The most important trend in gold investing today

The Chinese and British governments see gold very differently. Could you ever imagine HM Treasury taking out an ad during The X-Factor, encouraging Brits to invest in precious metals?

Well, that’s exactly what the Chinese government has been doing since 2009 on CCTV, its national broadcaster. The cultural significance of gold in China can’t be understated. It is the traditional gift given after a baby is born, on wedding days, on birthdays and at Chinese New Year. Gold is the symbol of wealth in China.

And those TV ads seem to be working. Demand for gold from ordinary Chinese citizens is going through the roof. I want to show why this is the most important trend in precious metals investing today.

China’s huge new middle class wants gold

By now you are surely familiar with China’s ‘economic miracle’. Growth in the world’s second largest economy is now dramatically higher than any other major nation.

All this growth is creating an enormous middle class. Recent research from the World Gold Council, the association of large mining companies, states that there are currently 300 million people in China considered middle class. In just five years this is forecast to grow to 500 million. By comparison, in the US, which has a population of 319 million, in 2011 approximately 163 million people were considered middle class.

So by 2020, the Chinese middle class is forecast to be roughly three times that of the US.

And there aren’t many places for these people to put their money. According to the World Gold Council, Chinese households have around $7.5trn in bank accounts in cash. These households also have a relatively modest $300bn in gold.

In fact, there is very compelling evidence that suggests the Chinese middle class has already begun converting their cash to gold. The following graph shows gold commentator Koos Jansen’s numbers for non-government demand in China:

Figure 1: Non-government gold demand in China, tonnes


Source: Koos Jansen

2013 saw a huge 93% jump in physical gold demand. So you can see why I believe the process may have already started.

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Chinese demand is a huge chunk of global supply

So Chinese demand for gold is increasing – especially among the emerging middle class. But what’s really important about the growing Chinese demand is that it could trigger a major shortfall – where demand exceeds supply. In fact, the numbers suggest this is inevitable.

Consider that in 2013 the total supply of gold, according to the World Gold Council, was 4,339.9 tonnes. With a lower gold price I would expect gold production to be relatively flat, so let’s assume that supply in 2014 is the same level as last year. And if we assume that this year Chinese households consume a similar amount of gold to last year (2,197 tonnes) and the government demand is also the same (600 tonnes), then total Chinese demand could well come in around 2,797 tonnes for 2014.

This compares with global supply in 2013 of 4,340 tonnes.

That leaves just 1,543 tonnes of gold for the rest of the world.

So Chinese demand for gold is high, and rising – 2,797 tonnes out of the 4,340 produced worldwide last year. If that doesn’t leave enough gold for the rest of the world, then the price will have to go up.

What we need to do is keep looking at the numbers, and pay more attention to what the physical market is telling us rather than what people are telling us about the physical market. I suspect that the trend we see in figure 1 will win out in the end.

One thing is certain: there is an increasing physical demand from the Chinese middle class and it’s very unclear as to where this gold is going to come from.

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