Why China is a positive and not a negative for the gold price going forward

Last week a report from the World Gold Council suggested that around 1,000 tonnes of gold is being used as collateral in Chinese commodity financing deals that would be unwound if the shadow banking complex was to collapse. Not surprisingly news of such a supply overhang depressed the gold price.

Since then analysts have pointed out that this is an assumption and based on little more than an estimate of gold imports. Moreover, last year gold experienced significant volatility and high local premiums in China that would not have made it ideal for financing. Copper is the usual commodity of choice for such deals. You don’t use assets carrying large premiums either.

Facts, facts

So it looks like a rather poor piece of work that has unnecessarily damaged the gold price based on supposition rather than facts. Indeed, ArabianMoney has always argued that China is a valuable support for the gold price and also a reason why it will eventually head much higher.

Certainly the selling of 880 tonnes of gold last year by ETFs would have depressed the price far further if it had not been for the uptake in China where the retail market for gold is particularly hot at the moment. Local retail investors want a little gold in their portfolios because perhaps deep down they know that good times cannot last forever. China has seen many episodes of paper money becoming worthless in its long history.

We have also flagged up the fact that this gold is on a one-way trip to China. It is not coming back. The Chinese have not sent a bar back in the other direction for years. Gold exports are illegal. Thus the supply shortage in the West will be evident when the ETFs want to stock up on gold again as would happen with the slightest whiff of inflation or problems in the bond markets. That’s positive for prices, not negative.

If money printing is going to get out of control then China and Japan are the two most likely culprits. Japan is already printing three times more per capita than QE3 at its height. Gold is a hedge against currency devaluation. It’s not something you can print.

Shadow banking crisis

Sure at the margins there would be gold sales if the Chinese shadow banking system imploded. Then again a far more probable scenario is a series of controlled detonations that will scare more local investors into buying something with a value that does not depend on any third party bank or financial institution.

From the Western side there is the view that recent money printing will finally result in inflation as economic growth gathers pace. That’s gold positive too. Then again if China and Japan get into trouble it is hard to believe over-inflated Western asset prices would hold up under the deflationary tsunami. US economic data splutters forward even now.

Precious metals are a hedge against falling stock and real estate markets, or at least fall by less and rebound more quickly. Gold remains an attractive buy at current price levels.

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