Due to the latest phenomena in China, some experts are calling this the “Gold Era”.
The Chinese are buying gold in record numbers and the trend has been increasing exponentially within the past year as the race for wealth-guarding picks up pace.
It has been estimated that China purchased approximately 490 tons of gold in the 2011 year – double the estimated 245 tons purchased just one year earlier in 2010.
With stories of China's gold hoarding blowing up headlines around the world, people are beginning to ask: “Who's buying all the gold?”...and “Why are they buying in such massive quantities?”
Usual Suspect #1: The People's Bank of China (PBOC).
According to Zhang Jianhua from the PBOC. “No asset is safe now...The only choice to hedge risks is to hold hard currency—gold.” Jianhua also commented on it being a wise move to purchase the expensive yellow-metal on price dips.
After Mr. Jianhua made these statements, global analysts immediately assumed they meant that the fifth-largest holder of gold would be on the prowl for even more of the glistening precious metal. Hence, an easy explanation as to "who's buying all the gold."
However, others argue that there is little proof to support that theory. Perhaps most the most important thing to remember before jumping to conclusions is the simple fact that it'd be an extremely rare scenario that China's government would want to purposefully disclose their short-term investment strategies, at the risk of hurting itself.
Second, the central bank has less purchasing power these days. China’s foreign reserves declined in Q4 2011, falling $20.6 billion from Q3. The first quarterly outflow since 1998 was not large, but the trend was troubling. The reserves declined a stunning $92.7 billion in November and December.
Third, the purchase of gold would be especially risky for the central bank, which is already insolvent from a balance sheet point of view. The PBOC needs income-producing assets in order to meet its obligations on the debt incurred to buy foreign exchange, so the holding of gold only complicates its funding operations. This is not to say the bank never buys gold—it obviously does—but there are real constraints on its ability to purchase assets that do not provide current income.
So if the surge in demand isn't coming from the central bank, where is it coming from?
Experts suggest that there is little demand from the nation's institutional gold investors. Obviously, there is always an industrial interest for gold, but China is already the world's largest gold producer. That being said, China's soaring gold imports means individuals are the ones demanding gold from foreign distributors.
Speculators debate whether this spike in demand (from citizens, individually) is simply seasonal OR if individuals will continue the buying frenzy in order to hedge against inflation. The Financial Times (and many other respected publications) seems to believe the latter explanation holds more validity.
On the other hand, Jeff Wright of Global Hunter Securities asserts that individuals are only buying so much gold right now because it's a Chinese tradition to buy golden presents in the dates surrounding the Lunar New year, which started last Monday, January 23.
That affirmation is easily refuted because the major surge in gold demand began as early as July in China.
Strangely enough, inflation has eased a tad recently in China, so the explanation that individuals are hoarding gold merely as a safe-haven has some flaws as well.
According to Forbes, there is a third – more sensible – explanation:
The best explanation is that individuals in China are using gold as a substitute for capital flight...
Estimates of capital flight are sketchy, but it appears there was $34 billion of it in the third quarter of last year and a $100 billion in the fourth...
Not every Chinese citizen is in the position to export cash, so the next best tactic for the nervous is to buy gold, a refuge from plunging property prices and declining stock markets as well as an anticipated depreciation of their currency.
The negative side of the story is that capital flight and gold purchases can drain liquidity out of the economy at a time when that liquidity is most needed.
Beijing can continue to work its magic as long as strict capital controls keep money inside the country. Once they fail to do so, however, all bets are off. The purchasing of gold, of course, results in the exporting of cash.
Bottom line is this: whatever the increased in gold purchasing may mean for China, it is – above all – “an indicator of panic”. Thus, it is probable that Chinese asset values will fail as a result of these gold exchanges.
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