By Hard Assets Alliance Team
By Justin Spittler, Hard Assets Alliance Analyst
After speculation that the US Federal Reserve would rein in its asset-purchasing program earlier than anticipated, Western investors began exiting gold-back exchanged-traded funds (ETFs) in record numbers, highlighted by $8.7 billion in net outflows during April.
While the languishing paper-gold market has many declaring the gold trade dead, demand for bullion has never been greater, as buyers have focused on the big picture that includes endemic debt levels and unsustainable money-printing schemes. This long-term investment approach is most prevalent in the Eastern world, where India and China, the world's two largest consumers of gold, are pouncing on the opportunity to accumulate gold at bargain prices.
Endless ink has been written on the disconnect between the paper and physical gold markets, yet it is a recently captured image courtesy of China Daily that conveys everything that needs to be said about this phenomenon.
In a scene reminiscent of frenzied shoppers on Black Friday, approximately 10,000 Chinese consumers gathered outside of a jewelry store in Jinan city for the opportunity to scoop up gold products at sharp discounts, after speculation in the West helped shave roughly a quarter off the price of gold.
The numbers coming out of China tell a similar story. Chow Tai Fook—the world's largest jeweler in terms of market capitalization—reported a 63% spike in sales during the second quarter.
Chinese Investment Demand for Gold Taking Off
While China's love affair with gold jewelry burns as bright as ever, more and more Chinese are flocking to the yellow metal as a hedge against currency devaluation just as inflation begins to rear its ugly head after decades of artificially stimulated growth.
According to the World Gold Council (WGC), Chinese coin and bar demand jumped 22% during the first three months of 2013 to a quarterly record of 109.5 tonnes, or more than twice the five-year quarterly average of 43.8 tonnes. Demand really skyrocketed following the massive sell-off of Western gold funds as China imported between 160 and 170 tonnes in April alone. By year-end, the WGC projects that net Chinese imports could eclipse 880 tonnes.
Chinese Buying Frenzy Leads to Shortages and Sky-High Premiums
With pent-up demand swelling, Chinese investors will soon have a new avenue to invest in gold, as the Chinese Securities Regulatory Commission recently approved China's first two gold-backed exchange-traded products (ETPs), which will be introduced by HuaAn Asset Management Company and Guotai Asset Management Company. Both yuan-denominated gold funds will be listed on the Shanghai Stock Exchange (SHCOMP). However, due to stringent regulations, the products will not buy and store bullion on behalf of shareholders, as the SPDR Gold Trust (GLD) does; instead the funds will mirror the domestic spot price by purchasing futures contracts on the Shanghai Gold Exchange.
Though merely paper investments, the funds will offer convenient exposure to gold as well as an affordable alternative to price-sensitive buyers facing hefty premiums on physical product. Investors with long-term horizons, however, will likely continue to own physical gold due to the superior security it affords.
At this point, the particulars for each fund are still being sorted out, though it is reported that HuaAn is seeking to raise between 2 billion and 3 billion yuan ($326-$489 million) during its initial offering—pennies compared to the more than $60 billion of bullion held by GLD.
Certainly, these new products will provide the Chinese investor with another option for adding gold to their portfolios, since restrictions limit Chinese investors from buying international gold ETFs. What remains to be seen is how many investors will sever their longstanding relationship with physical gold for paper instruments.
In any case, the announcement of these two new gold funds represents the latest in a steady stream of bullish signals to emerge from China lately. Still, it is important to recognize that physical bullion will continue to drive the international gold market due to the fact that ETF holdings represent just 1% of the entire 175,000 tonnes of the above-ground gold stock. Though paper markets have demonstrated an ability to sway the gold price, the market for bullion will decide gold's fate over the long term.
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