How to Profit From the Chinese Gold Rush

by: China Play Stocks
The Chinese are buying gold in a hurry. I will start with some numbers and facts synthesized from recent media articles including this Bloomberg report and this China Daily article.
China is the world’s biggest producer of gold, with Chinese mine output reaching a record 340 tons last year. Even with this record production, China’s imports through October 2010 rose to 209 tons and, just in the first two months of 2011, China’s imports climbed to 200 tons. The Industrial and Commercial Bank of China (OTCPK:IDCBF) started opening physical-gold linked savings accounts in December 2010. More than 1 million such accounts have already been opened with more than 12 tons of gold stored on behalf of investors.
The China Daily article reports that jewelers at shopping malls across Beijing are witnessing a gold rush. Beijing Caibai, the city’s largest jewelry store, reported that sales of gold and other jewelry totaled more than 4 billion yuan ($608 million) until March 1 of this year, a 70% increase from last year. Gold sales in large malls city-wide increased by at least 40% in the first two months of this year. This includes gold bar sales, in addition to jewelry.
The impetus for the Chinese retail demand for gold is clear. China’s bank deposit rates lag well behind inflation, resulting in net negative returns for China’s retail savers. The stock market has been lackluster over the last year. Gold prices, on the other hand, have been soaring. So, the average Chinese investor is rushing to buy gold, partly to hedge against inflation and partly to profit from expected further appreciation of gold. This frenzy will continue as long as gold prices keep rising. The Chinese savings rate is quite high and a good chunk of that money is stored as cash in bank deposits. Even a small fraction of this money rushing out to buy gold will result in a further increase in Chinese imports of gold.
The Chinese retail demand is only one half of the story. China’s central bank has been building up its gold reserves to diversify its foreign exchange reserves away from U.S. Treasury bills. China’s gold reserves are small compared to those of other major world economies. See this table of the top-10 reserves:
Click to enlarge
China’s current gold reserve of 1,054 tons is only 1.7% of its foreign exchange reserves. Germany, another leading export power, has 70% of its foreign exchange reserves in the form of gold. China has publicly stated its intention to boost gold reserves. But China has not been more aggressive in boosting its central bank gold reserves for a variety of reasons, including the desire to not make prices unaffordable for its citizens. One Chinese official recently went on record saying that China wants to ensure that its citizens can buy gold without having to compete with the central bank. Any major signal from the Chinese central bank about boosting its reserves will send gold prices soaring as speculators try to front-run the bank. The Chinese officials, as usual, are smart and patient. But the trend is clear, and very bullish for gold as well as for gold producers.
So how can you profit from this Chinese gold rush? You can buy the gold ETFs GLD and IAU. You can buy the gold miner ETFs GDX and GDXJ. A third, albeit a slightly more risky route, is to buy Chinese gold miners. When it comes to serving China’s demand, Chinese miners clearly have a transportation cost advantage due to their proximity. Chinese miners also enjoy lower costs of labor compared to peers. Many Chinese gold mines are open-pit mines which are cheaper to process. Finally, like their global peers, Chinese gold producers have also been expanding globally by acquiring miners worldwide.
Perhaps the safest bet among Chinese gold miners is Zijin Mining Group (OTCPK:ZIJMF). It is China’s biggest listed gold producer by market value. It operates the Zijinshan Gold Mine, which is the largest open pit gold mine in mainland China. It trades at a reasonable P/E of about 16. It also produces copper, so you get the additional benefit of another hot commodity. It recently reported that its 2010 earnings were up 36% even though its gold production was down by about 8%. This article provides the following facts about Zijin’s low costs:

In 2009, Zijin's gold bullion production costs were a mere USD 271 per troy ounce, while its production costs of gold concentrate stood at USD 202 per troy ounce - both very competitive when compared to its global peers, especially since Zijin's cut-off point for low grade ores is at less than 1 gram per ton. According to analyst reports, Zijin's mineral production costs are 30% lower than those of its international gold producing peers.

The following chart shows that Zijin has underperformed both GLD and GDX over the past year. Given the increase in Chinese demand for gold and the relentless rise in the price of gold, Zijin should start to catch up with both GLD and GDX soon.
Click to enlarge

Disclosure: I am long GLD, IAU, GDX, GDXJ, ZIJMF.PK.