Gold leasing helps China’s banks fill import quotas as retail demand sinks…
CHINA’s GOLD imports are being boosted by banking deals to lease bullion and raise loans, according to a new analysis, masking 2016’s hard fall in household gold demand from official trade data.
Gold-leasing deals offering cheaper finance costs than China’s central-bank interest rate, says Tom Kendall, head of precious metals strategy for Chinese-owned ICBC Standard Bank in London.
“Now, more than anywhere else, gold is widely used in China as a means of raising short-term liquidity” both by state-owned enterprises and also smaller-and-medium sized private firms.
China’s gold market is “highly evolved”, Kendall explains in the latest quarterly Alchemist magazine for trade body the London Bullion Market Association (LBMA), more sophisticated and less focused on physical demand and supply than many outside observers believe.
With China’s private demand and physical imports joining its gold-mining output as the world’s No.1 in 2015, “Jewellery and retail investment demand for bullion is clearly a large component of the Chinese market,” he says, “but…in reality a multitude of financial forces are at work.”
Already by 2014, two-thirds of daily transactions on the Shanghai Gold Exchange were “investment trading, or rather, derivatives trading,” said then-SGE chairman Xu Luode at an LBMA conference in Singapore.
“In my opinion, the desired ratio should be something like 20% [physical] / 80% [derivatives] or 10%/90%,” said Luode – formerly a senior official at Beijing’s central bank, and now executive vice-president at Bank of China (SHA:601988).
Here in 2016, writes Kendall, Chinese corporations outside the bullion industry are using gold leases “as a financing vehicle…a mechanism” for exploiting the gap between different interest rates.
Kendall gives the example of Chinalco ( SHA:601600), the state-owned aluminum giant, which in June borrowed 10 tonnes of gold bullion from China’s Bank of Communications (SHA: 601328, also known as BOCOM).
Selling that metal through the futures market, Chinalco said it would raise CNY 3 billion (almost half-a-billion US Dollars) of finance, with a ‘hedging’ contract then protecting it from any rise in the gold price by the time it needs to return 10 tonnes to BOCOM – like ICBC Standard and Bank of China, a full member of both the Shanghai Gold Exchange and the LBMA.
The annual fees on this 12-month deal – including the cost of leasing, trading the futures contracts, and also the price hedging – “shall not in aggregate exceed the benchmark interest rate for one-year loan set by the People’s Bank of China,” said Chinalco’s statement to the stock market.
With price-protected gold-financing deals cheaper than cash borrowing costs, this growth in China’s gold leasing market is enabling Chinese banks to “fulfil their import quotas” says Kendall at ICBC Standard – pointing to the government-set limits which would otherwise be reduced for future shipments if only part-met – “at a time when physical demand from the jewellery sector has slackened.”
“We think that trade data is somewhat overstating underlying demand,” agrees a note from Swiss investment and bullion bank UBS, pointing to “double-digit percentage declines” in estimates of China’s consumer gold demand.
“There is still no sign of the [jewelry] sector bottoming,” said analysts Thomson Reuters GFMS in their April-to-June update published last week, with China’s jewelry demand – usually accounting for 60% of the country’s world-leading consumer purchases – marking its weakest quarter since 2009, down by almost one quarter from Q2 last year.
China’s slowing GDP growth doesn’t fully explain this fall, says independent consultancy Metals Focus, because “Chinese retail sales (of all consumer goods) have achieved double digit gains in recent years [and] also during 2016-to date” while household gold demand has dropped by 20%.
This isn’t the first time that China’s finance sector has boosted gold bullion imports, using them to exploit the gap between different interest rates and prices rather than selling that metal to meet private demand.
Coming after 2013’s price-driven surge in household gold buying, early 2014 saw a further jump in China’s imports as bullion was ” used for short-term financing,” said Beijing analyst Liu Xu at Capital Futures at the time, noting that “tight money conditions [were] fueling such deals.”
By March 2014, analysts quoted by the Financial Times in March 2014 estimated that one-third of all China’s copper imports were for collateral in complex financing deals, while US investment bank Goldman Sachs saidgold could account for 30% of all such activity, perhaps totalling $250 billion from 5 years before.
New regulations in June 2014 then sought to curb this boom in ‘trade commodity financing’, raising both the cost to banks of issuing short-term letters of credit and also the size of deposits required from customers wanting foreign currency.
“Increased costs and higher [foreign exchange] volatility has made hedging currency risk more expensive” again, says Kendall, while metal borrowing by jewelry manufacturers has also fallen on the sharp decline in retail gold sales.
Within China’s domestic finance sector however, 2016’s tighter credit conditions, plus falling profit margins for corporations and that lower consumer demand for gold jewelry, have combined to make gold leasing for non-gold businesses attractive to both lenders and borrowers, says Kendall’s article for the LBMA, What Has Aluminium Got To Do With Gold?
“In effect, what the slowing Chinese economy has taken from the gold lease market with one hand, it has started to give back with the other.”
Adrian Ash runs the research desk at BullionVault, the physical gold and silver market for private investors online. Formerly head of editorial at London’s top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and is now a regular contributor to many leading analysis sites including Forbes and a regular guest on BBC national and international radio and television news. Adrian’s views on the gold markethave been sought by the Financial Times and Economist magazine in London; CNBC, Bloomberg and TheStreet.com in New York; Germany’s Der Stern and FT Deutschland; Italy’s Il Sole 24 Ore, and many other respected finance publications.
See the full archive of Adrian Ash articles on GoldNews, or get more fromAdrian Ash on Google+
Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News, RSS links are shown there.
Disclaimer© 2010 Junior Gold ReportJunior Gold Report’ Newsletter: Junior Gold Report’s Newsletter is published as a copyright publication of Junior Gold Report (JGR). No Guarantee as to Content: Although JGR attempts to research thoroughly and present information based on sources we believe to be reliable, there are no guarantees as to the accuracy or completeness of the information contained herein. Any statements expressed are subject to change without notice. JGR, its associates, authors, and affiliates are not responsible for errors or omissions. Consideration for Services: JGR, it’s editor, affiliates, associates, partners, family members, or contractors may have an interest or position in featured, written-up companies, as well as sponsored companies which compensate JGR. JGR has been paid by the company written up. Thus, multiple conflicts of interests exist. Therefore, information provided herewithin should not be construed as a financial analysis but rather as an advertisement. The author’s views and opinions regarding the companies featured in reports are his own views and are based on information that he has researched independently and has received, which the author assumes to be reliable. No Offer to Sell Securities: JGR is not a registered investment advisor. JGR is intended for informational, educational and research purposes only. It is not to be considered as investment advice. Subscribers are encouraged to conduct their own research and due diligence, and consult with their own independent financial and tax advisors with respect to any investment opportunity. No statement or expression of any opinions contained in this report constitutes an offer to buy or sell the shares of the companies mentioned herein. Links: JGR may contain links to related websites for stock quotes, charts, etc. JGR is not responsible for the content of or the privacy practices of these sites. Release of Liability: By reading JGR, you agree to hold Junior Gold Report its associates, sponsors, affiliates, and partners harmless and to completely release them from any and all liabilities due to any and all losses, damages, or injuries (financial or otherwise) that may be incurred.
Forward Looking Statements
Except for statements of historical fact, certain information contained herein constitutes forward-looking statements. Forward looking statements are usually identified by our use of certain terminology, including “will”, “believes”, “may”, “expects”, “should”, “seeks”, “anticipates”, “has potential to”, or “intends’ or by discussions of strategy, forward looking numbers or intentions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results or achievements to be materially different from any future results or achievements expressed or implied by such forward-looking statements. Forward-looking statements are statements that are not historical facts, and include but are not limited to, estimates and their underlying assumptions; statements regarding plans, objectives and expectations with respect to the effectiveness of the Company’s business model; future operations, products and services; the impact of regulatory initiatives on the Company’s operations; the size of and opportunities related to the market for the Company’s products; general industry and macroeconomic growth rates; expectations related to possible joint and/or strategic ventures and statements regarding future performance. Junior Gold Report does not take responsibility for accuracy of forward looking statements and advises the reader to perform own due diligence on forward looking numbers or statements.