China is unlikely to see a surge upswing in demand for the yellow metal this year as the market consolidates after the 2013 price tumble, but forces will drive demand higher in future.

China, which has long had a love affair with gold due to distrust of official money and as a source of jewellery, is unlikely to see a surge upswing in demand for the yellow metal this year as the market consolidates after the 2013 price tumble, but underlying forces will drive demand higher in future, a new report says.

Barring a financial crisis in China – not an unlikely prospect – consumer demand for gold in China remains robust, and even a crisis would boost the attractions of gold as a safe-haven asset, the World Gold Council said.

The WGC’s report comes at a period when gold has seen dramatic price changes in recent months, some of which is attributed to the appreciation in the dollar and the expectation that the US Federal Reserve will turn off the taps of ultra-cheap money. (As gold is priced in dollars, a rise in the currency typically pushes prices down, and vice versa.)

At one point last June, gold fell to $1,180.57 per ounce, having fallen from its record of $1,921.17 reached on September 2011.

Wealth managers in recent years have been notable holders of gold, given its traditional attractions as a store of value and low correlation – at least over long periods – to equities.

The WGC report on China noted that the country has experienced a revolution in attitudes towards private sector holdings and investment in gold since the-then ruling Communist regime banned private dealing in the metal in 1949. Over the past 10 years alone, private persons have been allowed to buy and sell gold. Since 2004, demand for gold bars and coins has soared from 10 tonnes to 397 tonnes in 2013.

Last year, the country accounted for 26 per cent of global private sector gold demand and consumers exploited the price retreat in 2013 to stock up on jewellery and bullion by a total of 259 tonnes, the report said.

“The scope for increased use of gold in portfolios is also considerable, the report said. The pool of private savings is vast with further scope for consumers to increase their exposure to gold. Chinese households collectively hold an estimated $7.5 trillion in bank accounts, while households overall allocation to gold - around $300 billion – is tiny by comparison. In addition, domestic gold prices will most probably remain at attractive and affordable levels during the next few years,” it said.

“The traditional appeal of gold to the Chinese people and consumers’ optimistic outlook for prices should result in private sector demand from all sources climbing to at least 1,350t by 2017,” it continued.

Explaining the surge in private holdings and trading in gold since 2004, the report continued: “This phenomenal increase is connected to the relatively limited set of investment options for savers in China. It is also a reflection of investors’ desire to diversify assets away from an over-reliance on volatile equities, illiquid property and bank deposits that pay negative real rates of interest. We judge that medium term prospects are very positive and demand could reach close to 500 tonnes by 2017, although in the meantime we expect 2014 to be a year of consolidation,” the report said.

Physical is best
Another trend, the report noted, is that Chinese individuals remain keener on holding physical gold than paper proxies or exchange-traded products linked to the underlying metal. However, several gold ETFs haven’t set the market ablaze, the report noted.

“Clearly these [gold] funds have not met expectations – the targets for initial funding were RMB 2-3 billion for HuaAn and RMB 1.6 billion for GuoTai. This is in part due to the fact that these products are aimed at institutional and high net worth private investors. It appears that the negative gold price trend and the related drop in high profile ‘western’ ETF gold holdings during most of 2013 may have put off such potential investors,” the report said.

Supply-side
The report noted that an important reason for the growth in the Chinese investment market in gold has been commitment by banks and authorities to create a modern, accessible market for the metal.

“Currently investors in China can purchase gold bars on the telephone, via the internet and at over 100,000 bank branches. An increasing number of China’s estimated 100,000 jewellery stores now also offer investment as well as gift bars. And this network continues to grow, making bullion products available in parts of the country where formerly they were absent,” it said.
The report went on to notice that another strong reason why people like gold is a long-standing fear of inflation, caused by bouts of hyperinflation during the country’s turbulent history.

The country was hit by hyperinflation in the 1937-49 period during the Second Sino-Japanese War and the final stage of the subsequent Chinese Civil War. Official money fell out of use and there was widespread use of barter, with metals and foreign currencies gaining favour. A more recent inflation period from late 1992 to 1996, when official inflation data hit an annual average peak of 24 per cent, was also a driver of gold prices.