This is a transcription of the speech delivered by Jiang Shu at the LBMA/LPPM Conference in Vienna, 18 - 20 October. Let us look at China’s demand versus the gold price in Chart 1 below. From 2000 to 2011, we can see a strong positive correlation between China’s annual consumer demand and the gold price.

Such a strong positive correlation made many people believe that as long as China’s gold demand went up, there would always be a bullish gold market.

Even when the bull market had gone away, many analysts and market participants still hoped that a surge in China’s gold demand could change the trend of the gold price. From 2012 until 2013, that strong positive correlation between China’s demand and the gold price had been weakened. During this period, although China’s gold demand was still on the rise, the gold market had witnessed steep price falls. If you had held the strong belief that China’s demand determined the trend of the gold price, you would have had to explain the weakened correlation between China’s demand and the gold price.

Commodity Financing

Some analysts think that China’s gold demand has been inflated during the past three years, and they point out two possible sources. One is large-scale commodity financing deals, which use the imports and exports of gold to gain the spread between the US dollar’s low interest rate and the RMB’s high interest rate and the RMB’s appreciation, just as happened in copper and iron ore. The other is goal-leasing transactions between gold-related enterprises and Chinese commercial banks, which keep a large portion of gold from real demand.

The following two measures seem to confirm the above conclusion. Let us first look at net exports of gold from Hong Kong to China’s mainland versus the RMB exchange rate, as illustrated over the page in Chart 2. We can see that there had also been strong positive correlation between the RMB’s appreciation and net exports from Hong Kong to China’s mainland.

From 2010 until 2013, when the RMB went up greatly, net exports of gold from Hong Kong to China’s mainland had also increased dramatically. Looking at the development of China’s gold-leasing transactions, we can see that China’s gold-leasing volumes had increased from 155.8 tonnes in 2010 to 1,370.69 tonnes in 2014, which means that China’s gold-leasing volume had expanded more than eight times in just a short period of five years.

Chinese gold-financing dues are thought by some analysts and investment banks to be processed in the following four steps:

  • Step 1: Onshore gold manufacturers pay letters of credit to offshore subsidiaries and import gold from Hong Kong to mainland China, inflating import numbers.
  • Step 2: Offshore subsidiaries borrow low interest rate US dollars from offshore banks, via collateralising letters of credit received.
  • Step 3: Onshore manufacturers get paid in US dollars from offshore subsidiaries and export the gold semi-fabricated products, inflating export numbers.
  • Step 4: Repeat step 1 to 3 to gain then arbitrage profits as much as possible.

However, in China, the importing process is different for gold than for copper and iron ore. For general trade, around 15 domestic and foreign banks enjoy a People’s Bank of China (PBOC), China’s central bank, licence to import gold. A few large jewellery companies also have a gold trade licence for general trade, but this is insignificant. In China’s international gold trade, onshore gold manufacturers are not big players, as is thought by some investment banks and international analysts, but China’s commercial banks are.

“With the rapid growth of China’s gold-leasing transactions, can China’s gold- leasing business lock so much gold that China’s demand is inflated?”

Can China’s commercial banks do some gold- financing deals to gain the arbitrage profits from their domestic and overseas branches? The answer is no. Why? Because all bullion imported through general trade is required to be sold first through the Shanghai Gold Exchange (SGE). Consequently, all gold flowing through the SGE is prohibited from being exported, so the importing process for gold is different from copper and iron ore. Most net exports of gold from Hong Kong to China’s mainland are not the result of arbitrage based on the RMB’s high interest rate and appreciation.

Gold Leasing

With the rapid growth of China’s gold-leasing transactions, can China’s gold-leasing business lock so much gold that China’s demand is inflated? The answer is also no. Currently, most of China’s gold-leasing transactions take the form of gold-related enterprises borrowing gold from banks. China’s gold-leasing dues are processed in the following three steps:

  • Step 1: Any gold-related enterprise that wants to borrow gold must have the qualification approved by the SGE and get the credit line from the commercial bank that lends it gold.
  • Step 2: The commercial bank lends the gold- related enterprise gold from its own stock or gold borrowed from the SGE’s interbank lending market.
  • Step 3: The gold-related enterprise’s gold- leasing value should not exceed the credit line that the commercial bank gives, and, at a specific future date, the gold-related enterprise must return gold plus interest rate to the commercial bank.

When gold-related enterprises get gold, they will sell gold through the SGE immediately and, at the same time, buy futures or forwards to hedge price risk for when they would buy gold back and return it to banks in the future. Therefore, in China’s gold-leasing business, what gold- related enterprises really care about is not gold itself but relatively cheap money.


Let us look at China’s gold-leasing rate versus the bank loans rate. Here, in Table 1, we have three columns. The first is the one-year gold- leasing rate. The second is the gold-leasing rate plus hedging cost. The last is China’s one-year bench lending rate. When we closely examine the three columns, we will find that China’s one-year bench lending rate is generally 2% higher than the one-year gold-leasing rate. The gold-leasing rate plus hedging cost is generally 50BPS lower than China’s one-year bench lending rate.

The money from the gold-leasing transactions is relatively cheaper than the money our company can get from bank loans, so that is the real point of China’s gold-leasing transactions, not the gold from the real demand, as many analysts in the international markets have thought.

Since the US dollar has a low interest rate, it is not surprising that China’s gold-leasing USD hedging cost is much smaller than the RMB’s hedging cost. Here, as you can see from Table 2, we have gold-leasing’s RMB and USD hedging costs. The first column is the gold-leasing RMB hedging cost and the second is the gold- leasing USD hedging cost. When we closely examine the two columns, we will find that gold-leasing’s USD hedging cost is generally 1% lower than RMB’s hedging cost. Of course, USD hedging has the exchange rate risk: if the RMB depreciated greatly and suddenly, just like the episode taking place on 11 and 12 August, with 4% depreciation in two days, gold-leasing’s USD hedging would lead to great losses.

Gold-leasing in China has become a standardised loan-like product of banks. Just like the effective money multiplier in macroeconomics, China’s 1,371 tonne gold- leasing volume needed much less gold. The gold-leasing business does not keep a large portion of gold from China’s real demand.

Inflation of Influence

In my opinion, China’s gold demand is not inflated by the assumed gold-financing dues and gold- leasing transactions. Then how can we explain the weakened positive correlation between China’s demand and the gold price? From my point of view, the answer comes not from the inflation of China’s demand, but from the inflation of China’s influence. Although China’s demand has a strong influence on the gold price, to most of China’s gold investors and market participants, China’s demand has not replaced the US dollar as the gold price’s number one driving force. It is interesting to note that when international investors met Chinese investors, the international investors were eager to gather information or even gossip about China’s jewellery demand and China’s gold reserve movement. At the same time, China’s investors were anxious to know how the US economy was and when the Fed would raise the interest rate.

We have collected 588 titles from gold analysis reports or articles from a very popular Chinese financial website, Hexun, from the beginning of 2015 to 6 September. Among these 588 titles, only 28 titles mention China as the gold price’s driving force, which represented only 4.76% of the whole sample, while 373 titles associated the US dollar and US things with gold price volatility, which represented 63.43% of the whole sample. To most of China’s gold investors and market participants, the influence of China’s demand on the gold price is even smaller than that of the Greek crisis. Of this figure, nearly 50% mentioned Greece. At the same time, less than 5% mentioned China.

China’s Dama

Perhaps someone would say that China’s demand was not determined by analysts’ thoughts, but by China’s Dama’s actions. China’s ladies in their 50s and 60s are thought to have a strong appetite for gold jewellery and investment gold bars, and even the international news media coined the phrase ‘China’s Dama’ to emphasise China’s importance. Let us look at the quarterly change in China’s consumer demand versus the gold price in Table 3. When we closely examine this, we will see that, in 2013, although there was a gold buying spree in China, it was the gold price that moved first, and China’s Dama just rushed to follow the downward trend, to gain the benefits like ‘on sale’ in the supermarket.

In summary, I think that China’s demand has not replaced the US dollar as the number one gold price driving force. Generally, China’s gold demand is not inflated, as some international investors and analysts thought.

Jiang Shu, Chief Analyst, at the China Industrial Bank from 2008 to 2015. Currently he works as the Chief Analyst for Shandong Gold Financial Holding Co., which is a subsidiary of Shandong Group. He manages Shandong Group’s research team and is responsible for formulating hedging strategies on behalf of Shandong Gold Financial Holding Co.