Guest Post: Chinese Gold Fever

Tyler Durden's picture

Earlier Lear Capital presented their view on what the basis for Chinese gold accumulation may be. Next we present a comparable analysis by SmartMoney.eu which takes a deeper dive into the demand mechanics originating in China. To wit: "In some parts of Asia, inflation is rampant. Especially in India, food prices and other staples are going through the roof. The prices of some vegetables and spices has risen more than 100%... In China, the prime goal of the communist party is to maintain social stability and to avoid unrest. Targeting inflation is key. Therefore, many Asians are investing their hard-earned money into precious metals. The latest news from China corroborates this: in the first two months of 2011, the Chinese have imported 200 tonnes of gold, which is as much as in the entire year 2010! This is just individual investor demand, we are not even speaking about central bank demand, accounting for the entire Chinese mainland gold production! Chinese gold fever has caused gold demand to triple in the past 10 years, according to the World Gold Council. The Chinese are about to overtake the Indians as the world’s biggest gold consumers." For short-term market timers, as we predicted a week ago, continued pressure on risk assets, such as that today, will most certainly result in forced liquidation in precious metals such as gold and silver. This is absolutely guaranteed as margin calls pile in, and hedge funds, already levered to the hilt have no choice but to sell all outperforming assets, among which gold is at the top. Once liquidations are completed, the question will then be: does the Fed resume its inflationary path (and as a just completed analysis by Zero Hedge confirms, the shadow banking system is once again declining leaving few options for Bernanke). If that is the case, then the long-term fundamentals from a speculative standpoint revert. Add to that the discussed organic demand, and increasingly loud calls for $2,000 gold may materialize sooner rather than later.

Submitted by Smart Money

Chinese Gold Fever

Investors are increasingly worried about rampant inflation, and they should. In the author’s home country, Belgium, the price of fuel just hit a new record. Other necessities are becoming more expensive, too. The price of many commodities is close to an all-time high, which does not bode well for the pricing power of many corporations, which are set to see input prices rise significantly. This will put severe downward pressure on valuations, hence stock prices. As a matter of fact, as the markets are trading at a price earnings ratio of 16 on average, the cyclically adjusted PE ratio (CAPE) is closer to 23, which is quite expensive! The CAPE is the Shiller PE, which flattens out the business cycle on a 10 year period, which gives a better idea of stock market valuations. Markets are far from cheap, despite what many mainstream media would like us to believe!

Savvy investors however, know better. They are sensing we might be hitting a market top in equities. With oil prices north of 100 USD per barrel, sensible investors are looking for ways to shield their wealth from a potential market correction, shifting their assets into tangible goods. It goes without saying that gold is the most obvious beneficiary of this secular move. Investor demand is high, and the yellow metal is hitting new highs almost every day.

It should thus not come as a surprise that demand is driven mostly by emerging markets. In some parts of Asia, inflation is rampant. Especially in India, food prices and other staples are going through the roof. The prices of some vegetables and spices has risen more than 100%. Due to the inefficient infrastructure and logistics in India, food cannot be transported easily and perishes on its way to the other side of this huge country. In China, the prime goal of the communist party is to maintain social stability and to avoid unrest. Targeting inflation is key. Therefore, many Asians are investing their hard-earned money into precious metals. The latest news from China corroborates this: in the first two months of 2011, the Chinese have imported 200 tonnes of gold, which is as much as in the entire year 2010! This is just individual investor demand, we are not even speaking about central bank demand, accounting for the entire Chinese mainland gold production! Chinese gold fever has caused gold demand to triple in the past 10 years, according to the World Gold Council. The Chinese are about to overtake the Indians as the world’s biggest gold consumers.

These figures show that daily demand for gold in China outstrips current demand to a large extent, pushing up prices incessantly.

And still, we are a long way from a gold hype. Mainstream media are still not touting gold as a sensible investment, retail demand, despite an increased interest, is not extraordinary and there is still quite a lot of room for central banks, especially those in emerging markets, to increase their gold holdings and diversify into the yellow metal, to the detriment of the US dollar and other fiat currencies. As the graph above shows, the USD gold prices is rising slowly but steadily, without overshooting on the upside. It clearly exhibits that we are in the second phase of the secular bull market in gold, namely the institutional phase. We are a long way from a top in gold. Before the masses wake up to this, the gold prices will have surged to levels that are unfathomable today.

We expect the gold price to hit 1600 USD per troy ounce by the end of 2011, which is in the cards if the trend continues. It will not be a smooth ride however, as we expect volatility to rise this year. Gold is traditionally weak in summertime and is likely to correct by early August, but these are excellent buying opportunities.

We continue to favour a balanced mix of physical gold (bullion bars, coins) and a quality selection of junior and mid-tier gold stocks. This ensures a healthy mix between capital preservation and leverage to the gold price!