Which Drivers Made Of China The World’s Largest Gold Market? [SPDR Gold Trust (ETF), iShares Silver Trust (ETF)]

Driver 2: A new middle class has more money to spend

The WGC points out in its recent report that only in the last several years has China seen an emerging middle class supported by higher incomes. Until around 2006 for example, Shenzhen, where 70 percent of the country’s jewelry is fabricated, only had 330,000 residents. This means that 30 years ago, China’s jewelry market and consumer demand for gold, was minimal at best.

Over the last 10 years however, a new middle class has emerged and consumers have been enjoying their new wealth. As GDP began to rise, people started buying more gold jewelry and coins. In addition to increased spending on these items, the investment demand for the yellow metal progressed as the population sought a hedge against inflation.

Driver 3: Industrial demand is increasingly important

Though not nearly as strong as the gold jewelry demand in China, the country’s rise in GDP has also increased industrial demand for gold. The WGC says that electronics are the dominant source of this industrial demand. Gold is used in cellphones, computers, circuit boards and recently the automobile industry has seen an increased demand for the metal.

Gold may seem like an expensive option to choose from to build cellphone parts or airbag connectors in vehicles, but as the report states, “Although manufacturers are always trying to reduce the cost of components and substitute gold with lower cost alternatives, this cannot be done where optimum performance and, especially, safety concerns are to the fore.”

In our slideshow, The Many Uses of Gold, we explain other ways gold is used; not only for industrial needs, but for medical and technological advances as well.

Driver 4: China is diversifying away from the U.S. dollar

When it comes to foreign exchange reserves, China’s totalled $3.8 trillion U.S. dollars in 2013, a sharp increase from the mid-90s as you can see in the chart below. There are several challenges facing the Asian nation’s monetary system too; the multi-currency system which includes the renminbi, yuan and the dollar is no easy task to manage.

But how are China’s foreign exchange reserves and monetary troubles a driver for gold demand?

China Gold Total Reserves Foreign Exchange Reserves 1994 2014 physical market

China: gold reserves vs foreign exchanges reserves from 1994 till 2014

For starters, according to the WGC, the majority of growth in China’s reserves (implied specifically by the country’s current account surplus) has been in U.S. dollars. China used the dollar to buy American debt securities, but upon the global financial crisis and the start of quantitative easing (QE), China has been pulling away from exposure to the dollar.

In a recent article from Casey Research, Chief Economist Bud Conrad even comments on the decline of the dollar’s reserve status in foreign countries such as China. He says, “In 2000, the dollar accounted for 55 percent of all foreign exchange reserves. In 14 short years, that number has dropped to 33 percent. By 2020, I project, it will drop to 20 percent. At that point, other large economies of the world won’t need dollars nearly as much for international trade.”

I believe that government policy is a precursor to change, so as fiscal and geopolitical challenges rise between the two countries, it’s no wonder China wants to back away from the dollar and thus, diversify to gold. Gold is a hard asset, making it a prime currency choice for China. In regards to gold, the WGC report even states that, “It cannot be created out of thin air at the whim of central banks. Nor can it be manipulated for the benefit of its issuer.”

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