Will A China Slowdown Affect Gold?

After finishing the second quarter at $1,505, gold is on pace to finish the third quarter with its 11th consecutive quarterly gain. Although gold has been in a bull market for the past decade, recent concerns from a China slowdown are weighing on many markets.  In September, gold prices and Asian stock markets had their worst monthly performance since October 2008.

According to the World Gold Council, China is the largest buyer of gold behind India.  China’s jewelry and investment demand is the fastest growing gold market in the world.  The strong domestic growth in China’s economy has given way to a rising wealthy Chinese consumer.  In the second quarter, which is usually a quiet period for China, Jewelry demand was 102.9 tonnes, 16% above prior year levels.  However, concerns are rising that may hinder Chinese gold demand.  On September 22, HSBC released their preliminary PMI survey that showed China’s manufacturing may shrink for a third month in September, the longest contraction since 2009.

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Aside from jewelry demand, China is a strong force in the investment aspect of gold.  In the second quarter, China was the second largest investment market for gold.  Total investment demand around the globe amounted to 359.4 tonnes, in which China accounted for 53 tonnes.  The Chinese turn to gold as an investment as inflation in the world’s second largest economy heats up.  In July, Chinese inflation rose higher than expected to 6.5%, a three year high.  Chinese authorities have made it a top priority to slow its economy and inflation rate. The People’s Bank of China has raised benchmark interest rates three times this year, and reserve requirements six times.  As a result, inflation in August eased from its three year high, but still remains above 6%.

Even though a China slowdown looks inevitable, investors should remember that gold has been one of the few winners this year.  One of the reasons as to why gold suffered a pullback in September, was due to investors needing to raise cash, and selling gold was the easiest way.  Sprott Management explains, “Investors still remember how badly gold equities got crushed in 2008.  There was a reason they sold off so aggressively however, they were the most profitable positions investors owned going into the ’08 crisis.  Gold equities had enjoyed a strong bull trend going back to 2001, with the HUI Index appreciating by 980% from its November 2000 low through to August 2008.  Investor behavior is fairly consistent-when panic hits, you sell your winning positions first.”

Precious metal investors concerned with a China slowdown should consider that gold still remains an attractive investment to the Chinese.  The World Gold Council reports, “The underperformance of the domestic stock market and a sluggish property sector further fueled purchases of bars and coins.”  A clear example of this is the Shanghai Composite Index, which is China’s benchmark index.  The index is currently trading at 2009 levels, while gold prices have increased more than 70% in the same period.  Gold also plays a significant culture role in China and India, which is not likely to change anytime soon.  The World Gold Council estimates that Chinese gold demand could double over the next decade.

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