Record Chinese demand could fuel optimism around gold price

News that the Federal Reserve was tapering its bond buyback program was just the signal that gold bears were looking for.

It seemed somehow morbidly fitting, from a gold bull perspective, that a year that saw the metal post its first year-over-year loss in 13-years would be capped off by Fed Chairman Ben Bernanke delivering what could be seen as the final nail the coffin for gold prices: a beginning to the end of the quantitative easing that was widely regarded as the key driver behind gold’s historic run.

And yet there is reason to believe that the old adage ‘it is darkest before dawn’ may be appropriate in the case of gold prices going forward — and just as dawn comes from the east, so too could the next key driver for gold prices.

While the slump in the commodity’s price has sent western investors to the exits en masse, the Chinese have taken the opposite perspective: gold is cheap, so it is time to buy.

Indeed demand in China has reached such proportions that the country is now the largest consumer of the metal. That distinction sits alongside its already established title as the world’s largest producer of gold, and it may very well be that its Central Bank is the largest investor.

That last point is contentious as there is no firm data to support the claim. Obtaining transparent data from the Chinese central government is notoriously difficult.

What the official numbers say is that since September of 2011 mainland China has imported 1,919 gross tonnes of gold from Hong Kong — that number is in addition to domestic production and that total is a record over a two year period.

So while Western investors have sold some 30 million oz. in ETFs holdings alone (for 2013 the amount of gold held by gold ETFs went down to 60 million oz. from 90 million oz.) the Chinese are proving to be indifferent to such momentum trades, as China imported 118 tonnes of gold in August alone — a 146% year-over-year increase.

For the year the country is expected to import over 1,300 gross tonnes and roughly 1000 tonnes net (i.e. after exports of gold are accounted for). That will mark a record in annual gold imports for the country and could well propel it past India’s record of net imports of 1,096 tonnes achieved in 2011.

The big question for investors to parse out is where all the gold is going.

If it is simply feeding an emerging fashion trend for the glitter of the yellow metal then the implications for global investors will be muted. If, however, as many suspect, the Chinese central bank is loading up on bullion in an effort to decouple its currency from the US dollar and create a powerful gold backed currency that would be the new global standard, well in that scenario, gold bulls could soon be clearing their collective throats in anticipation of a serious gloating session.

Officially China’s central bank is still a pedestrian when it comes to gold reserves. With official holdings of 1,054 tonnes of gold, it ranks sixth in the world and pales in comparison to heavy weights such as the U.S. (8,133 tonnes) and Germany (3,391 tonnes).

But consider that the Chinese have a vested interest in keeping any large scale interest in gold a secret. The country is, after all, the largest single entity holder of US debt, and consequently US dollars. If it has a strong appetite for increasing its gold reserves, and if it made the true extent of that knowledge public information, it might have a severely detrimental effect on the value of those US dollars that it hold so much of.

Some other points to consider about gold prices going forward.

The outlook for gold demand in India could be brightening. While this year saw the government intervene in the country’s always strong gold market by way of a hefty import tax, there is already talk in the country that those taxes may be cut next year. Any reduction would be positive for Indian demand and supportive of higher gold prices.

On the equity front gold miners have done a fairly decent job of responding to market complaints and have cut fat, reduced debt and increased dividends. If this trend continues and gold prices can rebound next year, the miners that have adapted to the new environment the best may be in for a strong positive re-valuation.