China’s Gold-Buying Spree

Back in May, I posted a blog entry called “Chinese Catch the Gold Bug,” in which I noted a strong surge in gold-buying by Chinese investors.  I attributed it, in part, to the Chinese government’s crackdown on the property market: uncertain whether real estate would continue to serve as a reliable store of value, like gold, the Chinese were turning to gold itself as an alternative.  Subsequently, I’ve observed how the vast amounts of new stimulus money injected into the Chinese economy have been channeled, initially at least, into tangible assets rather than consumption, fueling skyrocketing prices for real estate, jade, fine art, fine wine, rare tea, etc.  The price of gold, of course, is determined by global markets, but I maintained that surging Chinese demand — consistent with the asset inflation story I was telling — was contributing to the 27% run-up in gold prices this year. 

Now the Wall Street Journal confirms that perception was essentially correct:

Gold’s record rally has been attributed to everything from worries about inflation, the dollar and the emergence of exchange-traded funds. One big factor many may have missed: huge buying from China.

Data cited Thursday by China’s state-run Xinhua news agency showed that China imported 209.7 metric tons of gold in the first 10 months of the year, a fivefold increase compared with the same period last year.  That surpassed purchases made by ETFs and surprised analysts, who until now had no clear insight into the size of China’s buying …

“Everybody in the gold market knew there was a surge in investment demand, but they didn’t know it was China,” said Jeff Christian, managing director at CPM Group.

As I’ve noted before, over the past two years, China’s money supply expanded by over 50%, due to a massive lending boom that helped generate record GDP growth.  That meant a lot of money shloshing around the Chinese economy, looking for somewhere to go.  Just as the government was battening down the hatches (for the moment, at least) on real estate investment, the gold market opened up.  “Until several years ago,” the WSJ notes, “China’s gold market was strictly controlled by the central bank, which bought all the gold mined domestically. It then sold the metal to jewelry makers.”  Recently, the government loosened restrictions on buying, both by individual and institutional investors.  “In August [this year],” the Journal reports, “[China] began allowing more banks to import and export gold, opening up the gold market to the institutions and their clients.”

Gold producers and investors are pretty excited:

“The big picture is that China is continuing to relax the rules governing the domestic gold market,” said Martin Murenbeeld, chief economist of DundeeWealth Inc., which oversees $69.9 billion in assets. “What we are seeing is the latent demand that has been there all the time and now can be exercised in the market because now the market is freed.” 

The World Gold Council estimates that China’s gold demand could double in 10 years as more investors there embrace precious metals.

I can’t say whether this long-term view is accurate or not, but it’s worth keeping in mind that the recent boom in Chinese buying has been fueled by a massive — and likely unsustainable — burst of money creation, the effects of which have been concentrated into a limited range of readily-accessible assets.  A bet on gold, therefore, may be seen as a bet on continued Chinese liquidity, just as China’s central bank is coming under increasing pressure to rein in inflation.

On the subject of “bars of gold”: yesterday, Fortune ran an interview with hedge fund manager (and notorious China bear) Jim Chanos, in which he explains the willingness of Chinese investors to purchase and stockpile multiple empty apartments as follows:

Chanos ticks off reasons for that kind of behavior. Individual Chinese investors are limited in where they can put their renminbi. They can stash it in a standard bank account and receive a negative rate of return, given an inflation rate running at about 3%. They can put the money in the stock market, but equities in China are much more volatile than those in developed markets. Capital controls limit investment opportunities for individuals abroad. So that leaves real estate.

Chanos acknowledges that China’s emerging middle class sees real estate as a store of value. To many, buying an apartment in Shanghai or Beijing is like buying a bar of gold. And many — “too many,” Chanos says — have kept on buying as prices have gone up in the past five years.

I thought I was having a fit of deja vu — or maybe an out-of-body experience.  Now where have I heard that before?  Possibly here (my interview with PBS) or here (with the Washington Post) or here (with Foreign Policy).  Or maybe here, here, or here.  The very first place I proposed this explanation was an article in the Far Eastern Economic Review, in June 2009, entitled “China’s Real Estate Riddle,” in which I observed:

Unless they already possess offshore funds, Chinese citizens have limited investment choices: they can gamble on an unstable domestic stock market, buy low-yielding government bonds, or stash their cash in even lower-yielding bank deposits. By contrast, real estate—occupied or not—offers them a visibly reassuring place to park their money, sheltered from inflation … For them, an empty condo is a store of value, much like gold, another asset that performs no practical function besides retaining its worth.

Really, I don’t mean to sound too proprietary — I’m actually happy that my idea seems to have resonated with people, and that they’re repeating it.  I admit it can be a bit disconcerting, though, to read it quoted back to me virtually word for word.  As I joked to a friend, I feel a bit hesitant even making this argument anymore because it’s so widely cited these days that my audience will have heard it from someone else by now, and assume I just copycatted it from them!  So for the record — so I can keep on saying it without sounding wholly unoriginal — you did hear it here first.