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January 13, 2014

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Should you be buying gold? That depends

People buy the precious metal for diverse reasons, making it impossible to draw blanket conclusions about the soundness of such investments. Before embarking on a bling fling, you might heed the advice of the World Gold Council and study prudent options available to investors.

The World Gold Council, the UK-based industry association, recently consolidated its operations on China’s mainland to reduce costs and improve efficiency.

Shanghai has become the group’s regional head office for the Chinese mainland, Hong Kong, Macao and Taiwan, while its existing Beijing office remains open, Albert Cheng, managing director of the council for the Far East, told Shanghai Daily in an exclusive interview in December.

He joined the council’s Singapore regional office in 1993 and became the managing director responsible for the entire Far East operations in 2003. He has been one of the four international advisors to the Shanghai Gold Exchange for 11 years.

Cheng discussed with Shanghai Daily different types of gold investment, the factors that influence prices, and the feverish buying by middle-aged women in China — the so-called Chinese “Dama” — after a price plummet last April. 

Q: Do you think gold is worth holding as a long-term investment?

A: That depends. First, we need to analyze why people hold gold. People buy gold either in physical forms like jewelry, bars and coins, and in other forms, more generally known as paper. Paper gold can be exchange-traded funds, which is a product that allows asset managers to hold physical gold on your behalf. Gold savings accounts and gold accumulation accounts from banks are also deemed paper gold. More sophisticated investors can participate in the futures market to buy options and do margin trading.

Buying gold jewelry is generally for self-gratification. It’s something to reward yourself, to make you feel good about yourself, just like buying clothing or handbags. Another mentality of buying gold jewelry is for value preservation. It’s a precious metal, so even when I don’t want it, I can sell it back. This hardly applies to other consumer goods, as only very expensive handbags have value for resale.

In terms of gold bars and coins, people buy them to store wealth. If you want to speculate on price, buying physical gold bars is not economical, especially commemorative gold bars and coins with specific themes, such as panda gold coins. The bars and coins are priced with a premium for the craftsmanship. And when you sell back the gold, the value-added part will be lost. Buying these for short-term investment also doesn’t make sense. It’s more for wealth preservation in the long term or for people who like to collect them as a hobby.

For those who want to speculate on gold prices, they should buy paper gold. If you buy a gold savings account or gold ETFs, you pay 100 percent cash. You don’t need to worry about an immediate loss when the gold price slumps because the bank will not call you and ask for a margin top up.

If you buy margin accounts or future contract, you need only to make a down payment of 7 percent to 10 percent of the contract value. But you are subject to a more dangerous situation. If the price of gold changes more than 7 percent, it wipes out all your investment. So it’s for professional investors, not for ordinary investors.

Q: Chinese “Dama” reportedly beat Wall Street in gold buying. Why did that happen?

A: Chinese “Dama” prefer something tangible, like gold bars and jewelry, which they can bring home. They want some gratification. So they enjoy going to the store and fighting with other “Dama” to buy something that is cheap. It’s like when department stores offer discounts on anniversaries. Housewives will wait for the day and rush into the stores to buy. I think “Dama” have been watching the gold market very carefully in the past few years. The price of gold climbed between 2009 and 2012, so they were waiting for a correction. There were many small corrections, but not like the one in April, when the gold price plunged. It was like a department store anniversary sale.

Some media say these “Dama” are locked in the gold market. But I think they will not regret it as they bought gold for gratification, not for investment. Some of them will give the jewelry to their relatives or children as gifts.

Q: What are the factors that influence the gold price?

A: Jewelry is about 50 percent of total gold demand; investment demand is about 30 to 35 percent. About 10 percent is demand for industrial use, and a small percentage is central banks’ purchase. These four types of gold users behave very differently and react to different market drivers. Some are more sensitive to the financial world, and some are more sensitive to income levels.

Industrial use, primarily for electronics manufacturing, remains stable at around 400 tons a year. Central bank purchases are dependent on policies. They may continue to purchase gold regardless of the price because they have to maintain the level of gold holdings. For example, in the last few years, Russia has been adding to its gold reserves from time to time because of the increase of its foreign reserves. So have Thailand and South Korea.

Each demand component reacts to different market forces. The Indian government has imposed taxes on gold, which will drag the price down due to weaker demand. But robust demand in China will pull the price up. The price fell a bit after the US government announced its tapering policy recently. There are lots of factors dragging the price up and down. At the moment, the strongest force is US monetary policy.

The gold price was partially bolstered by the Fed’s quantitative easing. The money began to flow out of the US and into the emerging economies after QE was launched. Some of the money has flowed into the gold market. Now the US has blown the whistle and said it’s going to start to close that window. So everybody will try to convert their investments into US dollars and go into the US stock market.

New driving forces may emerge in the future. For example, if China announces an increase in gold reserves from 1,054 to 2,000 tons, there would be an immediate drag-up force in the market.

Q: Why does China maintain its gold holdings at around 1 percent of foreign reserves?

A: China opened the gold market 10 years ago, which made it very convenient for people to buy gold from banks. The vice governor of the People’s Bank of China said earlier that the government should not compete with the public in gold buying; otherwise it will push up the price. My personal estimation for China’s hidden holding of gold reserves by its people is about 4,000 to 5,000 tons, which is the result of accumulation in the past decades.

Q: Is there a bottleneck in China’s gold production?

A: There’s no bottleneck. China’s production has increased significantly in the past 10 years. Mine production last year should be around 430 tons, quite a jump from 211 tons in 2003.

China has been the largest producer for about five years, mainly because other countries have seen falling production. South Africa used to be No. 1, with yearly production of 700 tons. So China’s production has been growing fast but is not that substantial.

Q: How could China become more influential in the global gold market?

A: The global gold market has been open for 43 years, after then US President Nixon stopped international convertibility of the dollar to gold in 1971. China opened up its gold market only 10 years ago, mainly focusing on the consumer market.

The Shanghai Gold Exchange originally provided a marketplace for gold producers in China and was later extended to wholesalers and consumers. This is a very fundamental market mechanism. But in the West, the gold market has been developed much further. China has been doing well but is still in the primary stage of a developed market. In order to participate in the global markets, China needs to introduce more developed mechanisms and products into its domestic market. It requires time and talent to build up.

Alternatively, China can develop the infrastructure here to allow international players to come in and work side-by-side with Chinese players. It’s another way to participate in the global market.

At the moment China’s is only participating in the gold market at the physical level. The whole industry needs to move up the ladder and get into the global financial trading world.

I think gold market development should occur in the Shanghai free trade zone. A firewall can be set up in the zone to separate the onshore and offshore markets. Then the international players can be invited to the FTZ. Eventually the firewall can be moved further back to make Shanghai a bigger international financial center.



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