The Chinese Factor

Late in September of 1999 the bullion market was turned into turmoil by the news that the European central banks had used the IMF/World bank meeting in Washington to spring a major surprise; the Washington Accord that limit sales by the participating banks to 400 tons per year for the next 5 years – due to expire in 2004 – and not to increase the amount of gold they out on lease.

The gold price, which had already increased from $255 to $270 in the period just before the announcement (insider trading by central bankers??) spiked to almost $340 in the days that followed. Then, with hard work from the bankers who ‘were staring into the abyss’, according to a private statement by the Governor of the Bank of England, the gold price was brought down to well below $300 again.

On that occasion the reaction to the news was immediate, but then the market was brought under control again; the latter being possible because demand for bullion could be satisfied by gold available from the vaults of the central banks. Last Friday there was another piece of surprise news, potentially of far greater import than the shock of four years ago, but this time the effect is almost sure to take a much longer time to take hold.

This time, though, if the article in Friday’s “China Daily” of Hong Kong turns into fact, the probability of the potential new demand being satisfied from available gold stocks while keeping the gold price under control is zero.

We all know that the Chinese economy has been growing at a furious pace for some years now, with annual growth in or close to double figures more often than not. China is not only building healthy reserves from its growing domination of the export markets, but Chinese households are becoming rich as well – and saving around 30% of their incomes.

All Asian peoples are great savers; Japanese households have saved about $12 trillion, an amount the Chinese lag, having made a much later start. But their savings already sit at an impressive $1,28 trillion.

A second shared characteristic of Asian peoples, though not unique to them, is that gold represents the ultimate form of wealth. Not all of them do it in the manner that is favoured in India, where gold in the form of jewellery forms the treasure chest of each family. Yet it is immaterial whether the preference is for jewellery, coins or bullion – gold is number one on the list of desired assets. Sunil Madhok in a 1999 article at gave a breakdown of the 33 000 tons of gold – as much as there are supposed to be in all central banks – just in private hands in India.

For example, a household with a monthly income between $231 and $578 would own on average just less than one third of a kilogram of gold jewelry. A family with monthly income of $1156-2312 would own as much as 2 kilograms of gold. However, there are 2,5 million households in this category in India, holding a total of 5 000 tons of gold – more than the gold reserves of any single central bank outside of the US.

China is more populous than India, but they are still near the bottom rungs of the earnings ladder. It will be quite a long time before a substantial number of Chinese families will own more than a few tens of grams of gold, let alone a good fraction of a kilogram. Yet, that does not mean that the statement by the gold guru of the bank of China, Xi Jianhua, that it makes a lot of economic sense to lift the current ban on individual trading in precious metals, is of no consequence.

Far from being of low impact, the possibility that the restriction could be lifted as part of a rational approach to some of China’s economic problems, is of much greater import than was the Washington Accord. Four years ago. Consider the statistics.

The China Daily article mentioned the results of a recent survey in which 20% of the respondents said that they would be prepared to invest 20-30% of their savings in gold. While the savings for individual households are relatively low, with limited potential for gold ownership per household, there are say 400 million households in China, of which 80 million could become substantial owners of gold, relative to their resources..

Xi’s calculated the demand for gold, if 20% of savers did invest as per the survey, would be 3000 tons – substantially more than annual production and half as much as the 2000 tons that are being sold over 5 years under the Washington Accord. Xi estimated the initial demand would be 300 to 500 tons, at the level of annual sales under the Accord.


The implications

First we have to wait and see whether China really will raise the restrictions on individual trading in precious metals. We know after decades of confining dealing in gold to the central bank, the Bank of China, the Shanghai Gold Exchange opened a year ago to much fanfare and almost immediate success. However, only a limited few institutions can trade there. We know that the seeds of capitalism have taken root in China, at first only in a few fringe provinces but, with proven success, the whole of China is now on the road to a form of free enterprise – with multinationals shifting their manufacturing operations to China playing an important role in this change. And in so doing enriching the Chinese worker beyond what was previously considered possible.

We know China and the US are at loggerheads largely because of the fact that a weaker dollar does nothing to stem the flow of goods from China – thereby keeping the US trade deficit in record territory – with Chinese authorities very reluctant to let the Yuan, pegged to the US dollar, float to a more expensive level. We also know that Chinese noses are being rubbed the wrong way by persistent airborne spying on their activities by the US as well as the US stance on Taiwan. In not untypical Eastern fashion they are sure to be waiting for the right opportunity to do some nose twitching of their own.

Of course, they have to be circumspect when they do so. With recent memory of Sadam Hussein and Afghanistan and Al Quaeda they know full well the kind of risks they would run if they were to openly act in a manner designed to discomfit the Bush Administration.

However, consider Xi’s reasons why allowing private trading in gold would benefit the Chinese economy. It would invigorate flagging consumption (alternatively, the Chinese save too much!); it would make a good sized dent in an embarrassingly large foreign trade surplus; it would reduce conspicuously large foreign exchange reserves (thereby also reducing over-weighted exposure to the US dollar); finally, with an outflow of funds from China to purchase gold, outside pressure to let the currency appreciate will abate.

These are four very powerful reasons in favour of a relaxation of the control over gold trading. If such a step were to be taken, nobody could accuse the Chinese of doing some nose rubbing of their own, because the logical reasons for doing so are obvious to all and the step can be easily justified in terms of economic fundamentals, including more than ample foreign reserves to fund the purchase of gold.

The statistics for India according to Madhok covered 240 million salaried and wage earners, or households in effect. In China the number of households are half again as many, yet it will take long time before they are on a par with Indian households in terms of earnings and ownership of gold. Yet, also keep in mind the estimates of 3000 tons and an initial 300-500 tons are based on only the 20% of households that responded – say 80 million of them – that they would invest 20-30% of their savings in gold. That still leaves 300 million households not accounted for, few of which would not buy any gold at all.

In other words, the total demand is staggering, well above 3000 tons and possibly double that selective estimate, even though it might take some years to develop fully. All it will require is a decision to let Chinese individuals own gold.



The manipulation of gold – generally to protect the US dollar – stretches back to the 1960’s and the London Gold Pool, an attempt to keep a lid on the gold price that failed under growing demand for US gold under the Bretton Woods agreement. There is some evidence suggests that the extended period during the early to mid 1990’s when the gold price fluctuated just below $390 was also a result of central bank engineering. However, since early 1996, when gold briefly broke above the $400 level, it is quite clear that gold no longer enjoyed a completely free market.

Massive leasing by central banks, to fund the Gold carry by hedge funds and others and also sustained forward selling, or hedging, by producers – pressed to do so by the bullion banks with forecasts of a lower gold price, which became a self-fulfilling prophecy – kept the gold price in a near constant bear trend until March 2001.

For all of five years all manner of subterfuge, blatant PR and selling of bullion were used to stifle any surge in the gold price which might place the short sellers at risk. In due course, increasing concern about the state of global finances, and particularly in the US, prompted prudent investors to move at least some of their assets into gold. This rising demand, seemingly coupled to a declining store of gold in central bank vaults, have now brought the price of gold close to the watershed $400 level.

The situation is becoming increasingly precarious for the short sellers of gold. The last thing they want is another major surge in demand – even if this should originate from those early speculators willing to take a chance an extreme eventuality, for example, such as that China actually decides to allow private trading in precious metals.

The China Daily article only appeared last Friday, but it is circulating madly through the internet. Keep in mind that the article is not some journalist’s speculation or the thoughts of an independent economist or a member of the Shanghai Gold Exchange, expressing some way-out wish. It comes from close to the horse’s mouth in the person of an official of the Chinese central bank – the “Bank of China’s gold expert”, as the article states.

What its impact on the markets will be this week or next, if any, is difficult to forecast. But if the speculation does turn into fact, it will be the biggest news event in the gold market since Nixon did his little bit in 1971.

If you were short gold and read the China Daily article at the link below, would you gamble that it is all a bluff? Of no consequence. Or would you be looking to cover your short positions as soon and as cheaply as possible? Jumping the gun on the other shorts. It could even be that the next week or two will provide a good test of the solidarity among the short players, including producers that are still heavily sold forward

If as an investor you are not yet into gold – perhaps even to Richard Russell’s ‘one third of liquid assets’ – how long can you afford to wait?

The link to the article is and then cancel the display of Chinese characters to get the English text.