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China’s gold purchases will drive prices higher over the next decade – Capital Economics
Thu Aug 29 2024
Gold has had a strong 2024 thus far, climbing roughly 20% since the start of the year, with analysts highlighting China as the primary driving force behind the gains as the People’s Bank of China (PBoC) purchased large quantities of the precious metal for 18 months straight.
While the PBoC has refrained from additional purchases recently, analysts at Capital Economics said the pause in gold accumulation is only temporary as “China’s gold rush has much further to run” amid a backdrop of rising global tensions, economic uncertainty, and ongoing efforts to move away from the U.S. dollar.
“Against the backdrop of central bank buying, strong physical gold demand, and a surge in ETF holdings, China appears to have been a key driver of the rally in gold prices earlier this year,” they said. “Looking ahead, we think that China’s appetite for gold will grow as its economy slows down this decade. This will put upward pressure on gold prices and could be a greater source of volatility in gold markets over the coming years.”
And it's not just the Chinese central bank that has shown interest in gold. “Alongside the PBoC’s purchases of gold, physical gold demand in China has also risen to pre-pandemic levels,” the analyst said.
“Crucially, a surge in demand for ‘paper gold’ assets such as ETFs and futures contracts appeared to have added fuel to the frenzy for gold in China,” they added. “This type of demand makes up a much smaller share of demand in China than in the West, but the extent of inflows into Chinese-based ETFs, for example, more than offset outflows from those based in North America during the February-April price rally.”
While Capital Economics sees a higher level of demand in the decade ahead, in the near term, they said the PBoC may continue to pause further purchases until gold price retreats from record highs.
“A combination of cyclical factors point towards gold demand in China weakening in the near term,” they warned. “Higher prices are already weighing heavily on jewelry demand, fiscal stimulus should provide a much-needed lift to the economy, and we expect stock market performance to pick up given that local equities seem lowly valued to us.”
“Bringing all this together, the attractiveness of gold relative to other assets will probably fall, and ‘safe-haven’ demand for gold in China is likely to ease,” they said.
However, the pause will only be temporary as the country is expected to see a notable deterioration in its economy, largely driven by losses in the real estate market.
“Further ahead, though, we expect China’s demand for gold to strengthen and put significant upward pressure on prices over the rest of the decade,” the analysts said. “This is largely because we think fiscal stimulus will only delay, rather than prevent, the impending property-led economic slowdown. This will weigh on the performance of investment alternatives to gold, thus boosting the metal’s appeal as a safe store of value.”
One of the biggest tailwinds for gold is the fact that it still makes up a small portion of China’s reserves, and as they continue to move away from the dollar, Capital Economics thinks that gold will help to fill the void.
“China’s central bank could be a major player in the global markets given that it is armed with $3 trillion of reserve assets but currently holds 5% of these in gold,” they said.
“To put this in perspective, if the PBoC were to increase the share of gold to in line with, say, India’s 9%, this would be consistent with the central bank demanding around 15,000 tonnes of gold – equivalent to about 30% of global gold demand in 2023,” they noted. “If these purchases were spread out across 10 years, this would add roughly 3% to annual gold demand each year and surely support prices.”
So, while they see demand from the PBoC remaining low in the near term, over the next decade, Capital Economics expects gold purchases by the Chinese central bank and Chinese citizens to ramp back up as the country’s economy grapples with various headwinds.
“The poor macroeconomic outlook and a lack of investment options is increasingly driving Chinese investors told gold. This, as well as the PBoC’s strategic purchases of gold, will mean that changes in Chinese demand will influence global gold prices more than ever before,” they concluded. “As a result, we may see more episodes of price volatility – most of which resulting in higher prices – as China treads a bumpy path down to annual economic growth rates of 2% this decade.”
Soruce: https://www.kitco.com/