The Shanghai Gold Surprise

by David Baker (dbaker@sprott.com) and David Franklin (dfranklin@sprott.com)

The physical gold market continues to develop in the most wonderfully counterintuitive way. While the paper gold price languishes below US$1,300 per ounce, physical demand out of China is now reaching previously unforeseen levels. If you’ve heard this story before, it’s more of the same, except that the demand tonnage is now so high as to be almost comical.

According to data released by the Shanghai Gold Exchange, the amount of gold contracts settled for physical delivery on its exchange reached a staggering 1,098 metric tonnes year-to-date as of the end of June.¹ This is an astoundingly large amount of physical gold. For perspective, 1,098 tonnes represents approximately 40% of the entire estimated global gold mine production in 2013. It also represents roughly 1/8^th of the US Treasury’s official gold reserves, and over 100% of China’s stated official gold reserves. If the rate of physical delivery on the Shanghai Gold Exchange continues at current levels, it will deliver the equivalent of over 100% of global mine production by the end of this year… all through one exchange.

In contrast, the COMEX futures exchange in New York, where the bulk of US gold futures are traded, saw a measly 160.7 tonnes of physical delivery requests over the same period (year-to-date to June).² Although the paper volume on the COMEX dwarfs that of the Shanghai Gold Exchange, the level of physical delivery requests is only 15% of that seen in Shanghai.

If the Shanghai data is true, when combined with the gold imports going into China via Hong Kong, we now have a situation where China is buying the equivalent of all global gold mine production produced on a monthly basis. How that can coincide with a gold price drop of US$400 per ounce over Q2 is beyond our capability to explain, but it does mean that China is now the undisputed hub for physical gold.

Interestingly, China’s demand for physical gold does not seem to be benefitting the growth of gold ETF products within the country. Bloomberg recently reported that China’s first two exchange-traded funds backed by bullion both had disappointing debuts, with Huaan Asset Management Co. reportedly raising only $195 million out of an expected $400 million at launch.³ Although the press has naturally concluded that this news indicates waning gold demand in China, we can’t help but think it shows that China’s gold interest is primarily focused on the physical metal, as opposed to financial products that trade on exchange. Certainly if the time ever comes where the physical gold market sets price discovery for the gold price (as opposed to the futures market) it seems highly likely that the first place that will happen now is within Shanghai itself.

Whether there’s a link between China’s increasing physical gold deliveries and the drop in gold inventories within the COMEX and GLD ETF remains to be seen, but whoever is supplying China’s gold appetite is supplying it in size. Despite gold’s lackluster price performance, these developments strongly suggest we could be in for an interesting summer in the weeks ahead. Gold is a finite resource - if China’s current purchase rates continue, it is going to own a significantly large proportion of global gold reserves.