China Becoming The Most Important Factor In Global Gold Markets

Includes: FXI, GLD, IAU
by: Hard Assets Investor

By Amine Bouchentouf

Ever since China entered into its series of five-year economic plans in the late 20th century, it's not a stretch to argue that its economic rise has been one of the most impressive in human history. Growing at close to double digits per year, China is lifting hundreds of millions of people out of poverty and has embarked on one of the greatest industrialization phases the world has ever known.

As I've been writing for more than a decade, China may be the most important factor influencing key industrial commodities such as iron ore, copper, and coal. China is already the biggest consumer and/or producer of the above-mentioned commodities, and its influence on other natural resources is expanding on a daily basis. In this installment, I will examine the quiet but steady role that China has had in the gold markets in recent years. Many market participants don't realize it, but China is arguably the most important factor in the gold market today.

The Biggest Gold Producer in the World

A lot of casual observers fail to realize that China is now the biggest gold mining and producing country on the planet. For more than 100 years, the country that dominated the gold mining market was South Africa. Blessed with large reserves of ore, an entrepreneurial mining culture, and a strategic geographic location, South Africa was the world's leader in gold production for centuries.

That all came to a crashing halt in 2007, when China overtook South Africa as the No. 1 gold producer globally. What's remarkable is the speed and scale with which China has been able to take the top spot. In 2006, China produced 248 tons vs. South Africa's 272 tons. Now, China produces more than 370 tons per year and may in fact reach 400 tons very shortly. What's even more impressive is that China has been able to ramp up production while all the other top-producing countries (such as South Africa, Australia, and the United States) decreased production.

As other countries have scaled back production due to labor, environmental, and logistical issues, the Chinese gold industry went into a consolidation phase and now produces more than 60% of its gold from only five provinces. China's state-owned and semi-state-owned gold companies are now some of the biggest in the world. From its position as not only the biggest gold producer, but also the fastest-growing gold producer, China has undeniable influence in setting gold prices globally.

One of the Top Global Gold Consumers

In addition to its dominance on the supply side, Chinese demand ranks it as the second most important consumer of gold products globally. Along with India, China is part of the two-country block that makes up for the bulk of global demand for physical gold products. While India currently holds the top spot for gold consumption, China is quickly closing in on its Asian counterpart and may soon overtake it as the biggest gold consumer.

Asian countries, led by India and China, have a deep-rooted belief in gold as the ultimate store of value and as a safe-haven asset. When farmers are blessed with a good harvest, the first thing they go out and buy is gold, whether in the form of gold bars or jewelry. Chinese gold consumption is growing at double-digit rates annually, driven in large part by rural consumers but also by niche urban markets. For example, the number of pawnshops in Chinese cities has exploded, which has helped increase demand for gold since consumers can now use their yellow metal as collateral for temporary financial solutions.

From its position as one of the biggest consumers of gold, China wields significant influence on setting prices, procurement policies, shipping routes (where to purchase the gold), and other key factors.

The Dominant Force in Gold Markets?

In addition to its dominance in both the supply side and demand side, China is playing key leadership positions throughout the intricate logistical and financial chain. For example, Chinese mining companies are now some of the most active gold miners in key producing regions such as Africa, Latin America, and Southeast Asia. Chinese companies have significant operations in key mining countries such as South Africa, Australia, Ghana, Peru, and Brazil.

Through these activities, China's reach into the gold market is global, as it controls significant amounts of the supply chain in key producing regions. This has often come at a cost of constant friction between Chinese mining companies and their host countries. Ghana, for example, has expelled Chinese mining companies and workers who were aggressively exploiting the country's gold mines without proper licensing and infrastructure. This just goes to show how far China's influence in the gold markets has gone.

Another key market that China may soon come to dominate is the gold ETF market. Over the last decade, the ETF space has been dominated by American firms who have launched and sponsored ETF products to reach a mass investor base. Most of the consumers of gold ETFs have been American and European funds. In a recent move, China has also made its way into the space by launching the first two gold ETFs to be traded on the Shanghai Stock Exchange.

As I wrote previously, there has been a disconnect between the physical markets (dominated by Asian buyers) and the paper markets (dominated by U.S. and E.U. buyers). With this move, China looks as if it may come to dominate this segment of the market as well. Of course, this will not happen overnight, since the ETF market in China is still in its infancy. For investors, it's critical to keep an eye on what China is doing, since it has such a significant impact on various segments of the gold market.

Disclosure: The author is long on gold.