market reserves from US$ 1.7 trillion at the end of 2004 to US$ 7.7 trillion in 2014 underpinned the global economy. Much of the capital that Asia’s emerging markets absorbed from trade surpluses, portfolio inflows and direct investments was swapped into U.S. and European debt markets, fuelling low interest rates and debt growth in developed economies.
Countries along the New Silk Road are originating a new way to use their savings, and that is a game changer with relevant implications on developed economies, mainly on the U.S. Treasury bonds market.
Russia is swiftly unwinding its U.S. Treasury bond position, from US$ 171 billion in October 2012 to US$ 70 billion in April, down 59 percent. Since January, euro assets held by Russia’s central bank have transcended its dollar assets, at 46.1 percent of total forex reserves, versus 39.6 percent. Russia has also been steadily buying gold; official gold reserves jumped from 403 tons in January 2007 to 1,247 tons in April, up 209 percent.
China’s U.S. Treasury holdings have remained relatively flat, at around US$1.2 trillion, since 2010, according to Treasury International Capital estimates. The PBOC claims to have held 1,054 tons of gold since 2009, though it may have three times that amount; estimates vary wildly. It’s an open secret that the PBOC buys gold in the over-the-counter market. How much they have accumulated is anyone’s guess.
In 2014, Alan Greenspan, a former president of the Federal Reserve, said that by redeploying even a relatively modest part of China’s foreign exchange reserves into gold, the yuan could take on unexpected strength in today’s international currency system. Buying gold bullion to displace the U.S. from its position as the world’s largest holder of monetary gold, China would likely incur a penalty for being wrong, in terms of lost interest and the cost of storage. Yet it would be a modest cost, if in the end this clears the way to a multiple and more balanced international monetary regime, less at the mercy of U.S. domestic objectives.
Miriam L. Campanella is a senior fellow at ECIPE in Brussels and associate professor at the faculty of political sciences, University of Turin in Italy. Koos Jansen is a researcher at precious metals exchange BullionStar in Singapore
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.
In this post we will analyze everything there is to learn about PBOC gold purchases. Grasping the exact size of their official gold reserves is unfortunately impossible, assuming they have more than what is publicly disclosed (1,700 tonnes late 2015), but there are many clues they’ve covertly bought hundreds if not thousands of tonnes of gold since 2009.
The purpose of this post is to get an overview of all clues and data in order to separate the facts from speculation regarding PBOC purchases.From there we’ll estimate how much above ground gold is held in China mainland – official (PBOC) and private reserves.
I have been writing for a long time the PBOC does not buy any gold trough the SGE, therefor PBOC purchases must be seen in addition to the flows of gold going through the famous bourse in Shanghai. Though, I deem it necessary to expand on this assumption one more time. I’ll tell you what I know and what I think.
We have a fairly good view on how much gold is going through the SGE and how much (non-monetary) gold is net imported into China from countries like the UK, Switzerland, Hong Kong and Australia (after which it’s not allowed to be exported and thus is accumulated in the mainland). If we add domestic mine supply to imported gold we can estimate how much gold is held in reserves by the Chinese. But, are any of these visible gold flows bought by the PBOC? If not, how much does the PBOC buy abroad in addition to the visible flows we see entering China mainland through the SGE? These questions are the springboard for our investigation.
Why The PBOC Would Not Buy Gold Through The SGE
I’ve made a list of reasons why the PBOC would not buy gold through the SGE:
1) The PBOC would prefer to buy gold with US dollars, while all physical gold on the SGE is quoted in yuan. To get a better grip on this subject it helps if we understand why the PBOC would buy gold in the first place, so let’s sum up all possible incentives. The main objectives for the PBOC to accumulate physical gold are:
Supporting the renminbi for its internationalization (adding trust and credibility).
Owning hard currency as the cornerstone of capitalism.
Owning reserves that protect the Chinese economy from external/internal shocks and inflation.
Owning neutral reserves that are not controlled by a foreign nation (the US).
Diversifying its excessively large US dollar (USD) reserves.
Hedge their USD reserves.
Overthrow the USD hegemony.
After reading this list it should be clear the PBOC rather buys gold with their foreign exchange reserves than with renminbi – China’s FX reserves are worth about $3.5 trillion and mostly held in USD. The amount of gold currently on the PBOC’s balance sheet is disproportionate to the amount of USD held. Hence, the PBOC would prefer to exchange USD for gold. All gold on the SGE is quoted in yuan, meaning the PBOC can’t exchange USD for gold through the SGE. Therefor, the PBOC is more likely to buy gold abroad and these purchases should be added to the visible gold flows we see entering the mainland through the SGE.
2) The PBOC would prefer to buy gold in large 12.5 Kg bars, which have nearly never traded over the SGE. It should be said the SGE is a subsidiary of the PBOC. In 2002 China’s central bank erected the SGE to develop the domestic Chinese gold market; for the people to trade gold in yuan. Thegold bar sizes available on the SGE are 50 gram, 100 gram, 1 Kg, 3 Kg and 12.5 Kg. Though, the volume of 12.5 Kg contracts (Au99.5 and iAu99.5) ever traded on the SGE is close to nil.
Only the 50g, 100g, 1 Kg and 3 Kg bars are traded, which are consumer sizes. This is a sign the PBOC is not likely to be buying gold through the SGE. Gold in large 12.5 Kg bars is relatively cheaper and more attractive for central banks. All central banks, that I know of, hold large bars.
3) The PBOC would prefer to hide its gold purchases. The reason we don’t know how much Chinese official gold reserves are is because this is the best kept secret in China. The PBOC buys gold in utmost secret or it would influence the market and geo-politics. If we think from the PBOC’s point of view, why would they leave a single trace when buying gold? Why would the PBOC buy any gold through the SGE for the world to see? I think they wouldn’t.
The PBOC, having an incentive to exchange its superfluous USD in the international OTC market for gold, is actually obliged to monetize the gold it buys abroad. And when these purchases are transferred to China they will not be disclosed in foreign customs statistics. Subsequently, monetary gold imported into China does not go through the SGE – we can see only the non-monetary small gold bars go through the SGE. Therefor, all visible gold exports to China, traded over the SGE, are not PBOC purchases in my opinion.
5) The PBOC would prefer to buy gold in an OTC market, not over an exchange like the SGE. The majority of global gold trade is done through the London Bullion Market; the most liquid market there is. This is not a central exchange like the COMEX, but an Over The Counter (OTC) market where buyers and sellers connect (electronically) one on one to trade gold without nosy analysts taking notes. The gold traded can be Loco London – located in London – or elsewhere. The London Bullion Market is ideal for the PBOC, as opposed to the SGE.
6) Another reason for the PBOC to buy abroad would be because it’s cheaper. Gold on the SGE often attracts a significant premium over London spot. Why pay that premium? Especially, if one is buying large quantities.
7) There is anecdotal evidence the PBOC covertly imports gold. Gold industry expert Jim Rickards has written in The Death Of Money (2014):
A senior manager of G4S, one of the world’s leading secure logistics firms, recently revealed to a gold industry executive that he had personally transported gold into China by land through central Asian mountain passes at the head of a column of People’s Liberation Army tanks and armored transport vehicles. This gold was in the form of the 400- ounce “good delivery” bars favored by central banks rather than the smaller one- kilo bars imported through regular channels and favored by retail investors.
This is very interesting. Not only because it demonstrates the PBOC prefers 400 ounce (12.5 Kg) bars over 1 Kg bars, but more so because it confirms the PBOC does not import gold through visible channels. This strengthens my assumption the PBOC does not buy any gold through the SGE. Again, all visible import (in general trade) is required to be sold through the SGE in China.
For information on how monetary gold might be imported into China by the military please read my post China’s Gold Army.
8) The SGE chairman has stated only consumers buy gold over his exchange. On the LBMA Bullion Market Forum in Singapore on 25 June, 2014, a speech was delivered by Xu Luode, then Chairman of the Shanghai Gold Exchange. Let’s read a snippet from Xu:
Last year, China imported 1,540 tonnes of gold. Such imports, together with the 430 tonnes of gold we produced ourselves, means that we have, in effect, supplied approximately 2,000 tonnes of gold last year.
The 2,000 tonnes of gold were consumed by consumers in China. Of course, we all know that the Chinese ‘dama’ [middle-aged women] accounts for a significant proportion in purchasing gold. So last year, our gold exchange’s inventory reduced by nearly 2,200 tonnes, of which 200 tonnes was recycled gold.
Xu mentions the amount of gold imported into China mainland in 2013 (1,540 tonnes). Would Xu be allowed to break China’s best kept secret on an LBMA forum? Would any of these imports end up at the PBOC? I don’t think so. Moreover, Xu explicitly says all imports and mine output (and scrap supply) has been sold through the SGE system to consumers, not the PBOC.
9) SGE withdrawals are elevated when consumer buying is strong. When examining SGE gold purchases by withdrawals from SGE designated vaults, we can depict a seasonal trend of strong demand around New Year (and in April 2013 when the price of gold made its famous nosedive). The Chinese people typically buy gold in this period as gifts for each other. Does this trend look like PBOC activity? No.
10) The WGC assumes the PBOC doesn’t buy gold through the SGE. From Understanding China’s gold market, July 2014:
China’s authorities have a range of options when purchasing gold. They may acquire some of the gold which flows into China; there has been no shortage of that. Butthere are reasons why they may prefer to buy gold on international markets: gold sold on the SGE is priced in yuan and prospective buyers – for example, the PBoC with large multi-currency reserves – may rather use US dollars than purchasing domestically-priced gold. The international market would have a lot more liquidity too.
11) All reliable sources I have regarding the Chinese gold market tell me the PBOC would not buy gold through the SGE. One of these gentleman with ties to bullion banks confirmed to me proxies of the PBOC purchase gold directly in the London OTC gold market that is shipped to Beijing with “own airplanes” (possibly by the Chinese gold army). A Chinese banker also told me the PBOC buys gold “in the OTC market”.
…We talked to the head of the largest refinery in Switzerland and he told us directly that all that metal that’s coming out of London (904 tons YTD) is being refined into kilo bars and send to China, as well as metal that’s coming in from other areas in the world, that’s all going to China. It’s way more than is being reported or moved through the exchanges. All the kilo bars go to the Chinese people but the PBOC is likely only buying good delivery.
With ‘good delivery’ Alex means the 12.5 Kg large bars that are not being sold through the SGE, but are imported as monetary gold into China without showing up in any country’s customs reports. The quote very clearly indicates that 12.5 Kg bars are imported into China for the PBOC without moving through the SGE.
Why The PBOC Buys Gold Through The SGE
For a balanced view, below are the counter arguments:
1) Gold traders on the SGE buy the dips. In the previous chart we could see SGE customers are very keen on buying the dips. Is this buying pattern caused by clever consumers or is the PBOC perhaps in play here? (My response would be, currently the SGE has 8,358 institutional customers – and 7.33 million individual customers, I believe these buyers can perfectly be responsible for the buying pattern we see on the SGE with regard to withdrawals in relation to the price of gold.)
2) Part of the gold sold on the SGE can be found on the balance sheets of Chinese commercial banks. Some analysts think this gold can be flipped to the PBOC’s balance sheet in the future. There is a lot of metal on the balance sheets of Chinese banks. Although the annual reports of the banks do not specify these holdings other than “precious metals”, presumably they can be gold, silver, platinum, gold savings accounts, gold swaps, leases, pledges, derivatives, and much more. Let us read a little through the annual reports from ABC, CCB and BOC to learn what these “precious metals” consist of:
Precious metals comprise gold, silver and other precious metals.
… As a major precious metal market maker in the PRC, the Bank provided customers with precious metal trading, investment and hedging services through leasing gold, trading of precious metal derivative to customers and trading physical precious metal in the Shanghai Gold Exchange, the Shanghai Futures Exchange and the London precious metals market.
In 2014, … the number of customers with the Account Precious Metals totalled 16,103,300.The Bank proactively explored Precious Metals Trading (Shanghai Gold Exchange) Agency business and the number of contracted customers of Individual Precious Metals Trading (Shanghai Gold Exchange) Agency business amounted to 2,160,700. It introduced innovative products including silver leasing for enterprises and PC client for Individual Precious Metals Trading (Shanghai Gold Exchange) Agency business.
With respect to investment and financial market business, the Bank introduced innovative products such as sales of physical precious metals to corporates…
The Group entered into various derivative financial instruments relating to … precious metals and other commodities for trading, hedging, asset and liability management and on behalf of customers.
As we can read the “precious metals” on the bank balance sheets can be many gold (or silver) products. I’m positive all this gold has at some point been through the SGE system and therefor belongs to the visible gold flows. But for now, let’s be open minded to the possibility some of this gold can be added to the PBOC balance sheet in the future.
Song Xin, President of the China Gold Association, General Manager of the China National Gold Group Corporation and Party Secretary, wrote I an opinion editorial in July 2014:
Establish a Gold bank. We need to establish our gold bank as soon as possible, and enable it to break the barrier between the commodity and monetary world. It can further help us acquire reserves and give us more say and control in the gold market. It may be guided under the PBOC and led by the China Gold Association, involving leading gold industry companies and commercial banks, and it’s business would include: gold pricing (fix), gold financing and leasing, gold-guaranteed payments, gold saving accounts, gold lending, gold production chain financing and issuance and trading of paper gold and other gold investments. This gold bank can then naturally use market-oriented methods to change commodity gold into monetary gold reserves, thus help us increase our strategic gold reserves.
3) All over supply in the Chinese gold market went to the PBOC. Probably the most logical reason why analysts think the PBOC buys gold through the SGE is because of the huge difference between SGE withdrawals and consumer demand as reported by the World Gold Council (WGC). Let’s have a look at this difference in a chart.
As you can see there is an immense difference between the purple bars (WGC demand) and the red bars (SGE withdrawals). Possibly some of this gold has been moved to PBOC vaults. (I’ve extensively been writing on these pages the difference was not filled by PBOC purchases - for a lot of reasons – but, I’ll briefly let go of this analysis here, simply to be able to present all pros and cons.)
4) The PBOC buys discounted gold on the SGE to support the Chinese gold market. There have been periods in, for example, 2014 in which gold on the SGE (Au99.99) traded at a discount to London spot. When the price in China is lower than in the UK this means there is relatively more supply in Shanghai than in London. In the periods of persistent discounts on the SGE – i.e. March 2014 – withdrawals remain quite high. Is the PBOC buying the discounted gold to take possession and support SGE trading?
I shall rest here. The purpose of the listed arguments is to provide you with as much information about the Chinese gold market and PBOC purchases as possible.
In short: according to my analysis the PBOC does not buy gold through the SGE!
How Much Gold Does The PBOC Hold?
What do we know about how much the PBOC is buying (abroad)? Allow me to present the clues we have:
1) From a study by Zhang Bingnan, Vice President of the China Gold Association, we can read the PBOC buys approximately 500 tonnes a year (August 2012):
Forecast the optimal gold reserve capacity in the next 20 years. The conclusion is: 2020, China’s gold optimal reserves should be 5,787 tonnes – 6,750 tonnes. 2030 should be 8,995 tonnes – 10,532 tonnes.
2) Yi Gang, deputy Chinese central bank governor, stated the PBOC is able to buy approximately 500 tonnes a year (March 2013):
We will always keep gold in mind as an option in reserve assets and investments. We are able to import 500-600 tons a year, or more, but we will also take into consideration a stable gold market. If the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers. We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small.
3) Song Xin, President of the China Gold Association, wrote on July 2014 the PBOC should first aim to reach the 4,000 tonnes mark:
That is why, in order for gold to fulfill its destined mission, we must raise our [official] gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.
4) According to Deutsche Bank Markets Research the PBOC buys 500 tonnes a year (November 2014):
In another example, the Chinese government’s open market purchases of roughly 500 tonnes per year have not prevented the gold price from plummeting in recent years.
5) Numerous Chinese analyst suggest the PBOC aims to hold 5,000 tonnes in official gold reserves. Roland Wang, World Gold Council China Managing Director, said (March 26, 2015):
China currently holds about 1.6 percent of its foreign exchange reserves in gold, which is relatively low compared with developed countries and some developing countries, WGC China managing director Roland Wang said.
“The ideal amount should be at least 5 percent of its total forex reserves,” Wang told Reuters in an interview in Hong Kong.
Remarkably, the exact same day Reuters published Wang’s statement Chinese newswire Caixin published a story on gold written by Hedge Fund manager Li Sheng (March 26, 2015):
Gold accounts for only 1.6 percent of China’s forex reserves. This is only a fraction of the figure in the United States and many other developed countries. If China ever increased the level to 5 percent, it would have an enormous impact on global demand for gold.
Li mentions the exact same numbers as Wang from the World Gold Council on the same day: 1.6 % and 5 % of total FX reserves. If China would announce they hold 5 % of total reserves in gold, this would translate into roughly 5,000 tonnes.
If the PBOC would have more than 5,000 tonnes of official gold reserves their ‘gold to GDP ratio‘ would be on par with to the US, Europe and Russia. One of the theories about our current international monetary system – that was detached from gold in 1971 – is that it can shift to a new gold anchored system when the power blocks have equalized the chips (Jim Rickards). In other words, if the US, Europe, Russia and China all have an equal ratio of official gold reserves to their GDP, the international monetary system could make a transition towards gold.
6) Jeremy East, Managing Director Global Head, Metals Trading, Standard Chartered Bank, stated the PBOC is planning to support the renminbi with gold for internationalization (June 25, 2014):
I was at the Shanghai Derivatives Forum at the end of May and one of the speakers was a representative of the [China] Gold Association. He gave us quite an interesting insight into the flavor of what is going on in China from a strategic perspective. Some of the things he talked about included that China planned to change the landscape of world gold markets. He talked about having a strong currency and about having that currency backed by gold, like the US dollar. He also talked about people holding more gold and encouraging more people to hold gold. That is not just individuals, but also the central bank. …
(By the way, China is not planning to “back” their currency with gold in my opinion, they’re more likely to “support” their currency with gold at no fixed parity.)
7) The PBOC could have bought as much as 1,750 tonnes of gold in London in between 2011 and 2015. Although, it’s virtually impossible to track monetary gold flows around the world, as these are exempt from international merchandise trade statistics, the least we can do is try. In September 2015 Ronan Manly and Nick Laird conducted an investigation with respect to how much monetary and non-monetary gold was present in the UK. Luckily, the London Bullion Market Association (LBMA) had published a few estimates in recent years about the total amount of physical gold in London (monetary and non-monetary). In 2011, there were 9,000 tonnes in London. In 2015, there were 6,256 tonnes in London – likely all in 12.5 Kg Good Delivery (GD) bars. These estimates from the LBMA combined with Manly and Laird their investigation have resulted in the next charts (conceived by Nick Laird, Sharelynx):
For a better understanding of physical gold located in London you can read this post by Ronan, this post by Nick or have a look at the next illustration conceived by Jesse from Cafe Americain:
Remarkably, according to estimates by the LBMA the total amount of gold in London decreased by roughly 2,750 tonnes in the period from 2011 until early 2015, while UK’s customs department discloses only 1,000 tonnes were net exported as non-monetary gold during this period. Implying, 1,750 tonnes have been (covertly) exported as monetary gold.
8) Dutch newspaper NRC Handelsblad published an article in 1993 about a 400 tonnes gold sale from the Dutch central bank that was partially bought by the PBOC (you can read a translation of the article here). From NRC:
“With 99 percent certainty we know that the People’s Bank of China has been one of the buyers of the Dutch gold”, said Philip Klapwijk from Goldfields Mining Services, an institute in London affiliated with the South African gold mines that specializes in research into the gold market. Also other London bullion dealers have a strong suspicion that China was involved in the gold sales of DNB. “We have noted that the Chinese central bank has bought gold in recent months”, said John Coley of the London bullion dealer Sharp Pixley and spokesman of the London Bullion Market Association.
I should add, in the nineties the PBOC was the primary (monopoly) dealer in the Chinese domestic gold market and in theory could have sold the gold to Chinese jewelry fabricators.
9) The PBOC could have bought as much as 600 tonnes of gold in Hong Kong in 2013. The PBOC (or its proxies like SAFE, CIC and the Bank Of China) is likely to buy bullion from places like the UK, US, Switzerland, Hong Kong or Singapore; the big gold hubs. Possibly, gold has at some point been imported into one of these countries, and disclosed in their respective customs reports as such, after which it was exported to China as monetary gold, without being disclosed in any customs reports. Let’s take Hong Kong for example. From January 2013 until March 2015 Hong Kong has net imported 836 tonnes of gold, illustrated in the chart below. That is a lot of gold for a country with 7 million inhabitants.
Some of this gold could have been visibly (non-monetary trade) imported into Hong Kong, and then invisibly (monetary trade) exported to PBOC vaults in Beijing. Resulting in less residual gold present in Hong Kong than data from the local Census Department indicates.
Facts And Speculation
Let’s chew on some numbers. In the first chart below I’ve plotted a conservative estimate of the total above ground gold reserves in China mainland on 30 September 2015.This conservative estimate is based on the assumption the PBOC has bought 654.5 tonnes of gold since 2009, totalling at 1,708 tonnes in September 2015 (this is what the PBOC officially discloses).
What about the amount of private reserves displayed in the chart? Let me explain my calculations from the starting point in 1994: Precious Metals Insights (PMI) has estimated that 2,500 tonnes of gold where held by population in the mainland in 1994, that’s the dark grey jewelry base you can see in the chart. The PBOC official reserves in 1994 accounted for 394 tonnes. In addition, Chinese domestic mining was 90 tonnes in 1994. Below is a chart showing historic Chinese domestic mining output.
China is said to be a gold “importer since the 1990s”, suggesting domestically mined gold was not exported after 1994. In the next screen shot from the China Gold Market Report 2010 we can read “China has been a gold importer since the 1990s”.
Furthermore, China began importing (non-monetary) gold a few years ago, have a look the next chart that shows historic gold trade between Hong Kong and China. Net imports ramp up in 2010. Other countries than Hong Kong, such as Switzerland, also started to visibly export to China after 2010.
So, the starting point in the first chart on Estimated Total Gold Reserves in China is computed as:
Subsequently, I’ve added yearly domestic mining output, as the Chinese didn’t net export any gold since 1994, and net imports every succeeding year in the chart. I’ve subtracted all PBOC official reserves gains before 2007 from cumulative domestic mining, the gains after 2007 have I have not subtracted from cumulative domestic mining. Why? Two reasons:
The Chinese domestic gold market (SGE) was fully liberalized in 2007 after which I think the PBOC stopped taking in any gold from domestic mines.
According to my calculations, from 2003 until 2009 total Chinese gold supply (scrap + mine + import from Hong Kong) wasn’t sufficient to meet total consumer demand and 454 tonnes in PBOC purchases over that period. Although the PBOC claims all purchases before 2009 were done from domestic mines and scrap, I don’t think that’s possible. Hence, I think the PBOC started invisible import somewhere in between 2003 and 2009. And therefor, anything the PBOC added to its official gold reserves after 2007 I did not subtract from cumulative domestic mining.
Lead by the aforementioned calculations, the PBOC had accumulated 1,708 tonnes and the Chinese private sector 13,070 tonnes on 30 September 2015 (in total 14,778 tonnes). This does not capture gold in the black market, that thrived before 2002, neither any assets from wealthy Chinese families. It’s the most conservative estimate I can make using all data I could find.
However, in my opinion the PBOC has bought a lot more gold in recent years. What all the clues mentioned above have in common, is that the PBOC has bought roughly 500 tonnes of gold per year since 2009. Let’s make a new more speculative chart:
The above chart is a copy of the previous conservative estimate, supplemented by 500 tonnes per year since 2009 in PBOC purchases, which I have not subtracted from cumulative domestic mining or cumulative import, as my assumption is this gold has invisibly been imported and not bought through the SGE.
Speculating: the PBOC has accumulated 4,000 tonnes and the Chinese private sector 13,070 tonnes as of 30 September 2015 (in total 17,070 tonnes).
Above you could read clues from Song Xin (China Gold Association, July, 2014) and Jeremy East (June 25, 2014) about China working on a new monetary system that will include gold. Something similar was said by Zhou Ming, General Manager of the Precious Metals Department at ICBC, when Jeremy East asked him at the LBMA forum in Singapore (June, 2014) if the statement “Western gold moves East” was true:
With the status of the US dollar as the international reserve currency is shaky, a new global currency setup is being conceived. Uncertain changes will happen to gold’s traditional dollar-pricing so the US dollar’s influence on gold pricing needs to be re-evaluated.
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