2007 proved to be a seminal year for the gold market in China. National consumption and production of the yellow metal reached record levels. The final decision on the establishment of gold futures was made, paving the way for the historic January 9, 2008 launch on the Shanghai Futures Exchange.

With gold prices rocketing toward $1,000/ oz, China’s climb to prominence comes at a time of global economic and political turmoil. Gold in particular has attracted momentous attention on the world stage, regaining much of its status as a store of value and safe-haven during turbulent times. The continued demise of the US dollar, rising oil prices and political tensions in the Middle East sent investors rushing into various means of gold ownership. The introduction of the GoldTracks exchange traded fund in November 2004 has resulted in nearly 800 tons of physical gold being diverted into allocation against the fund. Record volumes for futures reached over 111,000 tons aggregately in 2007 on the three major exchanges, COMEX, TOCOM, and CBOT. The over-the counter market, primarily in London, saw significant investment demand in the latter half of 2007.

2007 Production and Consumption in China

According to GFMS, Limited, China’s gold output reached 276 tons in 2007, an annual increase of 12%. This vaulted China into the top position for global gold production, topping South Africa by about four tons. It was the first time since 1905 that South Africa was not the leading gold producer in the world. Severe power disruptions in the early part of 2008 have sent mining companies in South Africa reeling, curtailing productivity and making it likely that China will retain its hold on first place again in 2008. Stratospheric gold prices will give enormous incentives for Chinese gold mining to increase output. The appetite for copper has propelled prices of that metal to recent record highs, and ramping up of Chinese non-ferrous mining will result in more gold, which is a byproduct of copper production.

The World Gold Council reported consumer demand in Greater China, which includes the mainland, Hong Kong and Taiwan, of 363.3 tons in 2007, up 23% from 2006 levels. Jewelry was the major component, surpassing 300 tons, a level not seen since 1997. Notably, demand in the fourth quarter was more than 94 tons, despite record high bullion prices. Mainland Chinese investment increased as stock-market volatility created greater risk. The Bank of China reported Chinese inflation reached an 11 year high in February, 2008 to 8.3%, fueling even more motivation for investors to set their gazes toward gold. China’s official reserves include 19,290,000 ounces of gold. This amount has not increased since 2002. Foreign exchange reserves, however, have exploded over the same period, making gold a much less significant portion of the country’s total reserves. Some economists, eyeing the Chinese dependence on the US dollar as their main reserve, have called for the State Administration of Foreign Exchange to increase China’s gold reserves. These exhortations come on the heels of the July 21, 2007 exchange rate reforms that somewhat loosened the Renminbi’s peg to the dollar.

Whether the Chinese monetary authorities will add more gold to their reserves remains in doubt. Current high prices make it an expensive proposition, but given gold’s inverse relationship to the US dollar, increasing gold reserves could be considered a hedge of sorts.

Diagram 1 Click to zoom.