Why China Wants Low Gold Prices?

One question that has not been asked sufficiently is, “How can China buy well over 2,000 tonnes of gold without sending the gold price rocketing?”

In the U.S. people believe that the gold price will fall even further in 2014 despite indications that Chinese demand will continue at current high levels if not rise even more. This is because U.S. investors have been selling gold to move into the rising equity market. With the developed world focused on events in its own part of the world it is assumed that their influence will dominate the financial world including gold. But this ignores events in the emerging world and their hunger for gold.

With ‘normal’ annual supply to the gold market around 4,000 tonnes annually you would have thought that such a heavy Chinese demand would have propelled gold prices higher. But it didn’t. We have explained why in earlier articles last year. We will write more about this in the future, but in this article we will look at just why the Chinese prefer to see low prices continue.

There are two primary reasons why they want low prices to continue:

• It encourages Chinese retail demand. - With Chinese middle class numbers set to rise considerably as the government there pushes their growth emphasis to the service sector, more and more Chinese will save and a good proportion of that will go into gold. So low gold prices will accelerate the volume of gold bought. Higher prices lower the overall volume of gold bought. The nouveau riche of China will invests in relation to the size of their disposable income, so the more gold they can afford with that, the greater the total volume bought.
• It has increased the supply of gold to China. - Low gold prices has discouraged developed world demand and encouraged more selling of gold in 2013, making a greater volume of gold supply to be made available for the Chinese to buy as it implies that the rest of the world’s gold demand remains subdued. Add to this is the choking off of Indian demand since August 2013, taking the now second largest gold buyer out of the market. Over a year this would remove 800+ tonnes of demand from the market.

As simple market theory tells us, the greater the demand over supply is, the higher gold prices will rise. So how can one buy gold in huge quantities without driving up gold prices? The answer has to be by buying gold outside the market and not buying in the market where gold prices are set. Another answer is to ensure that where one does buy in a market where prices are set, one buys “on the dip”. In other words don’t buy when prices are rising, buy when they are falling and only take the gold that is on offer in the market.

Market Fragmentation

We know that China has and is buying gold mines and can direct the gold of those mines straight to China.

We also know that many gold producers, such as South Africa, are not bound to sell their gold to the London market or direct it to any market [such as they sold to the ‘gold pool’ in the seventies] in particular but can sell to anyone they want.

Traditionally, bullion banks made buying commitments to certain mints and producers to supply gold on a long-term basis, but today they do not have the same hold on newly mined gold, which can go to any solid buyer. A client like a non-banking Chinese importer for large quantities over a lengthy period is as attractive a client now as the bullion bank.

The price paid to the supplier is referenced to the market prices at the time of delivery. Because the gold does not pass through the London gold market it no longer plays a part in determining prices. The more gold that is bought that way [off market], the smaller the London/New York market becomes.

This leaves market like London and its five bullion banks pricing gold on the basis of only part of the global market, so not truly reflecting global demand and supply. If both demand and supply in the traditional markets, such as London, is lackluster the gold prices set there will continue to look weak, despite the massive and rising demand elsewhere.

Indian demand is routed through London, so the loss of such a big buyer knocked the stuffing out of London’s demand. Add to that U.S. selling [also routed through HSBC to London] and it is no wonder that prices fell in 2013. Should Indian demand return once more then gold prices will turn higher.

The loss of traditional demand from India and the additional supply of gold from the U.S. has supported falling or stable low gold prices in London and will continue to do so, ignoring Chinese demand.

We have no doubt that China will continue to buy in a way so as to be a neutral influence on gold prices in 2014.

Agreement between the U.S. and China for lower gold prices?

Some commentators believe there is an agreement between China and the U.S. to suppress gold prices. It is a matter of history that the U.S. does not want gold to be seen as money, but wants the world to believe that the dollar is. China is moving towards elevating the Yuan to a position of a global reserve currency. It appreciates the monetary turbulence that this will bring as the Yuan challenges the dollar and becomes part of a multi-currency reserve currency system. That’s why it is buying gold as a factor that will give the Yuan global credibility. China, once it has acquired a certain level of gold reserves [it will keep increasing them after this point is reached], has every interest in seeing the gold price rise to a point where it is a reflection of true value, whereas the U.S. does not.

Consequently, the two do not have the same objectives or interests as the other. Hence, there can be no agreement between the two to suppress gold. Rather, China is taking advantage of the current state of the gold market and the persistent selling of gold from the U.S. based gold Exchange Traded Funds to acquire the gold that is being sold ‘on the dips’, so as to not drive gold prices higher.

(In the next article we will look at how long China can keep their influence on the gold price as little as we see now.)

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