Published February 21, 2014
For investors who thought gold lost its luster, think again. Call it the China effect. Just as the Asian tiger’s hunger for commodities to feed burgeoning infrastructure projects drove up prices of commodities from oil to copper, so too could Chinese demand for gold.
China overtook India last year as the world’s largest buyer of physical gold, according to the World Gold Council. In 2013, Chinese demand for gold bars, coins and jewelry soared 32% to a record high, as China imported 1,066 metric tonnes of the precious metal, or more than one third of the 2,968 metric tonnes of gold produced globally.
And last year’s record wasn’t a one-hit wonder. This year, the World Gold Council expects China to remain the world’s largest consumer of physical gold. While down slightly from last year’s record level, the research body projects China will still gobble up a robust 1,000 tonnes to 1,100 tonnes of gold in 2014. China accounts for roughly 25% of global demand for gold and is likely to boost its share in coming years. The stock of gold in China is less than half of India and consumption per head in China is still catching up to other markets.
The Chinese gold rush comes after China’s government lifted restrictions on gold ownership. Until 2002, Beijing barred citizens from owning gold bars and coins. Culturally there’s been an appreciation for gold for a long time in China, but citizens weren’t able to access it to the extent they have over the past 12 years. Now that China has lifted restrictions, the government has unleashed pent-up demand.
“It’s not coincidental that China increased its annual demand for gold over the past 12 years after it reduced restrictions,” said Juan Carlos Artigas, director of investment research for the World Gold Council in the U.S. “It created the avenue for consumers and investors to access gold more easily.”
As incomes rise in China, people view gold, whether in the form of bars, coins or jewelry, as a natural vehicle for savings and diversification. Shorter term, rising affluence is also driving Chinese to buy gold as a hedge against China’s teetering property sector and a stock market that’s fallen nearly 40% over the past four years. If bouts of cash crunches continue this year and economic data disappoints, that will likely drive Chinese to continue buying gold to preserve their wealth.
While gold is influenced by numerous global investment factors from inflation to monetary policy or economic strength, Chinese demand for gold will likely help drive the metal higher at a time when the Fed is pulling back on its monetary stimulus and the global economy is showing signs of perking up.
The spike in Chinese demand also comes as gold could begin trading on fundamentals again this year – much like stocks – both of which have seen prices skewed by global monetary policy in recent years following the global financial crisis.
Investors shunned gold last year, pushing down the metal’s price by 28%, as the U.S. Federal Reserve signaled it would begin drawing down its multi-billion-dollar bond purchase program and as prospects for the global economy looked up. But 2014 has been a different story for the precious metal. The futures contract for gold for delivery in April is trading at $1,309 per troy ounce, up nearly 9% for the year. The rally in gold has been driven in part by investor concerns that a slowing U.S. recovery could slow the pace at which the Fed draws down its bond purchases.
Peter Sorrentino, senior portfolio manager for Huntington Real Strategies Fund (HRSAX), who called the end of the commodity super cycle in 2012, said China’s demand for gold will be a major driver for the metal’s price over the next several years.
“At some point the world goes back to the supply and demand factors and demand is there,” said Sorrentino. “Production hasn’t been moving up materially over past ten years and demand doesn’t look like it will fade any time soon.”
Along with increasing demand from its citizens, Sorrentino believes China’s central bank will move to increase its gold holdings to hedge its $3.8 trillion foreign currency reserves and guard against any sharp gyrations in currency and capital flows as global monetary policy changes.
India Will Still Drive Gold Demand, too
To be sure, while India is taking a back seat to China, demand for gold from India remains strong. Though Indian demand has recently been tempered by higher import duties, strict import quotas and restrictions on gold-related lending and coin sales, the World Gold Council projects India will import 900 tonnes to 1,000 tonnes of gold this year. That compares with 1,000 tonnes to 1,100 tonnes from China. India and China each account for 25% of global gold demand and are important markets for gold over the long run.
“As China, India and emerging markets increase their share of global GDP they will have a larger impact on the amount of money going into savings from those places,” said the World Gold Council’s Artigas.
Shining Up Your Portfolio
While gold has had a nice rally so far this year, Sorrentino said the selling pressure isn’t over, but that he’s buying on any dips. The fund manager expects the precious metal to experience more volatility in 2014, but end the year 15% higher from current levels and grind higher over the next five years.
He’s also invested in major global miners Freeport-McMoRan Copper & Gold (FCX), Barrick Gold (ABX), Rio Tinto plc (RIO) and BHP Billiton Limited (BHP). To play smaller mining companies his fund is invested in Market Vectors Junior Gold Miners ETF (GDXJ). He’s also playing metals directly through the Central Fund of Canada (CEF) along with actual futures. Huntington Real Strategies fund is up more than 3% this year, compared with the MSCI World Index, which is down 0.17%, and similar commodity funds, which are up about 1%.
Maybe all that glitters is still gold.