Deregulation set to lift China gold demand

Plans to free up China's gold market are likely to boost imports of the precious metal to satisfy investor demand, putting the Middle Kingdom on course to eclipse India as the top global consumer in a few years.

China, the world's largest consumer of base metals and the second biggest user of oil, is on gold bugs' radar screens, with any hint that Beijing may want to boost its gold holdings rippling through international markets, sending bullion higher.

So far China's central bank has shied away from the international market and has instead been building reserves from its domestic mining industry, the largest in the world.

But that may change after the People's Bank of China said in August it would let its banks export and import more gold in a program to drive the development of the country's market in the precious metal.

By opening up the market, the PBOC may be able to draw tonnes of gold into China, which it could then pick up on the domestic market, without disrupting market equilibrium too much.

"The way they will accumulate a massive amount of gold is by opening up imports and making sure there is heck a lot of gold swishing around in the domestic market," said Mark Pervan, a senior commodities analyst at ANZ.

"It's just too big a player in the market. Investors are looking for any signs of China buying gold on the world market. If Beijing said it was buying 100 tonnes, prices would leap, not because of this 100 tonnes, but because of the 300 tonnes the market would expect to follow."

Alternative Investment Channels

Appetite for the precious metal has grown rapidly in China as investors worried about inflationary pressure turn to alternative investment channels.

Demand was expected to rise to around 600 tonnes in 2011, according to a Reuters survey of five analysts, and may go even higher.

"The jewelry sector is growing, as is demand for investment gold. A clampdown on property investment and speculation in other markets has resulted in more money going into gold and jewelry," said William Adams, analyst at FastMarkets.com.

"Jewelry demand in China has probably managed to rise and may even be growing at a faster pace than the average over the decade of about 7 percent."

China's gold consumption this year is forecast between 450 and 600 tonnes, with a consensus of 500 tonnes, analysts surveyed by Reuters said. The WGC estimates demand at 510 tonnes.

Several researchers have urged Beijing to increase its gold reserves to diversify more of its $2.6 trillion in foreign currency reserves, and a more open market would allow the central government to build stocks of gold more quickly, without sending tremors through the international market.

Although no detailed follow-up rules have been announced, analysts expect Beijing to open up the gold market as a prelude to deregulation of bond and foreign exchange markets.

"It really flags the start of a theme of deregulation in the financial markets. They are using the gold market as a test case," said Pervan.

China's total demand has risen by around 20 percent in three of the past four years, while demand for gold as an investment jumped 60 percent in 2009, data from the WGC show.

On an annualized basis, China's retail investment demand would rise another 44 percent in 2010 to more than 150 tonnes for this year, while jewelry consumption will rise only 2.5 percent to 360 tonnes, based on Reuters calculations using WGC data.

"We expect China to participate a lot more in the precious metals market," said UBS analyst Edel Tully. "We expect imports to accelerate. They (the Chinese) are making a very good attempt to catch up with India, which is the largest physical market."

Usurping India?

Gold demand in India, battered by poor monsoon rains that darkened the outlook for farmers, the country's key customers for the metal, slumped last year, as high prices felled imports by about a third.

But India's overseas purchases may rise to a record high and even breach the 800-tonne mark this year, as demand is fed by a healthy monsoon that promises good crops.

If Chinese consumption continues to grow at recent rates, it could take the top spot from India in three or four years.

There are no official figures for mainland China imports, but data from Hong Kong, Asia's biggest bullion trading center, shows exports from the region to the mainland in the first eight months of the year were already nearly double those for all of 2009, pointing to surging appetite on the mainland.

On an annualized basis, China would import 118 tonnes of gold through Hong Kong, the main conduit for gold flows into the mainland, versus 44 tonnes last year and 90 tonnes in 2008.

China's gold output in the first eight months of the year rose 8.85 percent from a year earlier to 217.953 tonnes, the Ministry of Industry and Information Technology said.

"Domestic production is unlikely to grow much next year, so we'll probably see a lot more imports," said Zhu Yilin, general manager of the research and development department of Jingyi Futures in Shanghai.

And that means Chinese investors will have little choice but to go out to the world market to sate their gold fever.

[Source: By Rujun Shen and Nick Trevethan, Reuters, Singapore, 10Nov10]

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