The World Gold Council (WGC) confirmed in February that 2013 saw China replace India as the world’s largest consumer of gold. For many gold market watchers, that announcement raised the question of how China came to take that position — and, more importantly, if it will be able to keep it. 

This week, the WGC came forward once again, this time with a report that answers both of those questions. Titled China’s gold market: progress and prospects, it outlines the factors that led to China’s rise to dominance and gives an overview not only of how much gold the country consumes, but also of where it’s going. In addition, it looks at the gold supply situation in the Asian nation.

The report’s conclusion is simple: “China’s gold market development is solid, on-going and for the long term.” Occasional setbacks are possible, but “the country’s massive population, continued rapid economic growth and, critically, its deeply rooted pro-gold culture” will keep it in the spotlight for many years to come.

For those interested in a more in-depth look of what’s in the WGC report, here’s an overview of its six main sections.

The climb to the top

Explaining China’s path to prominence, the WGC states that over the past several decades, China has transformed “from a poor, under-developed country to a major trading nation with burgeoning levels of wealth and a positive growth outlook.” Its gold market has followed the same path.

However, that development was not without stumbling blocks. For instance, in 1950, the country prohibited private ownership of gold and placed the gold industry under state control. It wasn’t until after 1978 that a gold market was gradually re-established, the WGC notes, and it took until 2002 for it to really begin to accelerate. Even now, the Chinese gold market is indirectly controlled by the state, though “gradual moves towards greater openness” are expected.

While continued gold demand strength moving forward is not guaranteed — particularly in the event of a “major financial crisis” — the WGC believes that overall, China’s ”economic outlook is positive for gold demand.”

Jewelry: the “bedrock” of Chinese gold demand

But who exactly is consuming all that gold? One answer is jewelry buyers — indeed, the WGC describes jewelry as the “bedrock” of Chinese gold demand, a fair statement given that it accounted for 60 percent of all private sector demand for the metal in 2013. Factors driving Chinese consumers toward jewelry made of the yellow metal include:

  • Accessibility: China has the largest jewelry manufacturing base in the world, as per the WGC. Last year, more than 85 percent of the 724 tonnes of gold jewelry fabricated in the country “were destined for the domestic market.” 
  • Middle-class consumers: The economic growth mentioned above has created a Chinese middle class with enough “disposable income to purchase higher value non-essential items” like gold jewelry.
  • More weddings: An increase in the age of the working population and more weddings have “underpinned growth in the number of jewellery consumers.”
  • Gifts: In addition to weddings, gold is often used as a gift on occasions like Valentine’s Day.

Threats to gold jewelry demand in China exist; nevertheless, the WGC sees it reaching at least 780 tonnes by 2017. This year, however, expect to see consolidation follow 2013′s “spectacular advance.”

Investment demand’s “special year” 

Chinese investors are also snapping up gold. Though bullion investment was “effectively prohibited in China” until 2004, since then demand for bars and coins has “soared,” hitting 397 tonnes last year, according to the WGC. That, the group states, reflects the fact that people in China have few investment options; it also points to investors’ desire to not rely too heavily on “volatile equities, illiquid property and bank deposits that pay negative real rates of interest.” Other demand drivers include:

  • Accessibility: Like gold jewelry demand, Chinese investment demand for gold has risen in part because it has become easier for people to get their hands on the metal. At the moment, “investors in China can purchase gold bars on the telephone, via the internet and at over 100,000 bank branches.”
  • Fear of inflation: Past events in China have left many residents with a “deeply ingrained fear of inflation.”
  • Poor stock market performance: Fearing manipulation, many Chinese investors steer clear of the stock market, preferring gold as a commodity that is traded internationally.

Medium-term prospects for investment demand are “very positive,” and it could rise to 500 tonnes by the time 2017 rolls around. Even so, the WGC again notes that 2014 should bring consolidation.

Expect a moderate rise in industrial demand

Industrial demand for gold isn’t a topic that comes up often, but the WGC devotes a short section of its report to that topic. It comments that such demand has grown strongly in China over the last 10 years, climbing to 66 tonnes last year. The next four years should see it rise moderately, driven by further growth in China’s gross domestic product, as well as by industrial production.

How much gold in reserve?

Of course, China itself is also a gold consumer. While the country has told the International Monetary Fund for the last four years that its official monetary gold reserves sit at 1,054 tonnes, the WGC notes that there has been much speculation as to whether China has increased those holdings. That guessing game has been spurred in part by “occasional ‘pro-gold’ and ‘anti-dollar’ statements from senior officials and other important personalities in the country” and the “growing apparent ‘surplus’ in the local market, after taking into account supply, demand and net imports.”

China certainly has reason to add to its gold reserves — the WGC notes that the country’s exposure to the US dollar is “outsized,” a situation that is undesirable for reasons such as geopolitical rivalry. That exposure would be mitigated by reducing its gold holdings.

Speaking to Mineweb’s Kip Keen, Marcus Grubb, managing director of investment strategy at the WGC, agreed, “[y]es, there is an ambiguity around some of the figures in China; and not only China in regard to the gold market I might add. In fact if you look at the gold market in China there’s clear evidence that more physical gold has gone in since around 2009 than is accounted for annually in measured consumer or industrial demand.” Even so, he said the WGC “stand[s] by the current reserve of 1,054 tonnes in China at the moment.”

That said, the report cautions that based on China’s past actions, any release of new gold reserves data “would occur at a time of [the country's] own choosing, and certainly not be in response to any market rumours.”

World’s biggest gold producer

In closing, the WGC touches on gold supply to China. It emphasizes that even though China imports a huge amount of gold, largely from Hong Kong, it still mines the metal as well. In fact, the Asian nation is the world’s largest gold producer, last year accounting for about 15 percent of global output. Around 600 mines produced that gold, states the WGC, but the market is “fragmented” in that half of it was put out by the top 10 producers. The WGC believes that in the long term, the country will not be able to produce more than 400 tonnes of gold per year.

Scrap supply is also a source of gold in China. Domestic scrap comes mainly from jewelry, and as a result has increased along with Chinese jewelry demand. Imported scrap, on the other hand, is derived mostly from electronics.

 

Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article. 

Related reading: 

China Set to Overtake India as World’s Biggest Gold Buyer

World Gold Council: Consumer Demand Hit Record High in 2013

2012 Top Gold-producing Countries