Koos Jansen
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Koos Jansen
Posted on 8 Apr 2015 by

Zooming In On The Chinese Gold Lease Market

The primary reasons mainstream gold analysts (and the media) don’t use Shanghai Gold Exchange (SGE) withdrawals as an indicator for Chinese wholesale gold demand, are – after a few others have been tested – Chinese Commodity Financing Deals (CCFD). Regarding gold these financing operations can be be conducted through round-tripping or gold leasing. Because of the structure of the Chinese gold market round-tripping gold flows are completely separated from the Chinese domestics gold market – the SGE system, and thus SGE withdrawals. There is no need to further investigate round tripping for our understanding of the Chinese domestic gold market.

Turning to gold leasing. The Chinese gold market is structured as such that gold leases are settled on the SGE; lessor and lessee come to an agreement after which gold is transferred from the lessor’s SGE Bullion Account to the lessee’s SGE Bullion Account. As I’ve stated previously lessees will only withdraw gold from the vaults of the SGE when the leased gold will be used in genuine gold business (The World Gold Council agreed with me in email correspondence), as a lessee that is merely seeking cheap funds has no interest in obtaining physical gold, he prefers to sell the leased gold spot at the SGE for its proceeds. Therefor, leasing gold for acquiring cheap funds adds little distortion to total SGE withdrawals when used as wholesale gold demand indicator.

However, to get to the bottom of this, which seems to be my mission in life, we must zoom in on the Chinese gold lease market. Below I present an article written by Minsheng Banking Corp in 2014, translated by Soh Tiong Hum and BullionStar’s Sales Executive See Hong Kang. The article provides essential data on the Chinese gold lease market, for the first time we can read how total lease volume is compounded, what industry segments are leasing how much gold and in what tenors total volume is divided. In a separated post we will analyze these numbers, as I’m still talking to SGE staff and Chinese banks to be positive on the meaning of all numbers. 

If you are confused about what the article states as being Chinese consumer gold demand (1,170 tonnes in 2013), consider this China Gold Association (CGA) estimate is measured at retail level and likely only from sales by CGA members. To familiarize with all demand metrics used in the Chinese gold market read this post.    

Some data handles:

2013 CGA vs WGC

Translation of the Minsheng Banking Corp article, written by Tang Xiang Bin, 2014:

Gold Supply & Demand, Gold Leasing And Shenzhen Market Research Report

Abstract: In 2013, domestic consumer demand for gold reached a record high of 1,170 tonnes for the first time, more than 35 % over 2012. As rationality returns to consumers, 2014 domestic gold demand may retrace back to normal levels after being depleted by last year’s explosive growth. As imports are able to meet gold demand, China’s gold market shall move from shortage to balance. We expect this year’s first quarter gold and jewelry spending year on year growth will drop to 10 – 20 % of the normal level, while second quarter gold consumption demand will slow further. Expected 2014 domestic gold demand should stay between 900 – 1200 tonnes.

2013 ushered in explosive growth in the gold lease market. The domestic gold lease volume grew substantially to 1,070 tonnes, an increase of 268 % y/y. Based on demand, 2013 gold leasing by enterprises and brand makers reached 781.1 tonnes, 73 % of the year’s total volume, which shows that China’s jewelry market is the most important customer segment. From the rate of growth, interbank gold loans grew rapidly. 2013 interbank leasing increased 439 % y/y which indicates that financialization of gold between China’s banks have strengthened.

Because China’s economy and credit market both face risk of deleveraging this year, gold leasing can satisfy banks’ need to expand their business as well as meet financing needs of gold enterprises when there is a credit crunch in the background. Therefore deleveraging is conducive to the growth of the gold lease market.

At the moment, Shenzhen already has the largest domestic gold and jewelry processing base, the largest center of demand for spot gold, the largest gold wholesale center, the largest physical gold settlement and the largest OTC market. In other words, Shenzhen has a competitive advantage for developing gold market activities. Backed by strong demand and an industrial chain, gold leasing in Shenzhen has great potential and space for development.

End of abstract

minsheng gold lease market report 2014

Domestic gold demand in 2013 grew enormously due to substantial fall in the gold price. National gold consumption grew to all-time high of 1,170 tonnes, a 35 % increase y/y. Although last year’s gold demand was not evenly distributed, volatile fluctuation between domestic and foreign gold prices reflected the fluctuation in demand. Large increases in gold imports were able to satisfy this sudden increase in demand. We expect this year’s jewelry consumption growth to retrace to normal levels. Gold consumption in 2014 shall maintain between 900 – 1200 tonnes. Following a rise of gold inventory in recent years, gold leasing enters a phase of explosive growth. 2013 gold leasing reached 1,070 tonnes worth RMB 300.6 billion, 268 % higher y/y. With deleveraging going on in 2014, both banks and clients have stronger interest to push gold leasing. Therefore gold leasing should maintain the trend of high-speed growth, hopefully becoming a bright spot when banks are going through downturn.

After explosive growth in 2013, domestic gold demand should retrace to normal this year

Gold demand in 2013 goes through huge growth

China’s domestic gold demand experienced explosive growth last year, overtaking India as the world’s number one gold consumer. For the whole of 2013, transacted spot gold (AU99.99) at Shanghai Gold Exchange hit 3,188 tonnes, 280 % growth y/y. Explosive growth shows demand for spot gold at the exchange exceeded the 2012 level. Besides the exchange, domestic consumer demand (especially in the first half of the year) also experienced explosive growth. For the whole of last year, Gold jewelry consumption broke a record with RMB 296 billion, 34 % increase y/y. In the second quarter, gold jewelry consumption broke quarterly record with RMB 82 billion, 28 % of the whole year.

Gold imports can satisfy domestic gold demand

Increase in gold imports satisfied explosive growth in gold demand. In 2013, gold demand grew explosively. 2,197 tonnes of physical gold left the SGE that year, a 193 % increase y/y. Because domestic production of gold is unable to meet demand, imports became an effective means. Import from Hong Kong increased significantly. In 2013, gold import from Hong Kong reached 1,498 tonnes, 179% increase y/y. Importing gold can satisfy domestic demand effectively.

As gold imports increased, the ability of commercial banks to supply the gold market increased visibly. Since 2012, China’s import from Hong Kong and SGE’s settlement volume on a monthly basis appeared to be consistent. The logic is really simple: The more gold the commercial banks are able to import, the stronger the ability of other participants in the gold market to provide gold liquidity. Conversely, if the banks lower the volume of gold imports, the ability of participants in the market to provide liquidity for gold would weaken. This year, the banks operating in the gold market have seen a test of their ability to react to a demand growth explosion.

Last April’s drop in the international gold price stimulated an explosive increase in demand for spot gold. Vibrant domestic demand quickly depleted inventory so that SGE’s Au(T+D) settlement dropped rapidly. Inventory dropped to 24.85 tonnes, the lowest level in May that implies power by banks and enterprises to deploy gold nearly withered. Gold imports stabilized domestic supply. Deployment by banks and enterprises recovered shortly, SGE’s Au(T+D) settlement also returned to normal.

After rise in demand, domestic gold demand will retrace to normal

It’s noteworthy that 2013’s explosive demand may be ‘abnormal’ consumption because it was triggered by the major correction in the international gold price since many years. As rationality returns, it is difficult to sustain this demand this year. Fact is consumption demand in the second half of 2013 already began weakening. China’s gold jewelry consumption growth y/y already weakened from July’s 44.7 % to 33.9 % at year-end. Demand at the SGE also weakened visibly. SGE’s monthly spot gold transactions fell from a year-high of 358 tonnes in July to 210 tonnes by October. In addition, SGE’s monthly withdrawals fell from 235 tonnes in July to 139 tonnes in October. We estimate that both figures will continue to slowdown and we should see the growth rate return to its’ normal 10 – 20% and gold demand at between 900 – 1200 tonnes.

The scale of gold lease market will continue to grow quickly

Over the past few years, the gold lease market has developed from nothing till the scale it is today. At last count in 2013, 23 commercial banks have gold leasing operations and the businesses participating in leasing have mushroomed to close to a thousand. In terms of scale, last years leasing market grew explosively with leased volume reaching 1,070 tonnes, a 268% increase y/y. Based on demand, 2013 gold leasing by enterprises and brand makers reached 781.1 tonnes, 73% of that year’s total volume, which shows that China’s jewelry market is the most important customer group. From the rate of growth, interbank gold loans grew rapidly. 2013 interbank leasing increased 439% y/y, which indicates that financialization of gold between China’s banks has strengthened. Because China’s economy and credit market both face risk of deleveraging this year, gold leasing can satisfy banks’ need to expand their business as well as meet financing needs from gold enterprises when there is a credit crunch in the background. Therefore deleveraging is conducive to the growth of gold leasing.

Gold lease market grew explosively in recent years

The gold leasing volume reached 398.06 tonnes in 2012. The breakdown of the lease volume:

  • Interbank leasing was 21.82 tonnes, 5.48% of total.
  • Refining companies leased 72.9 tonnes, 18.31% of total.
  • 110 tonnes was used to produce brand name gold products, ie, gold products with brand names, 27.78 % of total.
  • Leasing for jewelry and industrial use accounted for 192.76 tonnes, 48.42% of total.

In 2013, the gold leasing volume grew substantially to 1,070 tonnes, a 268 % increase. The breakdown of the lease volume: 

  • Interbank leasing was 117.7 tonnes, 11% of total.
  • Refining companies leased 171.2 tonnes, 16% of total.
  • 363.8 tonnes was used to produce brand name gold products, ie, gold products with brand names, 34% of total.
  • Leasing for jewelry and industrial use accounted for 417.3 tonnes, 39% of total.

Based on growth, gold lease demand in 2013 increased by more than 100%. Interbank lending grew by 439 %, refining companies leasing grew 135 % and brand name companies leasing increased 116 %. Increase in loans between commercial banks indicate that rise in demand pushed the growth in activity between commercial peers as well as increasing financialization of gold in China’s banks. Based on demand, 2013 gold leasing by enterprises and brand makers reached 781.1 tonnes, 73% of that year’s total volume, which shows that China’s jewelry market is the most important customer group.

The Chinese gold lease rate reached its top in the second half of 2013 at 10.2 %, the lowest rate was 2.1 %, the average was 4.19 %. Among various tenors of lease contracts, 1 year leasing accounted for 44.26 % of total contracts, 6 to 12 months was 35.24 %, 3 to 6 months was 10.38 % and less than 3 months 10.12 %.

Gold lease market has prospects to be a bright spot in banking that is deleveraging

China’s economy and credit market are facing risk of deleveraging this year. In the deleveraging process, ‘big’ business drivers that banks enjoyed in the past few years are consolidating whereas ‘small’ drivers that have unique proposition have the prospects to become a bright spot.

Firstly, first quarter economic statistics came in below market expectations. Important economic numbers like manufacturing value added, retail sales and investments look weak which leaves hints that first quarter economic growth is likely to come in below government target. Secondly, this year’s M2, new loans, financing numbers are evidently slowing down which indicate that China is undergoing deleveraging. In this macro environment, banks are trapped in a dilemma. On one hand, deleveraging forces banks to be wary of risks associated with ‘big’ businesses that have been expanding tremendously. On the other, banks are pressured to deliver profits. Under pressure from such concerns, banks are more willing to develop businesses that are not constrained, not high-risk and have unique propositions. Gold leasing can satisfy banks’ need to expand their business as well as meet financing needs of gold enterprises when there is a credit crunch in the background. Therefore deleveraging is conducive to the growth of gold leasing.

Along with the flow, Shenzhen has best competitive advantage to develop gold market

Map Shenzhen China

After nearly 2 decades, a multi-layered gold market was shaped in Shenzhen. It’s supported by manufacturing, driven by physical trade and supplemented by leasing. In the 1980s, Shenzhen took over Hong Kong’s jewelry manufacturing by offering lower costs. After 20 years of development, Shenzhen became an integrated production, value-added processing and wholesale chain. According to data from the People’s Bank of China, the value of gold and gem-set jewelry production and processing is 70% of the total (Chinese jewelry production and processing) and the export value for gold jewelry is 30% of the total (Chinese jewelry production and processing). Shenzhen, therefore, qualifies to be the largest processing base, the largest wholesale center and most competitive city. Based on such an achievement, Shenzhen conceived the earliest domestic jewelry retail market, which transformed a very visible gold market.

At the moment the Shenzhen gold market has SGE membership system, commercial banks and OTC gold trading. Products include jewelry, physical gold, paper gold as well as gold leasing. SGE’s historical data shows that Shenzhen physical gold delivery is 45% of national total that makes it the largest delivery location. Data from the Shenzhen Gold and Jewelry Association states that gold usage in Shenzhen city is 90% of national total. Shenzhen is therefore China’s largest spot gold market driven by trading in physical gold. Based on incomplete data, there were 921 finished gold lease deals in Shenzhen in 2013, with an accumulated gold lease volume of nearly 110 tonnes. This number was 26.36% of the total gold lease volume of gold-using enterprises in ChinaAdditionally, Shenzhen has a massive OTC market but lacks sufficient data for evaluation. Based on estimates, OTC market volume in Shenzhen is comparable to spot trading on the SGE. The OTC market comes in 2 parts:

  1. Non-standard physical gold including gold ore, recycled gold etc. This gold comes from domestic gold sources, passes through Shenzhen and Hong Kong and forms a production-supply-retail chain.
  2. Black market speculation including locking in gold prices, downside hedging and simple profiteering from gold spot and futures.

Shenzhen is already China’s most important gold market. It is the largest jewelry-processing base, the largest demand for spot gold, the largest wholesale center, the largest physical gold delivery location and the largest OTC market. Shenzhen has the most competitive advantage to develop gold business. Backed by strong gold demand and manufacturing, gold leasing in Shenzhen also has tremendous potential and room for development.

Koos Jansen
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  • awgee

    I am confused. Are you saying that there is another exchange, Shenzhen, from which gold is entering the mainland, or is the gold moving through Shenzhen already counted in the the withdrawls from Shanghai?

    • http://goldchat.blogspot.com/ Bron Suchecki

      The reference to Shenzhen OTC market means it is off exchange, ie doesn’t flow through SGE. If it did flow through SGE, this statement wouldn’t make any sense “OTC market volume in Shenzhen is comparable to spot trading on the SGE”.

      This statement “The OTC market comes in 2 parts: Non-standard physical gold including gold ore” is also at odds with the statement “All domestic mining output in China is required to be sold first through the SGE before entering the Chinese market place” (https://www.bullionstar.com/blogs/koos-jansen/the-mechanics-of-the-chinese-gold-market/)
      Need some more clarification.

      • KoosJansen

        OTC trades are negotiated of-SGE, but settled on-SGE. In the weekly report below you can see the OTC volume framed in red. These numbers are not published on the English SGE website.

        • awgee

          Sorry, but I am still confused. I read what Mr. Suchecki read and was/still am unsure of what, “OTC market volume in Shenzhen is comparable to spot trading on the SGE”, means. I read it as saying that the amount of gold traded in Shenzhen is about the same as the amount of gold traded on the SGE. Am I reading that correctly, because it would be surprising if the amounts were close to equal. I was under the impression that the gold traded on the SGE is physically located in Shanghai. Is much of the gold traded on the SGE acually located in Shenzhen?

          Second, can I assume that, “negotiated of-SGE”, is a typo and you meant, “negotiated off-SGE”? If, “negotiated off-SGE”, then my original question remains; is more gold entering the mainland via the OTC Shenzhen market? Or is the gold traded in the OTC Shenzhen market already reflected the SGE withdrawls?

          The statement, “”All domestic mining output in China is required to be sold first through the SGE before entering the Chinese market place”, referenced by Mr. Suchecki would also appear to indicate that the mining output, “The OTC market comes in 2 parts: Non-standard physical gold including gold ore”, that is traded OTC Shenzhen does not meet the SGE gold bar standards. Is the mining ouput that OTC Shenzhen trades first refined and manufactured into SGE acceptable form? Or?

          Bottom line: It appears that there is a large OTC gold market in Shenzhen. Is all the gold traded OTC Shenzhen reflected in the SGE withdrawl data, or does the SGE withdrawl number exclude gold that is round tripped through Shenzhen back to Hong Kong? Or something else entirely?
          Thanks for your patience.

          • KoosJansen

            There are over 50 SGE designate vaults all over China mainland. “Physically” it’s traded between those places. Though Shenzhen appears to have “the biggest vaults”.

            I meant off-SGE. Good questions about OTC market! I primarily focussed on the lease parts of the article, I’ll check with professionals (and if that part is translated correctly). Haven’t spend a lot of work on Chinese OTC market yet. Perhaps non-standard gold is allowed to be traded in the OTC market before it physically enters refineries to be cast in standard gold bars and shipped to SGE vaults.

            There is always more to learn.

          • KoosJansen

            So this is how it is. The rule (page15 https://static.bullionstar.com/blogs/koos-jansen/wp-content/uploads/2015/03/China-Gold-International-Resources-Corp.pdf):

            On October 30, 2002, the Shanghai Gold Exchange commenced operation under the supervision of the State Council. Thereafter, the PBOC ceased its gold allocation and gold purchase operations. All PRC [People’s Republic of China] gold producers are now required to sell their standard gold bullion through the Shanghai Gold Exchange, and prices of gold on the Shanghai Gold Exchange are determined by market demand and supply, which essentially converge with the price of gold in the international market.

            Coz the SGE has the best liquidity miners want to sell through the SGE, so they cast standard gold bars (bars of 50g, 100g, 1Kg, 3Kg or 12.5Kg, with a purity of Au9999, Au9995, Au999 and Au995) and sell the vast majority through the SGE. If standard gold is sold off-SGE it is not exempt from VAT, on-SGE it is exempt from VAT.

            In theory they can sell ore/dore (non-standard gold) off-SGE.

          • http://goldchat.blogspot.com/ Bron Suchecki

            Strictly speaking, miners would not have the capability to refine to 9950 or 9999 or cast standard bars. Given the VAT on them selling dore to the refiner, I’m guessing they would probably get a refiner to toll refine their gold into SGE forms, which the miner can then sell on SGE (or back to the refiner).

            Re the OTC markets, my understanding is that phrase is use only to refer to off exchange business to business transactions and consumer to consumer to business to consumer would not be classed as “OTC” by western commentators and would be called “retail” or “consumer”.

            In the context of this article the use of OTC is fine, but your source/translator should be careful in future to not use OTC for “sell a gold ring to your neighbor, this can be called an OTC trade” type references in future articles as this will be misunderstood by western readers.

          • KoosJansen

            Many mines have their own refinery in China I have been told. (the rule is All PRC gold producers are … required to sell their standard gold bullion through the Shanghai Gold Exchange)

            I think it’s best to let the translator make an exact translation and then for us to learn how to read it. If the Chinese term for OTC is wider, let’s keep that in mind. (Google Translate also translated it as “OTC”)

          • http://goldchat.blogspot.com/ Bron Suchecki

            If a mine has a refinery that demonstrates a high level of industry inefficiency/immaturity – refining dore is an economies of scale business.
            Chinese is a reader responsible language, which means it is the responsibility of the translator to understand the context and choose the correct word. If a language used “man” generically to refer to men and women in some contexts and also in other contexts to refer to men only, then it is not correct for a translator to just robotically use “man” in the translation when the context means “people”. It is not up to the reader to “learn” how to read it as nuance can be lost in the translation and thus the reader has no chance to be able to understand.
            In the case of precious metals or other technical translations you need a translator who is aware of the industry specific terms and issues to give a correct translation. A good example is “consumer” which can mean generically all users of precious metals (individuals and wholesale/industry users) or can also mean only retail individual investors. You interpretation and conclusions about Chinese gold demand can be materially affected if the translation of “consumer demand” was in the broader or narrower sense. If CGA or SGE are using consumer broadly whereas WGC uses it to mean only individuals then aren’t comparing apples to apples. Just something to consider, that’s why I’m picky on this matter.

  • http://goldchat.blogspot.com/ Bron Suchecki

    Worth noting that the references to leasing volumes in this article are to turnover during the year, not balance/amount of leases held at a point in time (which is what I really want to know).

    For example leasing 1t for a month and rolling it each month would give volume turnover of 12t, leasing 1t for two months and rolling would give 6t of leasing turnover – but in both cases the amount leased on an ongoing basis is the same at only 1t.

    • KoosJansen

      That’s what I’m trying to get 100 % confirmed.

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