China's grip on gold prices means a higher floor, but this week's weakness may be the flipside
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(Kitco News) - Precious metals prices remained on their lower trajectory this week, continuing the steady slide lower that began after the last FOMC meeting on Sept 20. Gold and silver have both fallen to their lowest levels since early March, with spot gold briefly dropping below $1,817 earlier on Wednesday and silver futures trading below $21 per ounce at the time of writing.
While the Fed’s higher-for-longer interest rate projections are the most cited driver for gold’s recent weakness, as they’ve helped drive the benchmark 10-year treasury yield close to 5% against the non-yielding metal, analysts’ historical models suggest gold should actually be far lower at this point in the cycle. What’s different this time around? China.
Chinese demand for the yellow metal has been propping up gold, keeping prices not far off their all-time highs despite massive headwinds.
The People’s Bank of China (PBoC) has been buying gold at a torrid pace for nearly two years now. According to updated foreign reserve data, China’s central bank bought 29 tonnes of gold in August, lifting year-to-date purchases to 155 tonnes. August also marked the central bank's biggest purchase since December.
But it’s not just the Chinese state that’s shown a voracious appetite for the precious metal. Recent months have seen China’s domestic gold prices spike well above international spot prices. The population’s appetite for gold was so great that the PBoC intervened, banning banks from importing gold, which pushed the spread between the spot price in Shanghai and London to a record $121 per ounce in mid-September.
Just as some of gold’s surprising strength has come from Chinese demand, it’s possible that some of this sudden and sustained weakness is also the result of China’s internal market dynamics.
Everett Millman, Chief Market Analyst at Gainesville Coins, believes the Chinese market has had a significant impact on gold prices outside the country, while the recent premium demonstrates the limited influence the global market has over domestic prices.
Speaking to Kitco News last Friday, Millman said that this week could provide an interesting test case, as local holidays are curtailing activity and liquidity in the Shanghai gold market.
“In addition to government policy in China, the fact that their markets are going to be closed for that period of time, that removes one of the largest consistent buyers in the market,” he said. “So I do think it removes some of the floor beneath the gold price. If you get selling pressure coming from the West, you don't have as much to counteract that in China. When traders are back at the office in China and the economy is back out of holiday mode, I think that could give a pretty strong boost to the gold price.”
Everett said that Shanghai’s high gold premiums could be helping to maintain the floor under global gold prices even if the import limits mean domestic buyers can’t actually buy enough gold to fully impact the international supply.
“It is undeniable that they're not able to buy as much as they want,” he said. “But again, we do see signs that demand on the ground in China is still rather high. It's just a matter of, is that gold available. And I do think that, throughout the world, when you see that kind of dislocation where there is a giant spread between the Shanghai price and the London price, it does at least have to pique investors’ interest as to why is that the case.”
Millman said the premium, and the sustained buying activity from China as a whole, influences the psychology and the sentiment surrounding the global gold market. “In terms of direct effect, I don't think it's the end-all, be-all. I don't think it's the only factor that's driving gold prices. But I would expect to see again, when Chinese buyers are back in the fold, that premium would perhaps again rise, and then we would see the gold price worldwide play catch-up and try and close that gap.”
Millman said he’s also had Western investors ask him how they might arbitrage the price difference between the Chinese and global markets.
“When you look on your screen and gold is going for $120 more in China, how can I get in on that? I think there are some very big structural impediments,” he said. “Perhaps traders in Hong Kong could take advantage of that, given their geographic proximity, but again, with the import curbs, the Chinese government does run a fairly tight ship in terms of controlling their own gold market. So I think it's interesting that there really is not an arbitrage mechanism to quickly bring Western gold prices back in line with what we're seeing in Shanghai.”
He said that China's appetite for gold is driven by a number of key factors, including the metal’s unique historical status, as well as tradition.
“On the one hand, there's a cultural component to it,” Millman said. “They have an affinity for gold, for lack of a better phrase. They trust gold; they know that gold is always good. No matter where you go in the world, people will exchange their local currency for gold, and it will tend to hold its value.”
But he said there’s also an economic and monetary component that China shares with other countries and regions that have undergone massive inflation and the collapse of the local currency. “You also see this in Turkey, in Germany, in places where there is still a strong memory of large currency devaluation,” he said. “Russia is another great example. People remember their local currency collapsing in value. Gold is not the only alternative for that. Sometimes you hear stories about people buying other durable goods, but gold is the most logical alternative to preserve your wealth or store your purchasing power in a form that cannot simply be manipulated away, or printed away.”
“So I do think that China is going to continue, due to that cultural affinity, but even more so perhaps due to that economic awareness that things can go haywire, and they can go haywire rather quickly,” Millman said. “I think in North America, we don't have nearly as strong of an experience with that. People's memories of the really hard times, of the Great Depression, those have largely faded. Around the world, that's not usually the case.”
Millman said that there are many places in the world where people have confronted the fragility of fiat currencies, and so they naturally turn to gold when they see signs of economic weakness, which have already been seen in China. “If that's exported globally, which is very possible, I think that continues to put a pretty strong floor beneath gold demand where people are going to continue to buy.”
“Unless we get the most surprising economic boom in modern history, gold will remain the main alternative for people to store their wealth,” he said.
As for how long Chinese government and citizen demand for gold could provide this floor for the precious metal, Millman said it’s very difficult to say, but he doesn’t see it fading anytime soon.
“Even macroeconomists, oftentimes their models point them in some direction, but they don't have a definitive answer,” he said. “The best answer I can give you is it's indefinite. Again, I would be quite shocked if we got an eruption of economic growth. I don't think even the most bullish economists on the global economy are predicting that. They're simply hoping that we continue to see modest growth. And in lieu of that, I see no compelling reason for them to stop buying.”
“The Chinese Central Bank is trying to get as much gold as it can get its hands on,” Millman said. “That's very much true for the average person as well. I think it would be sustained at least until the quote-unquote soft landing that we could see, if that does come to fruition. But I see it continuing until further notice.”