Tucked away in the Financial Times Annual World Gold Conference in the summer of 1999 was an intriguing presentation by Mr. Ouyang Wei, the then editor of China Money. Wei's thesis, which is applicable to most forms of material consumption in China, was that China is potentially a vast market for gold products.
Per capita annual gold sales, at least according to official statistics, stand at only 0.2 grams, compared with a world average of 1.5 grams. Chinese in Hong Kong and Taiwan buy as much as 9 grams a year. The numbers stack up – if every Chinese bought only one gram more a year, then China's annual demand would be 1,200 tonnes. In an increasingly affluent China, if 10m wedding partners a year could be persuaded to exchange gold rings, then that would graft a new habit onto consumption.
According to official data, China produced nearly, 172 tonnes of gold in 1998 and set a target of 170 tonnes in 1999. Gold Fields Mineral Services, which questions the accuracy of official production data and the way it treats unofficial output, published its own 1998 estimate of 160 tonnes. As for demand, the World Gold Council predicted that sales in China during the first three quarters of 1999 were 149 tonnes, 3 percent higher than in the same period in 1998.
Plans for deregulation
Given the potential of the market, it is not surprising that the World Gold Council, whose role is to promote the use of gold on behalf of its members, has long maintained a dialogue with the Chinese authorities, hoping to bring about a gradual deregulation of the world's last great gold market.
The council has set out its aims in China as achieving major regulatory breakthroughs in the areas of gold flows, pricing and gold operations by foreigners. It also drafted and submitted to the governor of the People's Bank of China proposals that were in part reflected in the reforms introduced by the Chinese in early. 1998. These proposals included moderations in the official People's Bank gold purchase price paid to producers to close to world levels, and permission for the central bank to adjust the gold price without reference to the State Council.
The World Gold Council also acted as advisors to the Chinese authorities in 1998 in combating unofficial supplies to manufacturers in China, and in attempts to price out smuggled gold. To this end it assisted in developing and implementing the testing of a new supply source of gold bars to an official manufacturer in Shenzhen special economic zone. This ties in with China's official policy of using Shenzhen as trial zone for the loosening of jewellery retail price control. Under the trial, the retail price for gold jewellery will be calculated after adding labour costs, including design, and a 5 percent sales tax to the wholesale price of the gold. This is intended to allow jewellers a better profit margin, and act as an incentive to innovate.
Opening of the market
Early in 1999 AngloGold, the world's biggest gold producer and a key member of the World Gold Council, announced that it supported the council's initiative to boost Chinese gold markets. Mr. Bobby Godsell, chief executive of AngloGold, said in Beijing that his company would partner the council in committing resources to assist the industry in China. The international gold industry, already engaged with China in several prospecting and mining joint ventures, is attracted by the potential for major finds in some of the more remote, unmapped areas, and by returns of up to 9 grams per tonne.
At the start of the opening of the sector in 1993, the Chinese authorities tried to restrict foreign participation to `refractory gold' where the return was perhaps less than 1 gram per tonne. Not surprisingly, this did not enthuse foreign companies and in 1997 the existing mineral resources law was amended to allow a much wider range of participation.
The exploitation and sale of gold is a sensitive political issue for many countries, and it is interesting to note in the amended 1997 law a shift in the Chinese government's priorities – Article 4 now specifies that, ?The state-owned [formerly 'state-operated'] mining enterprises shall be the principal force in mining mineral resources.? This seems to imply that the state will stand back from operation and instead rely on ownership.
From the foreign company's perspective, the 1997 law is silent on a number of points that seem to be favourable to foreign investors – for example, there is no maximum exploration or mining period and there is no relinquishment obligation for licences. This is in contrast to the practice of many Asian countries where exploration is limited (for example, to four years in Malaysia) and the mining period curtailed (although it can be for as long as up to 50 years in the Philippines and Mongolia). Furthermore, in China security of tenure and concession transferability are also assured.
A fragmented industry
However, despite the best legal efforts of the authorities in Beijing, the gold industry remains fragmented, with many layers of bureaucratic control from province down to township level, all wanting their cut in this lucrative and portable sector. A number of joint ventures have been suspended over disputes with the local Chinese partner. Elsewhere on the margins, there have been reports of wild-eyed gangs of Chinese prospectors descending Klondike-style on new finds, gouging out the surface ore and then moving on, leaving only the poorer ores and environmental havoc in their wake.
China is still in the process of sorting out its gold policy and taking a realistic, unsentimental view of the monetary value of this asset. It has a strong player in the Bank of China Group, with an enviable reputation for getting the market price right. But even the best players cannot avoid the cost of carrying official reserves of 12.7m ounces, even if China's gold holdings look underweight as a percentage of total foreign exchange reserves when compared to those of the US or European Union.
Furthermore, with international prices recently having fallen to below US$260 per ounce even Chinese mines, with their cheaper labour and rich seams, start to become uneconomic. The new game in town is commoditisation of the gold price – it will fluctuate like other commodities such as oil, wheat, or pig bellies as the laws of sup-ply and demand dictate. And 1.2bn Chinese could represent some demand.
This article was written by John Adams, previously Manager, for China at the Bank of England. His market report Deregulation of the Gold Market in China at 495 pounds (US$750) is available from AMCD (Publishers) Limited, on: telephone/fax: +44 (0161) 434 5105, or by e-mail on: email@example.com