The Shanghai Gold Surprise by David Baker and
David Franklin | Friday, July 19, 2013
The physical gold market
continues to develop in the most wonderfully counterintuitive
way. While the paper gold price languishes below US$1,300
per ounce, physical demand out of China is now reaching
previously unforeseen levels. If you’ve heard this
story before, it’s more of the same, except that the
demand tonnage is now so high as to be almost comical.
According to data released by the Shanghai
Gold Exchange, the amount of gold contracts settled for
physical delivery on its exchange reached a staggering 1,098
metric tonnes year-to-date as of the end of June.1 This
is an astoundingly large amount of physical gold. For perspective,
1,098 tonnes represents approximately 40% of the entire
estimated global gold mine production in 2013. It also represents
roughly 1/8th of the US Treasury’s official gold reserves,
and over 100% of China’s stated official gold reserves.
If the rate of physical delivery on the Shanghai Gold Exchange
continues at current levels, it will deliver the equivalent
of over 100% of global mine production by the end of this
year… all through one exchange.
In contrast, the COMEX futures exchange
in New York, where the bulk of US gold futures are traded,
saw a measly 160.7 tonnes of physical delivery requests
over the same period (year-to-date to June).2 Although the
paper volume on the COMEX dwarfs that of the Shanghai Gold
Exchange, the level of physical delivery requests is only
15% of that seen in Shanghai.
If the Shanghai data is true, when combined
with the gold imports going into China via Hong Kong, we
now have a situation where China is buying the equivalent
of all global gold mine production produced on a monthly
basis. How that can coincide with a gold price drop of US$400
per ounce over Q2 is beyond our capability to explain, but
it does mean that China is now the undisputed hub for physical
gold.
Interestingly, China’s demand for
physical gold does not seem to be benefitting the growth
of gold ETF products within the country. Bloomberg recently
reported that China’s first two exchange-traded funds
backed by bullion both had disappointing debuts, with Huaan
Asset Management Co. reportedly raising only $195 million
out of an expected $400 million at launch.3 Although the
press has naturally concluded that this news indicates waning
gold demand in China, we can’t help but think it shows
that China’s gold interest is primarily focused on
the physical metal, as opposed to financial products that
trade on exchange. Certainly if the time ever comes where
the physical gold market sets price discovery for the gold
price (as opposed to the futures market) it seems highly
likely that the first place that will happen now is within
Shanghai itself.
Whether there’s a link between China’s
increasing physical gold deliveries and the drop in gold
inventories within the COMEX and GLD ETF remains to be seen,
but whoever is supplying China’s gold appetite is
supplying it in size. Despite gold’s lackluster price
performance, these developments strongly suggest we could
be in for an interesting summer in the weeks ahead. Gold
is a finite resource - if China’s current purchase
rates continue, it is going to own a significantly large
proportion of global gold reserves.