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BMO analysts say China’s gold buying binge is just beginning


China's Gold Buying Binge Just Beginning

Analysis by BMO commodity research analysts, Rory Townsend and Colin Hamilton, suggest that above ground reserves of gold in China both privately owned and those owned by the central bank are significantly higher than annual consumer demand and official purchases might suggest. Here are their key points on Chinese gold supply and demand.

Bottom Line

Ongoing purchases by the People’s Bank of China has led to significant market speculation over how much gold China, the largest gold consumer, actually consumes annually. Based on available data it is impossible to conclude if officially stated gold reserves differ to actual gold holdings. That said, our analysis would certainly suggest that above ground reserves of gold in China both privately owned and those owned by the central bank are significantly higher than annual consumer demand and official purchases might suggest. However, given the geopolitical backdrop and concerns over U.S. dollar dominance, we view further net additions to gold holdings as highly likely.

Key Points

RMB weakness has prompted the PBoC to reportedly halt issuance of new gold import quotas. Market chatter suggests that imports over the past one or two months has been from Q2 quotas which are all but used up, and the PBoC is reportedly believed to have stopped Q3 quotas to reduce capital outflows and help strengthen the RMB. Despite the seasonal ebb in demand this has tightened the domestic gold market, helping to lift the Shanghai gold premium over London prices.

We expect total Chinese gold supply to edge up 1% y/y to 532t this year. Despite our forecast for a 2% y/y drop in mine supply (363t), this should be more than offset by a 10% y/y increase in recycled supply. Longer term, we still expect the continued safety and environmental inspections in China, and a crackdown on small-scale mining, to result in mined gold output resuming its structural decline.

Over the last decade, SGE withdrawals totalled 19,115t, while Chinese consumer demand was just 10,741t. The bulk of the disparity between consumer gold demand and SGE withdrawals, often considered a proxy for wholesale gold demand, is believed to be comprised of direct purchases on the SGE from jewellery fabricators, bullion banks, and institutional investors. It is widely viewed that the PBoC does not purchase gold directly on the SGE.

If the PBoC targets holding 5% of its official reserves in gold, it would need to hold ~2,775t. Many industry participants believe that 5% of official holdings being in gold was the magic number, however, that was admittedly prior to the recent flaring of geopolitical tensions and seemingly rising concern over U.S. dollar dominance. At today’s gold prices, this would require an additional 638t of PBoC purchases above current stated holdings.

If China’s central bank gold holdings were to represent the same relative volume compared to M2 money stock as in the U.S., it would translate to 15,320t in total gold reserves. Another conceivable target for Chinese gold holdings is a set proportion of M2 money stock, which at present in China amounts to US$39 trillion. In the U.S. M2 money stock was ~$21 trillion in June, and as such U.S. official gold holdings would equate to 2.4% the relative value. If PBoC gold holdings were to represent the same relative value against China’s M2 money stock it would translate to gold reserves swelling to 15,320t, representing an uplift of 13,183t on officially stated reserves.

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