China companies hoard gold for collateral

Chinese companies may have accumulated up to 1,000 tonnes of gold for use as collateral in financing deals rather than to meet consumer demand in recent years, a new study says.

The report by the World Gold Council said imported bullion was being used "to raise low-cost funds for business investment and speculation", and was part of the wider growth in shadow banking in China.

Other metals, including copper, have been used extensively as collateral by Chinese traders affected by tight credit conditions, raising concerns of a sudden fall in prices should the financing deals unwind.

Precious Metals Insight, a consultancy that provided figures for the report, said that by the end of 2013 gold financing could have reached a cumulative 1,000 tonnes of gold - equal to a nominal value of $40bn.

"Most of this has been built up since 2011, when gold has been increasingly used as the basis for a variety of financial operations in China that have required the importation of very large quantities of physical bullion," the report published on Tuesday said.

The WGC said that Chinese demand for bullion will cool this year, removing a powerful prop for prices, before picking up again in 2015 as a rising middle class increases its exposure to gold.

China overtook India as the world's largest gold consumer last year thanks to soaring purchases of jewellery, minted Panda coins and small gold bars.

Demand surged 32 per cent to a record 1,066 tonnes, according to the WGC.

At the same time, gold suffered its biggest annual price drop since 1981, losing more than a quarter of its value as western investors slashed their holdings of gold-backed exchange traded funds.

The precious metal lost its lustre in Europe and North America as economic conditions improved and the concerns of runaway inflation because of ultra-loose monetary policy receded.

The WGC said there would be little growth in China's gold consumption in 2014 because of last year's "exceptional" advance.

It also said that state purchases might explain the very large and growing surpluses in the Chinese market.

"We expect 2014 to be a year of consolidation," said the report, written by veteran gold market analyst Philip Klapwijk. "The sudden price drop in 2013 meant some Chinese consumers brought forward jewellery and bar purchases, which may limit growth in demand in 2014."

However, the traditional appeal of gold to Chinese consumers and their optimistic outlook for prices should result in private sector demand from all sources climbing to at least 1,350 tonnes by 2017.

"Rising real incomes will create many more potential consumers with greater spending power, particularly in the third- and fourth-tier cities," the report says.

In addition to being the world's biggest consumer of bullion, China is also the world's largest source of mined gold.

Over the past decade, production has doubled from 217 tonnes to 437 tonnes.

But according to the report, China may not be able to output 400 tonnes or more over the long term because of falling ore grades, a declining reserve base and rising production costs.

Stricter enforcement of regulations and rules, especially environmental controls related to gold mining, would also limit production.

The latest official figures show that China imported and produced far more gold in 2013 than its citizens bought.

Many traders say the gap in the country's gold consumption data can only be explained by central bank purchases.

The People's Bank of China has not provided an update on its bullion reserves since 2009, when it reported a holding of 1,054 tonnes, making it the world's sixth-largest holder of gold.

In the WGC report, Mr Klapwijk said the "surplus" in the Chinese market stems either from official purchases or the extensive use of gold for financing purposes.

"While it should be stressed . . . that there has been no acknowledgment by the PBoC or other Chinese authorities of an increase in national gold reserves, past practice suggests that any new data release would occur at a time of their own choosing and certainly not in response to any market rumours," the report said.

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