Chinese people have a tradition of keeping gold for the next generation. Now, they apparently want more gold, not simply for their children, but for the sake of investment and maintaining the value of their assets.
A combination of a lackluster local stock market and a state-led clampdown on property speculation are set to spur private capital flows into gold and push up prices that have already topped US$1,200 per ounce.
Beijing has responded to this growing private demand by pledging to expand the domestic gold market with the ultimate aim of helping stabilize the country’s financial sector. The People’s Bank of China (PBoC) said on August 3 that it would further open the gold market and improve tax policies for investment in the precious metal.
Banks will be allowed to trade more gold and steps will be taken to develop renminbi-backed gold derivatives. There is to be some alteration in foreign exchange policies with a view to bringing more foreign players to the market – currently only five overseas banks, including HSBC (HBC.NYSE, HSB.Euronext, HSBA.LSE, 0005.HK) and Standard Chartered (STAN.LSE, 2888.HK), are members of the Shanghai Gold Exchange. Greater foreign participation means higher turnover and more potential counterparts for domestic banks keen to hedge their gold positions.
This liberalization will "help improve the competitiveness of financial markets" and "help expand investment channels to meet domestic investor needs," the central bank said in a statement.
China is already the world’s largest producer of gold and second-largest consumer after India, but domestic demand is expected to exceed supply. The World Gold Council predicts that China’s consumer gold demand will double in tonnage over the next decade. Over the past five years, demand has risen at an average annual rate of 13%.
In 2009, Chinese consumers purchased 461.9 tons of the metal at a total value of more than US$14 billion – 11% of global demand.
This is in part a reflection of the limited investment opportunities open to Chinese individuals. Cash is being siphoned out of the stocks and real estate, but with interest rates trailing inflation rates, bank deposits are not an attractive option. Gold is more viable, and although prices are down from the June peak, they are still up for the year.
The unknown factor in all this is Beijing. Do the reforms signal a move by the government to boost central gold reserve and thus further drive up prices?
There has long been talk in the market that Beijing wants to use its huge foreign exchange reserves to buy more gold as a means of diversifying its investment portfolios with the US and European economies still so weak. Official gold holdings have risen by more than 400 tons in the past few years to 1,054 tons. This is the sixth largest holding globally but it accounts for less than 2% of China’s foreign exchange reserves.
Beijing is likely to channel more of its foreign exchange into gold, but it would only do so gradually. The last thing the government wants is to create waves in the currency and commodity markets.
China’s partial liberalization of the gold market should be viewed in the context of economic stability.
First, by encouraging private investment in gold, the government is steering people away from the volatile equities and real estate markets towards an asset that is inherently stable. This would ease the impact of any future financial crisis.
Second, an active and liquid gold and gold derivatives market will help retain foreign capital on the mainland. The government is continually wary about “hot money,” which flows in and out of the country in big, rapidly gathering waves, largely based on expectations of currency appreciation.
Third, placing more importance on gold will boost the independence of China’s monetary policy.
The government has been gradually opening up the gold market for some years now, setting up the Shanghai Gold Exchange and encouraging banks to offer gold investment products. An easing in restrictions on gold imports will likely see more products launched into the market. These may include the already well established "paper gold," or gold saving accounts, wealth management products aimed at middle-class investors and an exchange-traded fund for gold in Shanghai.
All in all, gold will be a good investment in the next few years against riskier assets amid economic uncertainties and tighter financial regulations. China’s rapidly-growing market for the metal suggests a solid bull run ahead.
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