LBMA Precious Metals Conference 2004 - Shanghai
Programme of sessions and speakers
Former LBMA Chairman
Good morning ladies and gentlemen.
It is a genuine pleasure to welcome you to this the 5th LBMA Annual Precious Metals Conference, which is our first event to be held in China. I see from the delegate list that the Chinese industry and the banking sector are extremely well represented here (as we knew they would be) but the good attendance today also represents the fact that many of you have made long journeys to participate in this Conference. This no doubt reflects in large part the fact that Shanghai has become a destination of choice not only for tourists but also for business people the world over. As you may already have seen, it epitomises the dynamism that characterises the Chinese market. An example of the vibrancy of the economic development in Shanghai was there for all to see last night at the cocktail party as we saw an endless two-way stream of heavy river traffic transporting every kind of raw material and product.
Many of you will be aware that we had planned to come to China in May of last year but with the advent of the SARS crisis, we were forced, at short notice, to postpone our trip to Shanghai until this year. One of the advantages of the postponement is that the Shanghai Gold Exchange (which was, in market terms, a teenager in June last year) has now matured and developed its systems and products, and the Conference gives us a very good opportunity to find out, not only about its past development but about its very exciting future. I should add that the LBMA has always had a policy of holding its conferences in venues which are important for the market – either in terms of production or consumption – or, as here in China, for both.
As you will have seen from the programme, a lot of the content over the next day and a half will focus on aspects of the future development of China and I would like to stress that this is not simply because we are holding the event here in Shanghai. In fact, we are always at pains to point out that wherever we hold the Conference, the agenda is an international one. Thus the reason for much of the China content in the programme is in fact the country’s importance as a producer, but above all, as a potential consumer of the precious metals.
As any observer of the commodities markets is aware, the China factor has been the major element in the supply - demand equation in recent years. This applies to demand for soft commodities, to industrial minerals, to base metals and of course also to the precious metals. However, we do not forget about China as a source of supply nowadays, particularly for gold and silver. As our Chief Executive mentioned in his remarks, the main area of growth in the LBMA’s Good Delivery List in recent years has come from China and particularly from its silver refiners. Since 2002, 6 Chinese silver refiners have joined the List, which emphasizes not only the importance of Chinese silver production in the world today, but the global significance of the Good Delivery List.
Those of you who have had a chance to visit the Forbidden City and see the displays of gold there will not be in any doubt about China’s long tradition as a consumer of gold though nowadays the consumption is a lot more evenly spread than when Marco Polo visited China some 8 centuries ago.
However, I do not want to give you a lecture on Chinese supply and demand as we have many experts with us here, who can do the job a lot more professionally than I can.
So let me instead turn to the LBMA and for those of you who are not so familiar with us, let me describe some of the recent more important developments. Until 1999, the LBMA was essentially a trade association of UK-based companies, many of them admittedly linked to international groups. Even at that time, however, the LBMA Good Delivery List was recognized as the de facto standard for the quality of gold and silver bars. In 1999, the LBMA decided to welcome foreign companies into its membership – as International Associates - and the first Associates joined in January the following year. Some two years later, an even more fundamental decision was taken – to allow companies whose trading operations were located outside the UK to join as Full Members. The LBMA now has a total membership of 101 companies involving 8 Market Makers, 52 other Full Members and 41 Associates. Through our conference and seminar programme, we have also reached out to other markets, in some cases to assist them as they developed their methods, regulatory systems and product offerings. For instance, last year, we held a Bullion Market Forum focusing on issues in the Indian market in New Delhi and this year we had a similar event in Moscow looking at the current challenges and future opportunities facing the CIS markets.
The world has become a smaller place thanks to improved communications and air travel (and in spite of the threat of terrorism and email viruses!). Globalisation does exist in the precious metals market and we do recognise that for products such as precious metals there is a single world market. At the same time, there are many regional markets, each performing the vital tasks of providing safe and efficient platforms for trading and ultimately satisfying the needs of our client base. Many of these markets do of course use London as a means of finance, hedging and for sourcing physical supplies.
The three pillars of the London market – the fixings, the clearing system and the Good Delivery List (the latter now enhanced by the introduction of proactive monitoring this year) provide a platform that can be used by companies around the world for a safe and effective means of trading gold and silver in a wide range of ways to suit and equally wide range of customer requirements. Those of you who do not have a copy of the “Guide to the London Bullion Market” – which was published in a Chinese edition last year and which will be available in a Russian edition shortly – may wish to contact the LBMA executive to obtain a copy.
The LBMA exists to ensure that London continues to provide an efficient service for the benefits of all it Members, its Associates and its customers. This, in a very real sense, is why we’re here.
Before I finish, let me add my thanks to those of Stewart to our friends in China who have assisted us with the organisation and the marketing of this conference. The Shanghai Gold Exchange has provided us with tremendous support in all aspects of organising the event and together with the China Gold News Organisation they have helped to ensure that everyone in the gold business in China was informed about the conference. I would also like to thank the speakers for the time and effort they put into preparing their presentations and for informing us about the current state of the market; and the session chairmen for their efforts. They not only have to introduce the speakers and ensure that their sessions finish on time: many of them have in addition been assiduous in contacting the speakers in their sessions over recent weeks to co-ordinate their contributions and ensure stimulating discussion after them. Finally, I would like to thank Kamal Naqvi and the members of our Public Affairs Committee who have spent many hours over the past year developing the programme.
And now it is indeed an honour to be able to gives me great pleasure to introduce Mr Han Zheng, the Mayor of Shanghai, who has graciously agreed to be present today to welcome us to Shanghai and tell us something about this fascinating city. Mr Han was Shanghai’s youngest ever Mayor when he was elected to this vital position last year but he has a wealth of experience in running large and medium-sized enterprises as well as the various organs of the Shanghai Municipality. Mr Han, please…..
Mayor of Shanghai
Governor, The People’s Bank of China
Shen Xiang Rong
Chairman, Shanghai Gold Exchange
Firstly, let me on behalf on the Shanghai Gold Exchange (SGE) China express great appreciations to all the guests attending this LBMA Precious Metals Conference. We feel honored to have this conference held in Shanghai, which shows the eyes and supports on the Chinese gold market as well as the SGE from the global gold fields. Now please allow me to on behalf of SGE and in my own name to extend our warmest welcome and sincerest greetings to all the attendants and friends and wish this conference a great success.
SGE officially opened on the October 30,2002, which meant the great achievement of the management system revolutions on the Chinese gold market. It is also a symbol that we have stepped forward to the standardized market principles gradually. On this occasion, I am honored to have this opportunity to give you a brief introduction on the SGE.
1. The basic information about SGE
Approved by the State Council of the People’s Republic of China and founded by the People’s bank of China (PBOC), SGE is a non-profit and self-management legal entity. SGE organizes the trading of gold, silver and platinum with the principle of openness, fairness, justness and honesty.
SGE adopts the membership system. Our memberships consist of qualified financial institutions and the corporations that produce, smelt, process, wholesale, import and export precious metals including gold, silver, platinum, etc. and products of precious metals. All the legal entities mentioned above should have fine credit and reputation. Currently, we have 128 members. As the general statistics, these members account for the 75% of the China’s total gold production, 80% gold consumption and 90% refining capabilities.
2. The whole operational conditions since opened
Generally speaking, the whole operational conditions are quite steadily with the smooth trading system and continuous increasing trading volumes. SGE launched the platinum on July 30, 2003 , AuT+5 on February 18, 2004 and trial business for small-scaled gold bars on June 28, 2004. On August 16, 2004, our new edition trading system officially came into operation and meanwhile deferred trading transaction was listed. Till August 31,2004 since opened, the accumulated trading volume had reached tonnes with a turnover of billion yuan. Follows are the main characteristics of the market.
1) The continuous expansion of market scales, the evident enhancement of investment ratio and the full display of allocation functions to the market resource.
From January 1 to August 31, the total trading volume was tonnes, up % year-to-year, and the turnover reached billion yuan, up % year-to-year. On June 25 this year, the daily trading volume even broke through 6 tonnes, the peak level since the open. The transaction conditions of the gold producers and users show there exist quite good connections between the supply and demand. After PBOC had abolished the monopolizations on the gold allocation and management, SGE took the basic role of allocation and management on the gold resource, stipulating the healthy and orderly development for the gold producing, circulation and consumption.
From the January 1 to August 31 this year, the delivery amount was tonnes, with the delivery ratio reached %, down % year-to-year. There is an evident increase on the investment business, which has become the main force to enlarge the trading volumes.
2) The improvement of price discovery function and the gradual formation of price-fixed mechanism. The gold price in SGE has been the dominant price on the domestic gold market.
On the first half of this year, the international gold prices were quite fluctuated and the domestic gold prices kept close pace with or were often higher than those on the international markets on the whole. Among those 123 transaction days, there are 86 days that our prices are higher than the prices on the international markets, the average spread reached 0.68yuan/g. On the rest days, gold prices on SGE are lower with the price difference of 0.32yuan/g. Now the transaction gold price on our exchange has become the reference benchmark for the gold producers, users and some investors, directing their operational activities and citizens’ consumption practically.
3) The increase of trading species and the abundance of market functions.
On the first half of this year, our exchange respectively launched the AuT+5 and Au50g in February and June. The market not only acts the function of allocating the gold resource but also improves the investment functions, which could be proved by the increase of market participants and the enrichment of profit-earned models.
These two years’ operation of us witnessed that the project design of us is accordance with the market requirement of development and the further appearance of the basic market function. On the whole we have reached the expected objective of management system revolutions on the domestic gold market, realizing the smooth transition for gold from the monopolization to market trading and achieving periodic success of this revolution.
3. Some plans on the development of SGE
Now we are only at the first stage of the development, PBOC, the whole society and the counterparts in the international gold fields have laid their big expectations on us as well as offered great supports and created a good external environment for us. Earlier this year on the working conference of PBOC for 2004, the governor Zhou Xiaochuan had made requirements on the Chinese gold markets. He required to “by making further development of the gold market, creating safety and high efficiency gold trading system and exploring the new trading species with investment and hedging function, the Chinese gold market should fulfill the transition from present spot market to a comprehensive financial market.” In addition, Governor Zhou had gave important instructions on strengthening our management, controlling the risks and meeting the needs of the market etc. while making inspection in this April. Under the guidance of PBOC, we will conduct followed methods gradually and designedly on the basis of the study and research on the successful experience of international markets and connecting the Chinese practical situations closely.
1) Setting up a safety and high-efficient gold trading system to ensure the development of SGE
Setting up a safety, efficient and high-capability trading system which could fully adapt to the development of trading business is a key point to the steady operation and sustainable development of us. To meet the further demands from the market, SGE started to probe into the development of new trading system. In the periods of brewing, projecting, designing and developing, we had organized the specialists on technology and business for many times to demonstrate it strictly, heard of our members widely and consulted on the international specialists seriously. The objective of developing is that the new trading system should be with advanced technology, high informatization, steady capability, well compatibility and strong loading ability. Thus this new trading system can meet the needs of sustainable development of business at maximum levels, with the characteristics of flexibility, retractility and transferability. Now the peak level of application system could support 1000 quotation per second and 3 million customers at the same time. Besides maintaining the current business, this new trading system can also support the spot, forward, deferred even futures trading methods.
After continuous developing and testing which lasted for almost a year, the new trading system came into operation on the August 16 this year. Now the new-edition trading system operates well with the steady host computers and smooth trading net. Through the simulative testing and practical operation, our members have had good commands of the business flows for the new trading system. It’s no doubt that the setting up of new trading system will provide us with a broad business platform.
2) Developing the new trading species with hedge functions on the gold market to meet the needs from various investors.
Since the official open of SGE, we could meet the consumption needs from the gold producers and consumers, but we should enhance the investment functions of the whole market. Accordance with the related files, the banking deposits of Chinese residents are as high as 12,000 billion yuan. If we list the individual gold investment, the monetary assets on the hands of the residents may be turned into the gold assets. Keeping the gold among the residents which can relieve the country’s heavy pressure on the currency market and take back some money is a favorable act that do good to our country as well as the residents. Meanwhile, gold has the duple attributions as general commodity and monetary commodity. As the research hold by related department, it showed that 20% of the informants would like to participate in the gold investments and the prefer to invest their 10%-30% financial assets into the gold markets. Using the above mentioned 20% the participants and 15% financial assets as the reference base, we expected there will be about 300 billion yuan flowing into the gold market after the wholly open of the domestic gold market, which means a huge market potential.
On June 28 this year, SGE began to list the small-scaled gold bars on the trial basis. These 50g gold bars have lowered the transaction entrance standard and enlarge the scope of trading participants, actively pushing the investment functions on the markets. At the same time, by listing the new product we can accumulate the experience and make full preparations for the entrance of individual investors. Under the supervisions of PBOC and the related government departments, we will further standardize the market and introduce the individual investors into our market system to ensure the steady development of economic constructions.
3) To improve the exertion of the market functions and gradually realize the transition to the financial markets from current spot physical markets.
To improve the exertion of the market functions, SGE continually strengthens its species creation. Now we have launched the T+5 and deferred trading methods on the basis of spot trading which could meet the needs of locking cost and maintaining the value to hedge the cost uncertainty due to the price fluctuation.
Current trial deferred transaction is conducted in the installment methods. The traders can choose to deliver before, on or after the contract day through the negotiation between the bidder and asker and the contract price is the matching price of the day.
We balance the supply and demand on the market by adjusting the deferred compensation that charged for deferred traders. We also regulate the margin ratio to ensure the smooth trading. Meanwhile, we protect from and control the risks by strictly executing the efficient regulation rules.
At present stage, we have launched the deferred trading in the domain of spot transactions in order to gain the experience. After the basic frame of financial product trading system with the investment and hedging functions had come into being preliminarily, we will fully take our advantages and absorb the advanced international experience to probe into the financial products as futures and options foreseeingly, realizing the diversify of trading products. We should not only make the trading products have the commodity characteristics, but also build up a relative perfect financial product trading system, pushing the creation process of domestic gold markets and fulfill the transition from the spot market to the financial market in deed.
Everything has its own beginning. Only do from the beginning, you may have the chance to conquer the difficulties. The emerging SGE will work hard and set a solid foot on the beginning stage. On consolidating the existed trading business, we will study and master the successful and matured operational experience on the international market as soon as possible. With keeping close with the times, SGE will speed up the development and take the pace of international markets, trying to be an important member of the whole financial system.
Finally, wish this conference a complete success, and all distinguished guests here prosperities with your business. Also welcome to visit SGE during these days.
Chairman, Ivanhoe Mines
Chairman: Paul Fisher, Head of Foreign Exchange Division, Bank of England
Head of Treasury, Bank for International Settlements
Ladies and Gentlemen, I am here today to speak to you about my view on the role of the public sector in the evolution of gold and of the gold price. And I should clarify that this is my personal view and not the view of the BIS.
This is the first time that I have been invited to speak at the LBMA and I am delighted to be with you in Shanghai. I fear however that this may also be the last time, as the bottom-line of my presentation is that the public sector will probably have a rather limited influence on the evolution of the price of gold in the coming year.
To start off, I would like to show you the recent evolution of Central Bank Reserves and the role of gold in these reserves. As you can see from the graph, Foreign Exchange Reserves have grown substantially over the last 10 years (average increase of 10% annually), with an acceleration over the last 3 years (average increase of more than 13% annually). This growth in reserves originates mostly from Asia as displayed by this graph on regional imbalances. Since the Asian crisis, most Asian countries have followed a policy of building sizeable FX reserves to protect themselves against volatile capital movements. The strong economic growth experienced in Asia is accelerating this trend as well as the FX policy in some Asian countries.
Lets now look at the share of gold in these reserves. It is no surprise that gold’s share of total reserves has been steadily declining since the beginning of the ‘80’s essentially for two reasons: predominantly it is due to the rapid expansion of FX reserves, particularly in the US dollar. To a lesser extent it is also due to the drop in the price of gold which despite periodic bounces, has never seen the price levels prevalent during the high-inflation era of the 1970’s and early 1980’s.
As you can see, gold now represents on average 10% of world wide reserves. The cause of this recent “bottoming out” is not due to recent purchases of gold by Central Banks, but rather to the recent increase in the price from lows of around USD 300 to current levels.
Now, if we look at the regional distribution of gold, you will notice that the US and Europe hold a large part of their reserves in Gold, while the Asian gold holdings are very low in comparison.
With this as the background we might ask in what way could the public sector influence the price of gold in the future?
There are three obvious ways:
- Central Banks or governments can sell (indeed in some cases the gold is owned by the government and not by the Central Bank)
- Central Banks can lend
- Or they can purchase gold
And these will be the three points that I will discuss.
- Central Banks can sell
Central Banks have been selling gold for quite a while, but if you look closely at the following chart you will notice that official sector sales have rarely represented more than 15% of the global supply of gold. For the coming year I do not expect a large change in the supply of gold from the official sector.
This is fully consistent with the renewal of the Central Bank’s Gold Agreement of September 1999 (the slightly confusingly named Washington Agreement as the US was not party to it).
Indeed through this accord the signatory Central Banks have not only limited their sales on an annual basis but more importantly they have provided the market with transparency regarding their intentions. If you look at the graph, Central Bank sales have never been that important as a source of supply, but it was more the uncertainty - the Sword of Damocles that they represented for the market (indeed as you know Central Banks own collectively 32000 tons of gold i.e. the equivalent of 12 years of production) - which had a detrimental effect on prices. Indeed this is no more, and in the same vein the signatories have decided to renew this Agreement, much in advance (March for end September) here again giving transparency to the market and also indicating the willingness of signatory Central Banks to continue to hold gold.
The new agreement is not much different from the previous one.
Here is a short summary of the differences (increased amounts, limited change of members):
The UK is not part of this second agreement but has said that they would let the market know if their policy were to change.
And if one looks at the major Central Bank holders of gold, the signatories plus those Central Banks and international organisations who are very unlikely to sell represent a large part of the holdings. To conclude, it seems unlikely that sales of the official sector will have a very significant impact on the price of gold in 2004/2005.
The second way Central Banks can have an influence on gold is through the lending of some of their gold in the lease market. Central Banks have expanded their leasing activities over the recent years, seeking an improvement in the return on their holdings. Actually, Central Banks are the dominant players in this relatively narrow market. The signatories of the Gold Agreement have recognised the effect of gold lending on the price of gold, i.e. it facilitates forward sales by producers or other market players, by limiting the amount of gold they intend to place in the lease market.
Over the last 2 to 3 years two parallel trends have developed.
- Some gold producers have re-evaluated their hedging strategies, particularly last year in view of the increasing price of gold, and hence have unwound their forward book, thereby reducing the demand on this market.
- On the other hand, there are some indications that Central Banks have lengthened the maturity of their loans.
As a result the gold lease yield curve has flattened substantially.
The size of this market is very difficult to evaluate. Around the year 2000 most market participants mentioned the figure 5000-5500 tonnes. It is clear that today the market has dwindled as shown by this graph.
The reduction in the size of the lease market appears to be a direct consequence of the unwinding of the forward sales by the producers. Rates have decreased sharply, and are now negative or zero for short maturities. The longer maturities have also declined, and the whole lease rate curve is now much lower and flatter than it used to be.
In my personal opinion I think that the probability that lease rates could rebound significantly in the short term is rather low (unless producers engaged in significant forward sales or there was a major change to the dynamics of the physical market i.e. jewellery etc). Indeed if it were to be the case, some Central Banks which withdrew from the market either because of the very low yield or for credit considerations (for many, a couple of basis points are hardly sufficient remuneration for the credit risk taken, even for depositing with very high credit quality commercial banks) would come back and take advantage of higher rates.
So again I do not see much changes from the official sector in the gold lease market.
Third way - Central Banks can purchase gold
Lets turn now to the third way Central Banks can have an influence on gold – they can purchase gold to hold it in their reserves. Referring back to the regional distribution of gold, the question is particularly relevant for Asian Central Banks which have large reserves and only a very small percentage of gold in these reserves.
What are the main reasons for Central Banks to shift their reserves to gold?
I have listed here the three which seem to me to be the most relevant.
First, the political reason.
Gold is an asset class completely different from the other monetary asset classes in Central Bank Reserves. It is the liability of nobody, the claim on nobody, is produced in limited quantity and due to its long history as money has always represented a safe haven asset. For this reason some Central Banks have judged it appropriate to accumulate this asset in order to protect themselves against extreme events. In addition, gold is often perceived by the general public as reinforcing the credibility of the monetary authorities.
Will Central Banks buy more on this political motive? Much will depend on the individual assessment of the international situation by each Central Bank and what they find appropriate as a percentage of gold in their reserves. Central Banks typically don’t comment on this and I shall do the same.
Second the protection against inflation.
Indeed gold, being a real asset, is one of the best protection against the increase in nominal prices, ie inflation. Historically, it has played this role particularly in periods of hyper inflation, or strong inflation (this was the case in the 70’s).
Again one has to recognise that Central Banks particularly in OECD countries over the last 20 years have been very successful in taming inflation and this partly explains the weakness of the gold price during this period. Nevertheless, Central Banks, amongst others, could still consider gold as an insurance against the return of high inflation, as improbable as it could be. However, new products like inflation linked bonds are now competing with gold for offering protection against inflation.
But I want to focus on my third point where I could try to give you an insight that is on how Central Banks look at gold in terms of portfolio considerations.
Third, portfolio considerations.
Indeed Central Banks have substantially increased their reserves. As a result many of them have split their reserves into liquidity portfolios and investment portfolios, where the liquidity portfolio is mostly driven by considerations of liquidity and the investment portfolio is more oriented towards total return.
It therefore makes sense to assess the interest of holding gold as a diversification asset in the investment portfolios of Central Banks which as you know are very keen to avoid a high volatility of returns.
For this I have looked at the correlation between gold and other financial assets as well as its relative return searching for periods where gold is negatively correlated to other assets and displays an out-performance. What does this mean?
For example on this slide I have plotted the rolling annual correlation between equities (as measured by the S & P 500) and gold in red on the graph. You see that this correlation varies quite significantly from positive to negative. In green you have the relative annual performance of gold versus equities, ie when it is above the zero line it means that gold outperformed equities. What you want to achieve is a nice diversification pattern where gold helps to smooth the returns of the portfolio i.e. periods where the correlation is negative and where the gold outperforms equities. And this happened quite frequently over the last 20 years, buttressing the argument made by some researchers that gold is a good diversification tool for an equity portfolio.
Alas, Central Banks, apart from a few exceptions do not hold much equities in their reserves – they tend to invest reserves in deposits and fixed income securities of the major OECD countries, and particularly in USD which over the years represents 60 to 65% over their investments (even more in Asia).
And here the picture is different, there are very few periods where you have the conjunction of negative correlation and out-performance of the gold. I should however make a caveat that the data is based on the annual rolling returns and therefore do not take into account shorter periods where gold can provide a real diversification.
For example for many Central Banks owning only gold and fixed income securities in May/June 2004 when US interest rates rose gold represented a significant diversification for their fixed income securities portfolio.
But over longer horizons this is less the case. The main reason for this is that 1 to 3 year fixed income securities in dollars vastly outperformed gold over the last 20 years (the results would be the same with most currencies).
In addition, Central Bankers are usually looking for returns but mostly for security, liquidity and stability of these returns. Again gold investment did not look attractive in that respect over the last 20 years, as shown by this graph where gold returns displayed a lot of volatility compared to US Treasuries.
Is it to say that gold is not interesting for central banks as a diversification tool for their portfolio? This is not exactly true for the following reasons:
- First, Central Banks usually have a much longer horizon than a year, and their investments in gold should be looked at on a longer period than for the usual asset manager. On this question of longer horizon, I cannot resist being in China and being French to remind you of a story that probably many of you already know. At the bicentennial celebration of the French Revolution, someone asked Chou en Lai what he considered to be the significance of the French Revolution. Chou en Lai paused for a second and then replied “It is too early to tell”.
- Second, Central Banks have a limited panoply of assets at their disposal in order to invest their reserves and even if the diversification brought by gold is limited, we have seen that it can be material over certain periods
- Third, past figures are not always a prediction of future development and this out performance of fixed income securities over the last 20 years is very much linked to an historical drop in interest rates which may not repeat itself before long.
Perhaps gold could be seen in the context of portfolio diversification as an insurance against fat tail events in fixed income markets . In this case it would clearly have its place in the portfolio of Central Banks.
Will these three reasons prompt much buying from Central Banks, particularly from Asia? It is difficult for me to tell but looking at the IMF figures I can tell you that so far purchases have remained extremely moderate compared to the size of total reserves.
Hence my conclusion which I gave you at the start. I guess that the official sector will have a rather limited influence on the evolution of the market and of the price of gold in the coming year.
This being said I still hope you will invite me next year.
Thank you for your attention.
Senior Portfolio Manager, BW Bank
First of all I would like to thank the LBMA for giving me the opportunity to present the in-vestment case for precious metals from the standpoint of a German investor. Of course being German has an impact on my view of precious metals. My grandparents and many others lost twice all of their money. First in 1923 by hyperinflation and then by currency reform after World War II. Due to these experiences Germans have been always suspicious of central banks diluting paper currencies.There is a certain belief in Germany that in the light of mone-tary history the fiat money system is a relatively young currency experiment, where future storms have yet to come.
In 1998, when the introduction of the Euro, the structural deficits of the US-Dollar and the huge government debt mountain in Japan were looming, we introduced precious metals in the asset allocation models of BW-Bank. The BW-Bank is one of the leading banks in the south western part of Germany with strong relationships to medium enterprises of the region. At the very beginning of 2001 we decided time had come to build a new Noah’s arch to weather currency storms, we anticipated. A year later we launched our gold fund, which owns mainly physical gold bars. This is why I want to explain today, why we and our investors are buying precious metals.
And when I say precious metals then I have to admit that the main part of my speech is deal-ing with gold, which differs in two aspects from other precious metals.
First of all industrial demand for gold is almost entirely powered by jewellery according to official figures from GFMS, whereas other precious metals have various industrial uses. So their demand reacts more sensitively to cycles in industrial production. The primary market for gold has shown a surplus and a stockbuild over the last two years, while the primary markets for silver and platinum remained in deficit.
The second far more important difference between gold and other precious metals is, there are enough above ground stocks of gold to fulfill the function of a liquid alternative to the main paper currencies. Gold is never scarce, as it may appear today in the case of some base metals, where the markets are heavily backwardated. There is always enough gold stored in vaults, thus it’s only a function of price, when these stocks change hands.
In the first part of the presentation I shall explain the investment case for gold. I will give a short interpretation, to show the main problem for financial markets, which principal solutions can be chosen and what policy makers are supposed to do. In the second part I will provide a brief on recent developments in European investor demand.
2. Investment case for gold
A. Today’s problem in financial markets
One of the last great secrets of economic theory is the existence of economic cycles. 70 years after the Russian economist Kondratiev detected the long wave, we still do not exactly know which forces drive the process of innovation and when they will set in. What we do know is that phases of rapid productivity growth are often accompagnied by overspeculation in finan-cial markets. In a time when growth and income prospects are overestimated, a lot of people are ready to indebt theirself.
If private debts accumulate an always higher portion of income is needed to serve the loans. A good part of the funds are consumed or invested in unprofitable stocks. So in many cases the money has gone but the debt burden is still there.
A central bank hardly can be blamed alone for asset bubbles, which are mainly driven by indi-vidual behaviour. But the task of a central bank is to take the wine off the table, when the party is best. The American Federal Reserve System failed to strengthen monetary policy, af-ter chairman Greenspan first warned about "irrational exuberance" in 1996.
B. Principal solutions to the problem
No matter if it is a fiat money system or tied to an objective credit limit as the gold standard - if in a monetary system debt problems are mounting there are only two principal solutions: bankruptcy or inflation.
One example for a bankruptcy solution is the Great Depression in the US in the thirties last century. In this solution policy makers are watching without action the default of big market players. Loans are closed out, money suply and prices are soaring. Real interest rates rise con-sequently, which causes a redistribution of wealth from debrors and tax payers to bond hold-ers, which often leads to very severe social disruptions. Rising unemployment favours the rad-icalisation in the political process. If you look at the aftermath of the Great Depression in Eu-rope, the whole political system was destroyed and paved the way for radical war hazardeurs.
In some cases of the "bankruptcy solution" a currency reform is necessary to get the monetary system on its feet again. After World War II Germans had to accept a loss of 90 per cent of their savings accounts, which were transformed 10 units old money to 1 unit new money. I fear in the next 10 years there could easily arise a situation, where some politicians have to explain to Japanese private households, that their nominal savings are gone, because they have been used to fund government consumption. I personally see no Japanese politician, who is in the position to take the risk to cut the Gordian knot of the huge government debt mountain. Aside from distribution effects the big disadvantage of the bankruptcy solution is that some person has to take the blame.
The opposite is true for the second solution: inflation. Even today this phenomenon cannot entirely be explained by economic theory. Is the reason for inflation government spending or monetary policy, or rather price policy of the oil multis or even wage claims of the unions? It is the charming aspect of inflation that no one can be directly made responsible for the dilution of nominal wealth. And in contrast to bankruptcy inflation relieves debtors at the expense of bond holders. Because nobody is obliged to hold fixed income securities, it is a perfect market solution, which works even better, if bond holders underestimate the inflationary process, the so called money illusion.
C. Policy responses
The conclusion could be easily drawn that in the US today it might be a policy target to pro-duce a reasonable inflation combined with very low inflation expectations. So what can policy do to assure this? The part of fiscal policy seems clear: the government is trying to take a part of the private debt on its own debt book. This can be realized through tax presents and exces-sive deficit spending.
But what can monetary policy do? Its main job is to avoid a bond selloff, which could coun-teract the policy target of relieving debtors. In other words the Fed is in our view trying to create money illusion to keep the real interest rates low at the short and the long end of the curve.
What has this to do with gold prices? The short answer: a lot. Why on earth should you hold paper money or bonds if the real interest is negative? In this chart you can see that real interest rates were negative two times: in the seventies and in this decade. In some aspects the seven-ties look like a perfect blueprint of our days. In the seventies the stock market crash of the “Nifty Fifty” was preceeded by an equity bubble of the so called concept stocks. Like in the seventies we have today growing geopolitical tensions combined with fears about oil supply disruptions. Additionally today it seems the western world is threatened by Arabian terrorist attacks. And like in the seventies I conclude that the Fed shows only a delayed reaction to rising inflation to keep the real interest in negative territory. The end of the gold hausse in the early eighties had come, when the Fed-chairman Paul Volcker aggressively raised interest rates, to “break the neck of inflation”. Today we need some more years with negative interest rates before a new “Volcker” can enter the scene.
It’s pretty clear that the interest rate policy of the Fed directly affects real interest rates at the short end of the curve. But how can the long end be influenced?
I believe there are three main instruments, how the Fed managed to keep long term real inter-est at a level around 1% at the same time, when real GDP expansion reached 3-4%.
- The steepness of the yield curve combined with the promise of the Fed to raise short term interest rates in a “measurable pace” are setting very strong incentives earn the carry between the long and the short end of the yield curve. Hedge funds play it in a leveraged way, where treasurers in banks and insurance companies choose plain vanilla constructs. It’s a very strong argument for gold, that the flight from bonds has yet not even begun.
- The repeated talk from Fed Officials about the probability of deflation or “well contained inflation”. The intention of the Fed to manage inflation ex-pectations at low levels became very obvious when Governor Bernanke talked about deflation in May 2003. At that time nearly all of the leading economic indicators promised a strong economic upswing of the world economy.
- The third component to calm inflation expectations are official inflation measures. Most part of asset inflation is not reported in these figures and the hedonic pricing system is overstating productivity.
- One simple example: a few weeks ago I bought a new computer for around 1000 Euros, which is the replacement for my old one which cost me also around 1000 Euros. Ofcourse the new one has a pro-cessing unit, which is at least five times as fast as the old one. The staticians present us with the illusion that the price of my new Per-sonal Computer is one fifth of the old one. But my personal benefit didn’t increase five fold. Typing a letter takes the same time as be-fore and surfing the internet is only a little bit faster. And with the new one it is as impossible as with the old one to fly to the moon.
- Secondly many focus on core inflation measures. My personal day looks like this: In the morning I drive to work by car, then I work around 10 hours with some small breaks for food and then I return home, have some food and go to bed. My only consumption ex-penditures on workdays are gasoline and food, which are not in-cluded in the core inflation the Fed might look at.
The last argument for money illusion is that most of todays bond portfolio managers never experienced a shakeout in the markets. Over the last 25 years the buy on dips strategy in the bond market was always right. But even when you have seen the gold price rising in the last three years, in real terms it is undervalued.
This slide shows us the US consumer price index and the gold bullion price in the very long run. This chart proves that gold is not loosing purchasing power over the years. It is money with a real interest rate of zero. In 1973 the first price explosion took away the undervalua-tion, which was built up in the sixties, when Gold was fixed to artificially low level of 35 nominal US-Dollars. The second price explosion at the end of the seventies brought gold far ahead of consumer price levels, consequently the next 15 years the gold price fell back to fun-damental levels. In the mid-nineties the gold market was depressed far below the cpi-line, because central banks discovered lending and gold producers discovered hedging.
Today gold is well below its long term fundamental value of around 600 US-Dollar.
3. Investment demand trends
I am personally convinced of gold as an investment story. Has the story been told and do in-stitutional and retail investors buy gold? If you compare the gold market in 2000 and in 2003 to cut the answer short: yes - a little bit. The story spreads and the investors start buying.
According to official GFMS figures investment demand and bar hoarding rose about 200 tons per year. In 2003 a good part of the additional investment demand came from European in-vestors, the overwhelming part from Germany. But investment demand was not the key drive behind the gold price appreciation of the last three years. It was only big enough to absorbe higher gold scrap and slightly higher central bank sales. In my opinion dehedging of gold pro-ducers and a builtup of a speculative long position at the Comex led to a rise in the gold mar-ket. Both of them are one time effects, which are supposed to fade out in the coming years. A good part of the remaining hedge books are part of financing arrangements, which cannot easily be excluded. Aside from that there is a strong incentive for gold producer to hedge, when the futures market moves in deep contango. In an environment of rising nominal interest rates combined with low gold lease rates we expect the contango to widen, so that dehedging should come to an end in late 2005.
And the motivation of speculators is not long term enough, to fill the gap between growing scrap supply and the loss of industrial demand. From my point of view it is not realistic to see the speculative position of the so called “Non Commercials” grow 300 tons every year. The opposite is true: most of these hedge funds are trend following. If the gold market shows a technical picture of trend reversion, it would not surprise me to see hedge funds changing to the short side. Since industrial demand should only modestly recover, the gold hausse can only be powered by investment demand.
I fear that in the year 2005 a situation could arise, where the gap between the promising in-vestment story and actual investor purchases could not be filled. There are only a few funds like ours, buying physical gold bullion, while there is little bit more supply of funds offering gold equities, which underperform the metal in the long run. Why do institutional and retail investors in Germany not buy, if they agree on the investment story?
The simple answer is: a lot of them are not allowed to by law. Since 1985 the German Invest-ment Act restricts open end usit funds to invest in precious metals or precious metals deriva-tives. Moreover insurance companies demand two features for capital investment, to meet regulatory requirement of the so called Deckungsstockfähigkeit. The first feature is principal protection and the second feature is some kind of an interest payment (coupon). This reminds me that some of the central bankers were told a few years ago, that each of their currency reserves have to deliver interest payments. Therefore gold could not be part of a modern cen-tral bank portfolio. According to this logic the German Bundesbank is certainly lucky with the losses they have on their interest bearing US-Dollar bond portfolio and unhappy with the gains, they have on their gold portfolio.
The good news is that average day to day financial business in Germany is always late in the cycle. The top of the gold market should be reached, when German insurance companies be-come heavy buyers of commodies. I think we have another few years until this will happen.
I am grateful for your attention!
Session 3A: Mining Supply Workshop
Chairman - Paul Burton, Editor & Publisher, World Gold
Chief Executive, Chamber of Mines of South Africa
Good afternoon ladies and gentlemen. It is a great honour to be here and to be given the opportunity to present a perspective on the new mining environment in South Africa.
Thank you, Mr Chairman, for your introductory remarks.
For just over four months – since the 1st of May 2004 to be precise – the mining industry in South Africa has been confronted with the need to conduct its business in accordance with the provisions of a new and significantly different legislative enactment.
So we most certainly do have a new environment in my country and for all of us who are involved in the mining industry there is hope – indeed confidence – that the new Act, known as the Mineral and Petroleum Resources Development Act, will serve the sector well and enable it to continue playing a cardinal role in the creation of opportunities, and wealth, for a significant number of South Africa’s people.
2. THE NEW ACT
The Mineral and Petroleum Resources Development Act – abbreviated quite naturally to the MPRDA – is what will be the main focus of my attention this afternoon. That, of course, is an essential requirement as it is the MPRDA and some of its associated constituents, that provide the key to understanding the new mining environment that exists in South Africa.
3. THE CHAMBER OF MINES
The organisation that I represent – the Chamber of Mines – has among its members mining companies that produce significantly more than 80 per cent of South Africa’s mineral products.
The Chamber has been constructively engaged with Government in the development of the new statutory regime since it first made an appearance as a Green Paper on Minerals Policy in March 1998.
Clearly, it has come a long way since then and during that period it has been the Chamber’s objective to try to influence the process in a manner designed to ensure that the mining industry will have an enabling environment that will allow it to continue making a positive input to growth and development. Critically important in this area has been the Chamber’s consistent argument that whatever policy is finally produced for mining, it is essential that it be internationally robust and competitive.
4. REWRITING THE STATUTE BOOK
For the purpose of clarity it is useful to understand, and have appreciation, of the overall context and the broader circumstances in which South Africa’s new mining law was written.
When the African National Congress came to power in 1994 at the time of South Africa’s first truly democratic election, there was an immediate commitment to rewrite the country’s entire statute book.
Considering the country’s racially discriminatory history this was a thoroughly understandable objective and given the importance of the mining sector it was evident that there would be specific and urgent focus on mining policy reform as part of the wider legislative transformation process.
The result is the Mineral and Petroleum Resources Development Act.
5. MAIN FEATURES OF THE NEW ACT
It is beyond the scope of my talk this afternoon to present a comprehensive analysis of the MPRDA. What I will be doing is sketching a picture of its most salient features and devoting a little time thereafter to one of the Act’s most significant accompanying components, the Broad Based Socio-Economic Empowerment Charter.
The Charter has been the product of negotiations between mining industry stakeholders – a voluntary and inclusive process – and is aimed at creating opportunities in the mining industry for South Africans who were disadvantaged by racially based legislative decree during the previous political era.
The MPRDA seeks to achieve several significant objectives.
- Sovereignty over mineral resources in South Africa – as is the case in most of the world’s major mining countries – is placed in the jurisdiction of the State.
- The Act seeks to expand opportunities for historically disadvantaged people to enter the mineral industry and obtain benefits from the exploitation of mineral resources.
- It aims to promote economic growth and mineral development.
- Additionally it seeks to promote employment, social and economic welfare as well as ecologically sustainable development.
5. RIGHTS TO PROSPECT AND MINE
As far as the actual business of mining is concerned there is provision in the Act for transition to a new dispensation in which old forms of prospecting, mining and mineral rights will cease to exist.
Under the new dispensation rights to prospect and mine will be derived from the State as the custodian of all mineral resources. Existing prospecting and mining rights will only remain in force for two years and five years respectively from the date of the introduction of the Act.
On their conversion into new rights, or if they are not converted in the two or five year periods that are allowed, all current rights will cease to exist.
In order to convert an old right to a new mining right the holder is compelled to lodge a social and labour plan and an undertaking on how it is intended to expand opportunities for historically disadvantaged persons to enter the mineral industry.
New prospecting rights – in terms of the Act – will be valid for the period specified in the right which may not exceed five years. The right is renewable once for a further period of not more than three years.
New mining rights are valid for a period not exceeding 30 years with rights of renewal, subject to the satisfaction of specified criteria, for further periods of up to 30 years each.
7. THE CHAMBER’S POSITION
Working on behalf of its mining company members, the Chamber of Mines adopted the following positions on the Mineral and Petroleum Resources Development Act:
- It fully supported the key objectives.
- It supported the concept that the State should become the custodian of the country’s mineral resources.
- Gave recognition to the fact that the new legislation, particularly with regard to the State exercising sovereignty over mineral resources, would align South Africa with mining policy imperatives elsewhere in the world.
- Fully supported the transformation provisions.
8. TRANSFORMATION PROVISIONS
It is these transformation provisions that I would like now to address. In terms of the MPRDA, South Africa’s Minister of Minerals and Energy is compelled, within a period of six months subsequent to the introduction of the legislation – in other words by 1 November 2004 – to ensure attainment of Government’s objectives of redressing historical, social and economic inequalities – as stated in the Constitution – to develop a Charter to set the framework targets and timetable for effecting the entry of historically disadvantaged South Africans into the mining industry.
Ladies and gentlemen it is with some pride that I inform you, with the Charter deadline still some two months away, essentially on its own initiative, the Chamber launched a Charter development process more than two years ago.
The outcome of this exercise is what has become known as the Broad based Socio-Economic Empowerment Charter for the Mining Industry. The finally agreed Charter document was signed on 11 October 2002 by representatives of the Chamber, the Department of Minerals and Energy, the South African Mining Development Association and the National Union of Mineworkers. It was officially gazetted on the 17th of last month
Making it clear that it is NOT Government’s intention to nationalise the mining industry the Charter further acknowledges that the transfer of ownership in the industry must take place in a transparent manner and for fair market value.
In the Charter, mining company ownership targets for historically disadvantaged South Africans are set at 15% during the first five years and 26% in 10 years. These are the requirements relevant to mining right conversions and, insofar as they apply to mining companies that are members of the Chamber of Mines, most organisations are already in compliance.
9. CONCERN OVER TARGETS
Quite recently, there was concern when it seemed that South Africa’s Government was moving away from Charter empowerment targets with an alleged insistence of a 51% historically disadvantaged individuals’ ownership requirement for all new mining applications under the recently introduced MPRDA. Foreign mining companies operating in South Africa were particularly perturbed and approached the Chamber of Mines to intervene.
I am not intending to cover the full detail relevant to empowerment requirements as reflected in the slide that is now on the screen. What is important, however, is to present an accurate perspective on the South African Government’s 51% demand.
Looking at the box at the bottom of the screen, and specifically to the category that reflects the position relevant to unused state-owned rights, where no mining or prospecting operations have previously been conducted, the Government has said that empowerment participation will be not less than 51%. This situation will apply only during the one-year transitional period starting on that critical date of 1 May 2004. Thereafter, the Charter requirements of 15% in five years and 26% in ten years will be applicable to the granting of rights.
Quite understandably Government is attempting during, a one year window period, to encourage the active and more meaningful involvement of historically disadvantaged individuals and companies in South Africa’s mining sector.
What is most emphatically relevant is that in all other categories reflected in the diagramme, the State’s intention is to observe the standards set out in the Broad Based Socio Economic Empowerment Charter.
10. CONCLUDING REMARKS
Moving towards conclusion I would like briefly to identify two additional developments relevant to the new environment in South Africa. The first of these concerns royalties – an issue that emerged last year when the National Treasury published a draft Bill governing the payment of royalties by the recipients of mining rights granted under the MPRDA. Following extensive consultation and the consideration of comments, the Treasury is currently preparing a further draft for publication later this year. It seems, despite strong opposition, that the Treasury will maintain its preference for an ad-valorem gross sales royalty determined by applying a rate of tax on the gross sales value of a mineral. It is the view of the Chamber that a profit based royalty would be preferable.
The proposed new royalty regime will not be brought into operation until 1 May 2009 when the five year period allowed for the conversion of old into new mining rights has expired.
On the second issue …………. in April 2004, South Africa’s Department of Minerals and Energy published a draft Precious Metals and Diamonds General Amendment Bill, the aim of which is to rationalise the regulation of matters pertaining to the downstream development of precious metals and diamonds and to promote equitable access to, and local beneficiation of, precious metals and diamonds. Following a process of consultation with stakeholders – including the Chamber of Mines – the draft Bill is currently being revised by the Department.
Mr Chairman, ladies and gentlemen with minor exceptions, I have concentrated this afternoon on just one major legislative development that is unequivocally concentrated on the industry that I represent. I hope that what I have said will have provided at least some clarity on the new legislative imperatives applicable to what in South Africa is a large and multi-dimensional industrial sector.
Thank you for your kind attention. I am now happy to try to answer any questions you may have.
Chairman - Kevin Crisp, Head of Marketing, Koch Metals Trading Ltd
Senior Director, Metals Research, NYMEX
Manager, Asset Allocation Research, World Gold Council
Bob H. Takai
General Manager, Commodity Business Department, Sumitomo Corporation
Managing Director, Shanghai Gold Exchange
Distinguished guests, good afternoon. I feel greatly honoured to have the opportunity to discuss some issues on gold investment. I would like to discuss the current situation in the Chinese gold market and make some projections for private investment.
A brief history of the development of the Chinese gold market
In the 1930s, the Shanghai Gold Business Exchange was one of the biggest gold centres in the Far East. At that time, gold was very popular as an investment.
After the new China was founded, the government conducted a consolidation in gold trading for over 50 years. A publication produced in 1950, Managing Methods for Bullion, stated that the People’s Bank of China (PBOC) held a monopoly on bullion trading. Private transactions in gold and silver were banned among the population. At the beginning of 1963, the state stopped providing raw material to gold and silver fabricators, and reclaimed gold and silver jewellery could only be kept in banks.
In 1982, China opened a retail market for gold jewellery. That was also the year that China Gold Coin General Corporation started issuing the famous Panda gold coins. In 1993, the state changed the price-fixing method for gold from a state-determined price to a floating one. In 2000, the Chinese government included the establishment of an open gold market in its five-year economic plans. In April 2001, the governor of the PBOC announced the abolishment of the gold monopoly with a planning management system. In June of that year, the weekly quotation system for the gold price officially came into operation, which adjusted the domestic gold price in accordance with the price on the international market. The Shanghai Gold Exchange (SGE) officially opened on 30 October 2002, representing an important breakpoint in the revolution of China’s gold system, and reflected the great progress being made.
I. The basis of private investment
- According to statistics from the central bank, the balance of domestic savings stands at 12,000 billion yuan. Such a high level suggests great potential for individuals to invest in gold.
- History shows that Chinese people have a special interest in and love for gold. In Chinese tradition, gold stands for wealth, luck and happiness. Thus there is a local custom of holding gold as a household reserve (we say “put gold in the bottom of the case”), which came about due to gold’s stable value, protecting holders from heavy losses even when there is sharp currency depreciation.
- Current investment channels for gold for individual investors in China are quite limited, though it is becoming an important alternative to stocks, bonds and the fund market. Research by a related department showed that 20% of respondents would like to invest in gold, with the preferred amount 10%-30% of their financial assets. It is estimated by some media that the next emerging investment market will be gold, after real estate, stocks and open-end funds.
- Gold price fluctuations provide opportunities for profit. In addition, the gold price is inversely correlated to the stock price. As part of a portfolio, gold could help residents to hedge risks.
- The domestic gold price moves in the same direction as that of overseas markets, so the stability of our market is strengthened. The current investment market is not very satisfactory: the savings interest rate is relatively low, the stock market is bearish, there have been bubbles in real estate, the futures market is quite risky. Once a private gold market is opened, it will draw a great deal of investors to trade and hold gold as an asset.
- There is great potential for gold demand. As stated in China Gold Report, in 2002 China’s average amount of gold holdings per resident stood at only 0.16 grams/person, much lower than the global average of 0.49 grams/person, which shows China’s great potential for gold demand. If that amount could increase by an average 0.01, domestic gold demand would increase by around 1,300 tonnes, and if all the demanded gold were released, that would be a “gold mountain”.
II. Products for private investment in gold
- Jewellery: The Chinese gold jewellery market has been open to the public since 1982. Because of the jewellery’s artistic aspect, its practical value is higher than its investment value. Although in recent years China’s average annual consumption of more than 200 tonnes of jewellery places it third worldwide, investing in jewellery is a low-yield option because of the lack of price volatility. The following diagram shows sales of gold jewellery for the past 15 years, given by the World Gold Council:
- Coins: These can be split into two categories: investment and commemorative. There are many options for investment coins (e.g. Pandas), which can be sold in the market, although there are costs for holding them. The limited range of subjects, high-standard artistic design and manufacturing and small-scale circulation help characterise commemorative gold coins as artwork. Coins with attractive images or special meaning can demand a higher premium, and the premium on gold and silver memorial coins is usually very high in the secondary market, far beyond the content value of the gold or silver, so there is a higher risk of price fluctuation. This type of investment is only suitable for experts on monetary coins; therefore, involvement in them is quite limited.
The diagram on the following page shows sales of gold coins in China from 1987 to 2003, provided by China Gold Coin General Corporation.
- Bars: These are the most common type of gold investment, referring to processed standard bars with specifications for purity, weight and shape marked on the bar when smelted. Currently many types of bars are in circulation in the Chinese market, such as the Yearly Gold Bar of China Gold Coin General Corporation, the CGS gold bar from China Merchants Bank and Gao Saier Corporation (CGS), and a 50-gram gold bar traded on the Shanghai Gold Exchange.
As opposed to commemorative bars, the price of investment bars is in line with the international gold price. Investment bars have good benefits for investors in that they can easily be bought, sold and traded globally, but their delivery cost makes bar price higher than the trading price of gold. There can also be problems with counter-purchases. Gold Account (Paper Gold): This does not aim to deliver the physical gold, but to win the spread through trade. Along the trading, investors do not conduct taking and delivering of gold, but only take down the transaction to the specially opened gold account, and pay and take through the assigned capital account. Investors could easily operate their gold accounts, so it is the most suitable type of private investment with high capital efficiency and low procedure fee.
- During the initial stage, demand for physical (bar) gold will greatly increase
At the initial stage of private gold investment, due to low limitations to entrance, price transparency and convenience in trading, the number of people involved in gold investment and demand for physical gold would increase substantially. There would be a portion of people to receive gold. That would influence both supply and demand for gold both domestically and internationally. We expect the development of the Chinese private gold market to provide gold producers and suppliers with good opportunities for growth, especially in terms of physical demand. There are currently 15 refineries that have been qualified from the Shanghai Gold Exchange to produce standard gold bars, and their products are of good quality and widely accepted by investors.
- Gold accounts would become the mainstream trading product in the market.
From the viewpoint of investment, the best choice for individuals is a gold account that is not aimed to deliver physical metal. When investors identify a trading opportunity in the market, they can take advantage of the price fluctuations with relatively low risk. Now the Shanghai Gold Exchange, taking advantage of being China’s central gold exchange, with its dominant price, information and circulation, is developing its sub-trading system, offering a channel for commercial banks to act as agents for individual gold investment. Subsequently, an investment market will be gradually established.
- The market should be cultivated and supported.
The establishment of any market requires efforts from all aspects, active cultivation and support. It should be a gradual process from the start of a private gold investment market and its subsequent boom, unlike the stock market boom and fluctuations over such a short period of time. The Shanghai Gold Exchange, as the organiser of the Chinese gold market, should promote the market with support from relevant national departments and policy guidance, and let the market finally embrace a truly private investment era.
Chairman - Serge Gambs, Head of Marketing & Sales, Refining Division, Metalor Technologies SA
CEO, Virtual Metals
Good afternoon. I am honoured to be on this platform and especially delighted to be able to address a topic other than derivatives. In looking at precious metals’ usage in electronics, one deals in terms not of tonnes, nor indeed even of ounces, but of microns. Going from the giant hedge book of the gold market to a nanogramme of gold in a printed circuit board is going from the sublime to the ridiculous, but it’s a useful reminder that there are many different market participants, each with their own objectives and needs.
While all precious metals find a home somewhere in the manufacture of electronic components, for palladium at least until 2000 this industry was of prime importance. In that year, global demand for palladium in electronics peaked at 2.4 million ounces, representing 28% of offtake. Then the price of palladium rallied to $1,100 per ounce and the manufacturers of multi-layered ceramic capacitors – computer chips to the layman – did what any cost-conscious industry would do – it found substitutes. Within 12 months, palladium demand in MLCCs was down to 1.2 million ounces or 16% of palladium demand in 2001. This sharp decline was largely due to the substitution of nickel, but it also marked a downturn in global demand for electronic components, and the industry was left with considerable inventories.
But, as Virtual Metals predicted throughout 2003 and indeed this year, the electronics industry has enjoyed strong economic recovery, so much so that manufacturers of the associate components have in many cases battled to keep pace with orders.
Despite this, the outlook for palladium usage in this sector now looks substantially more vulnerable than it did even 2 years ago. In previous forecasts we assumed that the rate of substitution from palladium to nickel would slow down, as the price of palladium returned to what might be considered more reasonable levels. We argued that those that had retooled and made the switch to nickel, namely the manufacturers of MLCCs in the Far East, were already in the forecast equation, and, of the remaining manufacturers in Europe and the USA, the majority would maintain their original fabrication technology, which favoured palladium.
The basis of our argument was that there remained a proportion of this industry where the high performance of palladium outweighed any cost advantage of using nickel based technology. Subsequent developments have proved this assumption overly optimistic in favour of palladium. Moreover, other factors are coming into play, factors which do not augur well for the metal.
Thus our initial assertion – that two thirds of the MLCC manufacturing capacity has substituted irrevocably to nickel – is correct. The top 10 manufacturers have made the conversion to nickel and are concentrating their R&D on improving their base metal products. But what of the remaining one third? Here too, palladium is under continuous threat from substitution with silver. In other words, palladium is being threatened by both base and precious metal substitutes. The silver substitution is not outright but is more of a gradual trend towards the manufacturers using a palladium alloy that contains an increasing proportion of silver. Discussions with people in the industry reveal that there is a concerted effort to, as one of them put it to me, “work palladium out of the equation completely.”
Whereas a decade ago palladium was favoured in high performance MLCC’s (since they remain very stable under a wide temperature range), and the content was 100% palladium, alloys now of more silver to palladium are being favoured and actively developed. Ratios with the proportions of 75:25 silver to palladium or even 90:10 silver to palladium are commonly found.
The future for palladium in this remaining residue looks even bleaker. There is now at the production stage (reportedly successful) MLCCs using 95:5 silver to palladium alloys, while at the developmental stage there are alloys of no more than 2% palladium, the rest being silver. In answer to the inevitable question, 100% silver alloys do not perform well as there are technical and structural limitations.
Another factor threatening palladium offtake in this sector is continued miniaturisation. In looking at this issue originally, Virtual Metals assumed that miniaturisation can and does occur but eventually reaches a minimum, beyond which performance is lost. The only factor that can then address the issue and continue the process is a technological breakthrough or development which then allows the process of miniaturisation to resume. Yet while this seems to be the case in most other products, it does not seem to be applying to MLCCs. The reason for this in the case of MLCC’s is that the performance (the capacitance) actually improves markedly with smaller and smaller units of product – quite the opposite to other components. Thus in the case of MLCCs there is a distinct technical advantage to miniaturisation over and above the cost savings. Thus size does count and further trends towards even more miniaturisation must be expected.
A third factor working against palladium is closely associated with miniaturisation that being the ability on the part of the manufacturers to thrift and constantly reduce the loadings of palladium. This comes about not only because of miniaturisation but also through thinner and thinner layers of palladium being applied to each capacitor. Again, there are the same technical advantages in that thinner applications of palladium achieve better capacitance in the final product. Thus five years ago the metal coating on an MLLC probably averaged 1 1/2 microns – today 0.8 microns are standard and coatings half this level are being tested.
In terms of loadings the thickness of palladium precious or base metal paste can vary enormously between MLCC designs and what the customer wants. With respect to palladium, this can be anything from 8mm-27mm per square inch of dialectic board (the initial substructure that then gets chopped up into the individual MLCCs). Assessing the amount of palladium per capacitor is, however, complicated, since in terms of size, MLCC’s can vary from one square inch to the size of a pinhead. So attempting to come to an industry average for the purposes of calculating loadings and then forecasting is hazardous, to say the least.
The outlook for the future of MLCCs is, without doubt, robust, though it is looking like palladium will only be there in amounts which continue to reduce dramatically. The growth of MLCCs is coming from two areas. First, there is apparently unquenchable demand for goods like mobile handsets, added to which the motor industry is now fitting as standard equipment MLCC-rich electronic features. But we are also looking at increasing intensity of use. The original mobile handsets which were the size of a brick and weighed probably as much, contained around 50 MLCCs. Today, thanks to bluetooth. 3G technology and most recently colour imaging, mobile handsets need about 400 capacitors per handset. Industry observers are quite comfortable with projected demand growth rates for MLCCs of 12% per annum.
But if all this substitution away from palladium towards both nickel and silver was triggered by palladium price spikes, surely there must still be some price sensitivities left in this sector? Industry participants and MLCC manufacturers claim that $200 per ounce palladium is too high and at those levels they have no interest in looking to salvage the metal. At $100-$150 per ounce their attitude towards palladium begins to soften and they sound more accommodating. But, far more damaging to more palladium offtake than the absolute price level, is the price volatility which, like the motor manufacturers on the issue of exhaust emission control, the MLCC manufacturers conclude “we just cannot stomach.”
With these candid comments from the consumers of precious metals in mind you have to wonder about the current rhodium price and the long term damage that the price rally will inflict on this already vulnerable metal. Without doubt, short term price spikes are jam for some but poison for many others.
On that note, I thank you for your time this afternoon.
Ichimitsu Itabashi and Hiroshi Sawai
Gold is used in field of electronics manufacturing as bonding wire that connects between IC chip and circuit board. World fabrication of gold bonding wire is about 150 tons in 2004, which represents a threefold increase over the last 10 years.
The reasons for using gold are due to the metal’s basic properties, which include low electrical resistance, ductility and no oxidation. Gold is drawn to a thinness of less than 30 microns in the manufacture of bonding wire.
There are some threats to bonding wire and the wire bonding process from new technological developments in semiconductor manufacturing. However, high-strength gold wire and high-reliability gold alloy wire are useful in the mass production field of electronics manufacturing in the future.
Wire Bonding Process
The integrated circuit (IC) in the wafer process is made on a Si chip, which is cut out from a single crystal Si ingot.
Wire bonding is one of the important steps in the assembly process. After the wafer process, the IC chip is cut into pieces and put onto a circuit board. The wire bonding process makes a gold wire loop and completes the electrical contact between the IC chip and the outer electrode of the circuit board.
After this wire bonding, the circuit board is covered by mould resin to protect it from outer stress and marking is put on the moulded package, then the IC device is complete.
Details of the wire bonding process are shown in Figure 1 and explained as follows.
a) Gold bonding wire goes through a ceramic cylinder tool, called a capillary.
b) A ball is made on a wire tip under a capillary by the discharge from a spark electrode of bonding machine.
c) IC chips on a circuit board are heated less than 473 K. A gold ball with a capillary is lowered onto the electrode of an IC chip and an ultrasonic vibration is added, then the gold ball on the wire tip is bonded to the IC chip.
d) After the IC chip bonding, the capillary goes up and moves to the electrode of the circuit board. The wire goes through the capillary and makes a loop between the IC chip and the electrode of the circuit board.
e) On the electrode of the circuit board, the capillary is lowered again and ultrasonic vibration is added. The gold wire is bonded to the electrode of circuit board without making a ball as in IC bonding.
The reason for the use of high purity gold has to do with the basic property needs of the wire bonding process. Bonding wire is an electrical wire, so it requires low electrical resistance. Gold has the third lowest electrical resistance of all metals. Making a ball on a wire tip also requires no oxidation. Gold doesn’t oxidize and is also a very ductile metal, corresponding to the complicated movements of the bonding machine.
The market areas for growth are mobile phone equipment and automotive applications.
The growth in mobile phone usage is amazing. Except for the newest models, the phones are very cheap, which requires reduced costs in manufacturing.
There are strong requirements for reducing the cost of fine wire, because the most of the cost of bonding is material cost.
There are various electrical units and systems in a car. The internal temperature of a car increases very sharply in summer and decreases to very low levels in winter in cold northern regions. Recently, there are increasing cases of electrical units being placed near the engine, which has a very high temperature. Automotive application needs for bonding wire therefore must correspond to the severe environmental conditions.
In 1994, world fabrication of gold bonding wire was about 50 tons. In 2003, it reached nearly 150 tons – representing a threefold increase over the last ten years.
However, there are some threats to bonding wire and the wire bonding process from new technological developments in semiconductor manufacturing.
One of these is flip chip (FC) bonding technology, which has the advantage of low electrical resistance, thus it is applied to the high-speed clock devices of high technology.
Another threat from the most advanced technology is Cu through electrode in a Si chip. This process is able to achieve chip stacking that FC bonding technology couldn’t, since, of course, the electrical resistance is low. Cu through electrode is in development by ASET (Associated of Super-Advanced Electronics Technologies) in Japan.
Wire bonding technology tends to be low- end products and low-cost applications by such threats from new technological developments in semiconductor manufacturing.
There is a strong requirement of fine pitch bonding to correspond to high-density composition for mobile equipment manufacturing. The bonding pad becomes a small area to achieve a small-sized package. The electrode pitch on a Si chip has become smaller due to the fine technology of the wafer process.
In order to realise fine pitch bonding, a small ball and a fine wire of less than 20 microns are required. High strength is necessary for bonding wire as a material property.
Fig.2 indicates IC bonding part of 40-micron pitch bonding sample.
A second technical trend is stacked bonding. Si chips are stacked in one device at SiP technology. Stacked bonding requires short and low loop making for lower chip bonding and long and height loop making for upper chip bonding as shown in Figure 3.
Short contact of lower wire and upper wire should not occur, of course for wires next to each other, but also if outer stress is added during the molding process.
Thus high strength is necessary for bonding wire to realise stacked bonding.
The third technical trend is high reliability. When bonding interface in the high temperature storage, Au5Al2 appears in the bonding boundary as the first inter-metallic compound (IMC). Au5Al2 is easily transformed into Au4Al. Au4Al is corroded by mould resin.
The electric resistance of the bonding point is rapidly increased by Au4Al corrosion phase – then IC device failure occurs.
High Strength Gold Bonding Wire
Many kinds of gold bonding wire are made to meet the various manufacturing requirements of semiconductor and electrical devices. High strength gold bonding wire’s breaking load is over 150 mN, which means 300 MPa at φ25 micron and 4% elongation. Over 300 MPa of high strength, gold bonding wire’s tensile strength is three times greater than 5N-purity gold.
High strength methods are types, volume and mixing of elements. General gold bonding wire keeps 4N-purity. This drastic change of property by less than 100 wtppm elements is based on field results in high purity metal research.
High Reliability Gold Alloy Bonding Wire
Cross-sections of encapsulated samples at 473 K for each hour comparing gold and a gold alloy including 1% palladium are shown in Figure 4.
During temperature storage, an IMC phase appears and grows in the bonding boundary. After 200 hours of storage, the IMC has grown about 3 microns thick. The IMC of 4N-Au is thicker than that of the gold alloy.
After 500 hours of storage, the upper part of the IMC in 4N-Au turns brown. There is no change in the gold alloy sample. After 1,000 hours, all of the IMC in the 4N-Au changes into a dark brown phase. However, only the peripheral region of the IMC in the gold alloy turns brown.
The electrical resistance of the 4N-Au sample rapidly increases after 200 hours, corresponding to the IMC phase’s colour change, which is confirmed in the cross-section observation shown in Figure 4. The electrical resistance of the gold alloy sample doesn’t change over the course of 1,000 hours.
Gold alloy makes a palladium barrier in the bonding boundary and blocks diffusion of Au atoms, so it may be difficult for Au5Al2 to transform into Au4Al. Thus gold alloy bonding wire guarantees high reliability.
There are some threats from new technological developments in semiconductor manufacturing to bonding wire and the wire bonding process. However, gold bonding wire will be useful in the mass production of electronics manufacturing in the future. The main trends of bonding wire are in demand due to cost reduction and corresponding to severe environment.
Fine pitch bonding and stacked package manufacturing can be achieved by using Tanaka gold bonding wire, and it is useful in the reduction of costs in electronics manufacturing.
And Tanaka gold alloy bonding wire guarantees high reliability requirement.
Market Research Director, Johnson Matthey PLC
Chairman - Paul Walker, CEO, GFMS Ltd
Chief Operating Officer, Tanishq, Titan Industries Limited
Chief Executive, Damas Jewellery Group
Ladies and gentleman, the world has changed dramatically in the last few years for marketers, and it would not be wrong to say that this is more relevant to the jewellery industry than any other product category.
Jewellery under Pressure from Modern Lifestyle Products: Our industry is still comprised of small and fragmented entities. Only a small number of us have the resources to make any meaningful contribution in the area of product, distribution and marketing…and create any lasting image for jewellery in the mind of the modern consumer.
After all, his or her purchasing power is under continuous pressure from other modern lifestyle product categories.
Multinationals, Huge Budgets and Modern Marketing Skills: To make it worse for us, almost all lifestyle brands enjoy the backing of multinationals with huge budgets and modern organised marketing skills. These being global brands, the massive communication efforts and the huge budgets are easily possible and financially viable.
Innovative Jewellery to Entice Young Generation: Now coming to our industry, I must confess that during my regular visits to exhibitions, I have seen many innovative approaches made by some jewellery entities, especially in the area of design/product. The World Gold Council, which was the pioneer in introducing marketing to the jewellery business in the world, has recently made some strategic contributions aimed at the young generation.
But in spite of the high price of gold enjoyed by them, the contribution is merely symbolic than what is required to make any lasting global impact. DTC, which is a comparatively new entrant to organised marketing, nevertheless has been extremely successful, resulting in a constant increase in global diamond sales. We have also seen a few manufacturers and retailers creating jewellery brands and marketing them.
Dubai – A Success Story: It is with pride that I say that in Dubai we promote jewellery as a collective effort of the trade. I would like to share this model with everyone in the global jewellery industry. The lesson we have learnt is that in a countrywide promotion like the Dubai Shopping Festival, jewellery has been more prominent than any other product category to benefit from the unimaginable purchasing power available in that one-month period. We could not have achieved this without the united approach of the Dubai Gold and Jewellery group.
United Global Jewellery Response: I feel that time is running out and that the entire jewellery industry from all over the world should use its collective resources for a global campaign, so that we create a young and modern lifestyle image for our product, jewellery.
World Jewellery Council: It may even be necessary to create a body to bring this vision into reality and make sure the future of our industry is well guarded.
I therefore sincerely request the entire industry, from miners to bankers, manufacturers, bullion dealers, wholesalers and the retailers from around the world, to come forward to vote for a new World Jewellery Council for our common product. Such an approach can ensure a constant growth for the entire jewellery industry, also allowing the players in gold, platinum, diamonds, etc. to benefit from this overall growth.
Time for Action: Last year, I introduced this topic in this very LBMA forum and subsequently took it to various other platforms. Everywhere, the response was overwhelmingly positive.
I realised that this initiative should now go into the next stage: action.
First Step: Dubai is ready to invest US$1 million. Are others prepared to join in?
I have great pleasure to announce today that the Dubai Gold and Jewellery Group is ready to invest US$1 million towards the global promotion of jewellery. It is only natural that I hope others who are present in this conference and those who may not be here, but are the beneficiaries of the jewellery industry, will come forward and raise a total minimum amount of US$25 million towards this initial endeavour. Once the benefit of such action permeates through different layers of the industry, I am sure you will be even more enthusiastic about future projects and the resources required.
This is our only option: I am but a humble jeweller, but I see this as the only solution to our current predicament. I realise we have great marketing minds in our midst who could think and do better than me in this specialised area of marketing – the lifeline of our future.
Can you think of any better option?
Chief Executive Officer, Platinum Guild International (UK
Managing Director, Marketing and Jewellery, World Gold Council
Chairman - Jonathan Anderson, Head of Asia Economics, UBS
Shanghai Prime Platinum Jewelry Ltd
Thank you Mr. Chairman and good morning Ladies and Gentlemen, my topic to-day is “Competing for the Chinese Consumers” And I will focus on talking of the role that gold, platinum and silver jewellery played in the China market in the past and future. Also I will brief you their development and trade perspectives.
Chinese Luxury Goods Market
Firstly I would like to talk a bit about the luxury goods market that jewellery belongs and closely related to.
As we all know, China, being a communist country, luxury goods market practically never existed Then starting the early eighties when the Chinese Government started to embraced an open economy policy, people have started to made more income and thus savings increased substantially. The annual income of the 1st line cities like Shanghai, Beijing and Guangzhou had increased 3 folds from US$100 in 1982 to US$300 in the late eighties. People started to afford to purchase valuable stuff and 24Kgold jewellery debuted as the first type of luxury goods and received a popular response. Though the 24K gold jewellery did existed a long time ago, but it was in the late eighties that we see a significant increase in both availability and consumption. Consumers were buying it not just for adornment purpose but also for investment in worrying the possibility of deflation of the Renminbi.
Then of course as everyone knows, the economy of China continues to grow from the early nineties and more luxury goods emerged in the market creating a wider choice for the consumers especially the groups of Nouveau Rich.
Among all, it is also in 1992 that marked the beginning of platinum jewellery era that eventually created a miracle of consumption record in the world in 2002. I shall talk more about it later.
Types of Luxury Good
In my opinion, there are basically 4 significant types of luxury goods in the China market. Jewellery- including gold, platinum and silver. They are local brands that are manufactured in China, one should note that it is not because the consumers prefer local brands but it was due to the fact that gold and silver jewellery except platinum were not allowed to be imported into China. It was not until March in this year, that 7 local companies were granted the import permit for both gold and silver jewellery.
Haute Couture-all foreign branded fashions and are very popular among the high income group.
Automobiles-one of the most expensive type of luxury goods in the early beginning. In the late eighties and early nineties, owning a car is definitely a symbol of status, either local made or imported.
Then we have the Antiques and Arts, starting from the early nineties, we were seeing a lot of auction houses emerged. The responses are very positive.
How the taste for luxury goods have changed with economic development
As mentioned earlier, 24K gold jewellery started as the first type of luxury goods. With the strong economic growth in the recent years, consumers also have more disposable income to purchase other luxury goods.
Branded goods from overseas became a must for the consumers that can afford them.
According to the estimation of Giorgio Armani, the fashion guru, there are 10 to 11 million of Chinese consumers that can and would purchase renowned foreign brand luxury goods in the coming years. They purchased these goods not only because of better quality but most important, a symbol of status.
Last year, Rolls Royce had sold 10 of their Phantom models within 4 months from August to December, the prices ranged from US$660,000 to US$700,000. Bentley also set up the record of selling their premium model “Mulliner 728 “ at a price tag of 1.44 million US dollars!
So there are no more priorities among the luxury goods, and the values for individual items also increased tremendously due to the uprising number of so called Nouveau Rich.
The development of Gold Jewellery
So much for the luxury goods market and let’s get back to the jewellery sector and let me brief you the development of the three precious metal jewellery in the market starting with the Gold Jewellery
There are two types of gold jewellery that exist in the market, the 24K Yellow Gold and the 18K Yellow and White Gold.
As we all know, the gold market was regulated by the People’s Bank of China (PBOC )and there were only a few state-run enterprises that have the operation permit or license to fabricate, wholesale and retailing gold jewellery.
All these enterprises dealt only in 24K Gold which is the oldest type of jewellery available in the market.
Due to the conservative management style of these enterprises, innovation and creativity for the jewellery designs were seldom the issues to be considered.
Thus most of the 24K gold jewelleries that were sold in the market were of old and traditional designs that have been around for decades and their quality were unavoidable lower.
As for the 18K Yellow and White gold jewellery, it was another story, the 18K gold jewellery entered the market, or shall I say, brought into China through Hong Kong illegally in the late eighties. They were mostly Italian made chains. The reason for the smuggling was due to the fact that no local fabricators have the ability to manufacture them at that time and the consumers want something better in designs than 24K
The consumers immediately welcome the beautiful and new designs of these chains and it was so popular in China that until to-day, most consumers still called the 18K chains as “Italian Chains” even when we are making them in China now by local fabricators.
With the successful launching of the promotion campaign “K.gold” from World Gold Council in last October, a new fashion trend for the young age group was further established.
Due to the popularity of white colour jewellery in recent years, thanks to platinum, 18K white gold jewellery also becoming more important. They are treated as a substitute for the platinum which prices are getting higher and higher.
Gold Jewellery Consumption Chart
For the consumption volume of the Gold Jewellery, you can take a look at the chart , it started from 1994 at about 10 million ounces and reaches 11 million ounces in 1997. In recent years, due to the dropping of the gold prices and the habit of buying gold among the consumers had changed, the volume has dropped to 6 million ounces in 2003, but it still tops the highest consumption in volume and value among the three precious metals.
The Development of Platinum Jewellery
Someone called it a miracle for the success of platinum jewellery in China but in fact, you need more than a miracle to achieve what platinum jewellery is to-day in China.
Let’s see how is happen!
Firstly, platinum is not regulated by the PBOC, any company; to be local or foreign can operate platinum jewellery in China.
In the early nineties, consumers especially the younger age group, felt boring with the old and traditional styles of the 24K gold jewellery and they wanted something new, something they can wear as fashion, platinum jewellery with newer designs appeared in the right time. Buying platinum jewellery became a fashion trend.
And for the fabricators, it also meant a lot of them to involve in platinum since it guaranteed a higher profit especially when it was set with diamonds. I will show you now a profit margin comparison chart and you can see why. (refer to margin chart)
From the chart you can see that in 1995 when platinum is US$430/oz and gold is US$370/oz, a piece of platinum diamond ring will have a 51.5% margin while in 24K gold, only a mere 4.6%.
Why I only mentioned platinum diamond jewellery and not plain platinum jewellery like 24K and 18K gold jewellery in my chart because platinum jewellery started as diamond set jewellery that eventually develop into other types like plain metal. Also because one can very seldom see any nice jewellery that set with gemstones, not to mention diamonds. The beauties of the diamond-set platinum jewellery outshine the rest in the jewellery counters and consumers immediately embrace the new born star.
Again due to fact that foreign companies were allowed to be involved in the platinum jewellery trade, these companies brought in not just capital but innovative designs to the jewellery.
We also shouldn’t miss the fact that due to price for the platinum metal is higher and the consumers considered it as more precious than gold.
We also have to thank the Platinum Guild International for its effort to promote platinum jewellery in China. Under its continuous successful promotion campaigns, they had created a top image for platinum being the most pure and rare metal one can buy and wear!
On top of that we have DeBeers that started a successful diamond bridal promotion campaigns in 1995, they promoted that the perfect metal to set with diamond is platinum and buying a platinum diamond ring for wedding is almost a must now in China, whether the groom can afford it or not is another story.
Platinum Jewellery Fabrication Chart
Let’s take a quick look at the China Platinum Jewellery Fabrication Chart. It is not the consumption chart because due to the high cost of the platinum metal, traders are more are unlikely to keep substantial inventories and so the figures in the chart show more or less the actual consumption situation in the market.
We see a fast and huge grow from 1994 that reached the highest volume consumption in 2002 at 1.7 million ounces. In 2003, there were a dropped due to the SARS and the high prices of the platinum metal. Traders became more cautious in making and stocking the platinum in order to avoid any risk in the case of the fluctuation in the metal prices.
The development of Silver Jewellery
Last but not the least; I will talk about the silver jewellery in China.
In 1999, when the PBOC liberalized the silver market, a lot of traders predict a huge growth for the silver jewellery in the market. It was based on the fact that white metal jewellery is popular and with the much lower prices of silver against platinum, consumers will definitely switched to silver.
Owing to the above reason, we did see some companies started to manufacture silver jewellery and thus seeing more updated designs in the counters of the jewellery stores.
But the fact is that the responses from the consumers were not too positive and rather slow, they still see silver jewellery as cheap jewellery that sell by weight. And they don’t see why they have to pay a premium price for something that has brand value.
This accounted to the fact that the traders did not pay too much attention in investing in marketing and promotion for their products. Without the drive force of proper marketing program, silver jewellery is difficult to take off.
But we shouldn't be too pessimistic with the silver jewellery market, the younger age groups are now fashion orientated and for them, they will buy jewellery for their designs more than the metal value. White colour is still the trend now and there is still a marketing and growth potential for silver jewellery.
Silver Jewellery Fabrication Chart
The chart for the Silver Jewellery Fabrication, again we are looking at fabrication side and not the consumption side. In 2003, the volume of fabrication reached more than 11 million ounces. But they were mostly exported and not sell in China. Please kindly note that in the Southern part of China, we had a lot of fabricators, mostly from Hong Kong that are utilizing the cheap labour in China, re-exporting tremendous amount of silver jewellery to all over the world.
But since we do have the huge capability in manufacturing, one can see that the manufacturing preferences will serve as a platform for these companies to enter the China market when they are ready.
Trade Perspectives on Gold Jewellery
So much for the market side and now let’s go forward to look at the trade perspectives on the three types of jewellery.
First, the gold jewellery, for 24K gold jewellery, due to the simple designs, it is easy to manufacture and though the margin is low, due to the fact that the return is very fast, a lot of traders still continue in dealing in it. But the fabrication operation is usually large to ensure a huge production to compensate the low margin.
But we will hardly seeing any innovation in designs among the traders as they are mostly aiming at fast production.
On the contrary, the 18K Yellow and White gold jewellery is gaining momentum, although the manufacturing require intensive technique, the margin is also higher than the 24K. In recent years, a number of 24K gold fabricators are switching to 18K, for them, the 18K gold market is new and have the potential to grow.
Trade Perspectives on Platinum Jewellery
It required the highest capital investment in machinery and metal cost, the manufacturing technique also commends a very high standard but in the meantime, margin is getting less comparing to 18K gold jewellery.
Traders are extremely concern about the high metal cost throughout the value chain and some of them are considering switching to 18K white gold which yields a higher return and less metal cost.
Trade Perspectives on Silver Jewellery
The capital investment is low for the machinery and so is the metal cost.
Traders tends to sell their silver jewellery in a high margin but in the meantime do not invest much in marketing.
China-jewellery margins (fabrication) Chart
In order to let you have a better understanding about the margins of both fabricators and retailers, I have prepared two charts for your references.
First, the fabrication side, you can see that 24K gold and platinum yield only 1.7 and 1.89% while the 18K yield a high percentage of 23,78%
China-jewellery margins (retailing) Chart
Then we can see the 2nd chart about the retailing side and again you can see that 18K had a much higher returns of 33.33%, while 24K and platinum are 17.1% and 18.1% respectively.
The Future Development of Jewellery in the Luxury Goods Market
As China becoming the member of WTO, a lot of imported luxury goods are going to enjoy a lower import duties.
Therefore a lot of foreign brands luxury goods will appear in the market and as for jewellery, we already have Cartier, Tiffany and Bulgari, more brands will be adding the list.
Due to the fashion trends and low margin, less 24K jewellery will be fabricated and most probably replaced by 18K.
Platinum will remains strong in bridal sector when the margin of diamond set will compensate the high metal cost.
Due to the lower capital investment and high margin, silver will continue to gain momentum in the market.
I see that gold still remains the largest market in terms of consumption and value.
The growth of platinum will depend on the metal prices and traders, if they will switch to other metal.
Silver, again I have to say that there is a real development potential and very soon, some companies that have foresight will take serious thoughts about it and then it can takes off accordingly.
Director, China Financial Services Ltd
When I left the Bank of England a decade ago, I promised myself that I would never write another paper on Developments in the Chinese Banking System. It is a tribute to the persuasiveness of the Chairman and perhaps the sensitiveness of this topic that I have been asked to provide an Olympian view of this rapidly evolving sector.
Given however that I have only 15 minutes, I have taken the theme of my talk to refer narrowly to banking alone – to the exclusion of securities and insurance business, which are equally important, and also changing at a swift pace.
We should of course remind ourselves that the banking system in China has evolved beyond all recognition. When I first came to China, 20 years ago this year, the People’s Bank did not exist – it was a department of the Ministry of Finance and in the same buildings. Today China not only has an active and skilled central bank, responsible for supervising the Gold Exchange, it also has three independent supervisory authorities, with of course the China Banking Regulatory Commission responsible for supervision of the gold trading of the individual banks.
I think most people here will already be aware that there are four big state owned banks in China, and also 11 banks with some form of shareholding, with many local banks. I would like today to focus on five areas of interest:
- IPOs by Chinese banks,
- The effects of WTO
- Bad debts and the AMCs,
- Corporate Governance
- The role of gold in banking in China
Two of the large banks, the Bank of China and China Construction Bank, were nominated at end-2003 to pilot joint-stock reform in China. This has taken three forms:
- The banks have received a combined US$45 billion recapitalization.
- They have sold more of their bad debts to the Asset Management Corporations (I will talk further about this in a moment).
- And they are preparing to issue stock abroad.
This last measure will be the acid test for the banks: if only they can persuade foreign investors to come on board. Of course the foreign investors will need to be convinced that the Chinese banks have put aside previous problems, introduced good Corporate Governance, and are able to meet most if not all of the capital requirements that today’s swift and dangerous banking world demands.
The Bank of China’s NPLs are now 5.5%, CCB’s 3.1% of total loans. These are encouraging figures, though they will in part be influenced by the earlier shedding of bad loans to the AMCs. It would however be disappointing if these figures were overly influenced by excessive growth in the loan side of the equation during the current investment bubble.
China has also said that it will go for a different local version of Basel II capital requirements – though still at the 8% capital cover level. The Bank of China has boosted its capital ratio by the issue in 2004 of subordinated debt for US$1.7bn, and its capital cover is now 8.3%. CCB will also reach 8% when its own subordinated debt issue of US$4.8bn is fully subscribed. Again, these are encouraging developments, particularly when set against the vast debt issues. However, much of the debt went to other state banks, so that there may be some circularity at work here.
The Chinese banks and authorities are however looking in the right direction, and are aware that progress can best be made by adopting best internationally agreed practice.
The motivation for these changes comes in part of course from the challenges that WTO presents to the Chinese banking system. These are perhaps more at the systemic rather than the business level: foreign banks currently only have 2% of total banking assets in China, some $41 bn, generating a profit of about 0.65%. And it is generally affirmed that the foreign share is falling. It may take at least 10 years for foreign banks to have any impact. However, they will be able to transact RMB business for local companies from this year in the major cities of Jinan (capital of Shandong, the major gold mining province), Fuzhou, Chengdu, and Chongqing. From 2005 Kunming, Beijing and Xiamen will be added. I expect bankers are even now booking office space to enjoy the perpetual spring of Kunming.
The Chinese banks and authorities view the threat more in terms of loss of staff and loss of accounts, and the banks fear that they may be left with the weaker staff and the worst clients.
Chinese banks do however have enormous advantages: they have vast branch networks in every city in China; they know the strengths and weaknesses of their clients; and they do not have legacy IT systems which can cause so many problems for foreign banks. In the UK of course we still have vast amounts of paper cheques in transit – a stage which China has been spared.
Mr LIU Ming Kang, when at the Bank of China, has given an interesting insight into the strategy of the Chinese banks to cope with WTO, and I would like to cite him here:
- Increase fee-based business
- Focus on competitive products
- Develop cash management, personal asset management and e-banking
- Apply advanced IT, Increase internal controls, Improve foreign branch network
- Acquire foreign clients abroad – as well as servicing Chinese companies.
- Target Fortune 500 multinationals in China.
- Provide listing services for Chinese companies through merchant bank BOCI
- List BoC in Hong Kong by 2005
These targets if met could indeed keep the Chinese banks on top of a difficult situation.
Whenever I come to China I am always astounded at the size and pace of development. I constantly have to tell myself that this is mainly financed by the banks: so they must be making some good decisions. We know that the whole process of loan making and risk analysis has been tightened up, and that managers who make poor loans are immediately under pressure.
Official data at mid-2004 showed that the non-performing loans were about 15.6% of the total loan book of the Big Four banks – some US$183bn. For the industry as a whole the ratio is slightly better – 13% or US$200bn. This percentage is falling (from 20% last year). But this is in part because over US$160bn of bad debts have been placed with the four Asset Management Corporations – Huarong (ICBC), Great Wall, Cinda and Dongfang. This scale of divestment is huge: in June 2004 the Bank of China and China Commercial Bank sold nearly US$34 billion in NPLs to one AMC, in preparation for their floatation next year.
Huarong AMC has enjoyed the highest recovery rate of the four AMCs collecting 32.5% of face value on a cumulative basis. The average at the other AMCs is lower. Huarong is currently selling the market NPLs with a face value of almost US$3 billion. In the first international NPL auction, Huarong sold a US$1.5 billion US portfolio to Morgan Stanley, Lehman Brothers and Salomon Smith Barney, while Goldman Sachs took $250 million S in NPLs. These firms have established local NPL servicing platforms and received control of the assets. They are operating in China to collect and resolve the loans acquired. China Cinda Asset Management Corp last year also co-operated with Deutsche Bank to repackage assets into a programme worth US$200 mn.
So there is appetite for these bargain assets: it remains to be seen whether the US and German purchasers can realise more than the average of 20% they paid for the assets. It also seems likely that we are looking at the more marketable loans; and the foreign interest is concentrated in power, energy, non-ferrous metal, transportation, water treatment and infrastructure. It is to be hoped that the supply of NPLs will soon dry up, and the AMCs will not be required to take on vast amounts of new bad loans. One way forward here is of course Corporate Governance.
4 CORPORATE GOVERNANCE
It has recently my privilege to organise two Conferences on Corporate Governance in China – one for the British Council and one for the EU with the CBRC. CG is certainly of strong interest in China – and for very good reasons. It is in fact a tool which allows a number of interested parties to sleep more easily in their beds at night.
For Chinese supervisors they know that if the basic requirements of CG are followed, banks may avoid some of the grosser errors we have seen elsewhere: analysis suggests that had CG been in place, the collapse of banks like gold dealers Johnson Matthey, or Barings in Singapore, as well as Credit Lyonnais in France, could all have been avoided by sticking to CG rules. Only BCCI, based on fraud, was beyond salvation. So the message is of course: learn from our mistakes.
For Chinese shareholders, they can be assured under the Basel rules, since the Corporate Governance principles adopted by the bank should be stated in the Annual Report. The Bank should adopt a “Comply or Explain” policy with regard to this code, or to any other code which may be applicable (e.g. because of foreign listing). This will of course bite on Chinese banks when they list abroad in 2005.
The shareholders will also have more power, if the AGM elects the Board, the Board elects the Chairman, and the role of Chairman and CEO are split.
For the Bank’s Managers, they will take comfort from the existence of a separate and independent Audit Committee to which both the external and internal auditors report; a Remuneration and Nomination Committee; and a Risk Committee.
It will be interesting to watch this shareholder democracy at work in China, as it develops over the next year or so.
5 CHINA: THE ROLE OF GOLD IN BANKING
I must confess that I am never sure what banks do with gold. One major UK bank told me that they had not seen any physical gold for many years – they just did hedging. And I suppose the withdrawal of Credit Suisse First Boston and Rothschilds from the gold markets sends a powerful signal about the profit margins in this area.
In China, the gold market seems to be alive and well: there are 13 member banks of the Shanghai Gold Exchange, with of course the local Bank of Shanghai, and the Pudong Development Bank. Shenzhen, as the major jewellery manufacturer for China is represented by the Shenzhen Development Bank. The major Chinese banks are involved in the import of gold, with foreign banks probably lobbying hard to join them. Of course the Bank of China, with its long experience of gold, has a dominating role in supply through imports. In the year to end 2003 it took about a quarter of all trades, and 60% of all financial members’ trades.
On November 18th 2003 the Bank of China started to offer, on a test basis, two-way gold trading (i.e. gold passbook saving account trading with no physical gold settlement) for individuals at its branches in Shanghai. This was the first gold trading business through an official financial institution since 1949. The minimum individual investors deals of 10 grams at about RMB1000 or US$125 – doubtless a fine margin on fine gold. I suppose that this is a useful addition to the trading on the SGE – currently running at about one tonne per day.
The services provided on the Shanghai Gold Exchange by principals may be illustrated by ICBC (Industrial and Commercial Bank of China), which acts as one of the clearing banks, and claims to provide ‘nine types of services’ to the market, including settlement, storage, gold trading and agenting, gold leasing, gold financing, purchasing, gold export and import, and individual gold trading services. ICBC’s clearing system allows trading funds to be settled within two hours. In 2003 ICBC was the largest clearer, with nearly 60% of transactions.
I also note the ongoing debate about the correct level of gold holdings for the People’s Bank as the central bank. We know that the European Central Bank holds some 15% of its reserves in gold. This makes the People’s Bank at 600 tonnes look underweight at only 1.6% of reserves. However, an increase to 15% – to over 4,200 tonnes– is probably too much excitement in one talk. It of course no longer sets the price of gold in China to the mines on one side and the jewellery manufacturers on the other.
FOREIGN BANKS AND GOLD MINING
In May 2003 the QFII scheme (‘Qualified Foreign Institutional Investors’) was introduced by the Chinese authorities, to allow foreign institutional investors access to the Chinese RMB local currency market for ‘A’ shares, previously restricted to Chinese investors. Quotas are approved by the State Administration of Foreign Exchange (SAFE), which has already issued approvals for US$1.4bn by mid-2004. UBS, which was the first authorised foreign entity, is reported to have a quota of US$300mn, of which perhaps US$50mn went into 3% of Shandong Gold Co. UBS also holds nearly 2% of Zhongjin Gold Corporation Limited ‘A’ shares. Merrill Lynch also has holdings in all three listed Chinese gold mining companies.
The Chinese track record on banking reform is good: there have so far been no major bank failures, and a vibrant securities industry has grown up alongside. The challenge now is to transfer risk from the state to the newly rich citizens by persuading them to buy into the banks. At the same time the state is discovering that allocation of capital without stringent economic constraints, such as profitability, can seriously distort investment patterns. In a country like China, where levels of wealth and employment are so diverse, it is however unlikely that the state can stand back from all forms of directed lending.
We are however not at a good part of the economic cycle for bank reform: the Chinese economy is perhaps now slowing down, and new loans for investment in overcrowded sectors such as aluminium, steel and cement have been suspended by the state. Investment is a vast 40% of GNP, and one third of this is investment in real estate. This spells an increase in bad debts in any language. I have no doubt however that the Chinese government and people will be as skilful in meeting these new challenges as they have been in the past. A stable and prosperous Chinese banking system is good for China and good for the world.
Thank you for your attention.
Manager, Antaike Information Development Co Ltd.
This presentation will cover five topics:
- A marketing mechanism for China’s silver market forms
- Production and consumption of silver increases after the market opens up
- Silver imports and exports flourish
- Development of China’s silver market to have global influence
- Development trend in China’s silver industry
A marketing mechanism for China’s silver market forms
Like gold, silver was historically an important currency and had the function of acting as a reserve currency. It was also used as a crucial settlement means among countries. With more and more silver being used in industry, the currency function has been disappearing. After the foundation of the People’s Republic of China, silver went through the following four stages:
In the initial stages of 1949-1955, the People’s Bank of China promulgated the Regulations of Administration of PRC on Control of Gold and Silver (draft) in April 1950 to keep the Renminbi stable. According to this regulation, gold and silver trade was operated by the PBOC, and trade amongst private individuals was not allowed. A unified purchasing and distributing policy was implemented. The state reserves of gold and silver were increased and the position of the Renminbi was enhanced.
In the period of 1955-1978 before a policy of liberalisation was adopted, the major target to manage the gold and silver industry was rectifying the purchasing policy, encouraging production in order to satisfy the strong demand from the large scale economic construction.
In Oct., 1977, The People’s Bank of China (PBOC) promulgated <Regulations of Administration of PRC on Control of Gold and Silver > (trial operation) that provided regulations on silver and gold management and was the first one of its kind in China.
In 1978-2000 after a policy of liberalisation was implemented, the major tasks of management of gold and silver is to adjust methods and strengthen the legal construction to adapt and ensure demand from economic development, reform, liberalisation and people’s living.
In June 1983, the State Council released the Regulations of the People’s Republic of China on the Control of Gold and Silver, which regulated the production, purchasing, distributing, manufacturing, using, recycling, import and export of gold and silver. Then in December, the Detailed Rules of Implementation of Regulations of the People’s Republic of China on the Control of Gold and Silver was released and implemented. In 1984, PBOC and the Customs General Administration of P.R.C. jointly published Regulations of Administration of Gold and Silver Entry and Exit.
Since Jan. 1, 2000 when China’s silver market had been completely opened, PBOC ceased to conduct purchasing and distributing. Silver producers and consumers are allowed to do business directly. The license system on silver products (except silver coins) manufacturing, wholesale and retail are abolished. Silver is treated as a common commodity as others.
Since 2000, China’s silver industry saw rapid development. Silver exchange market has basically come into forth. In 2003, the silver production and consumption surged to 4,500 tonnes and 2,000 tonnes, up by 200% and 60.77% over 1999. While Shanghai White Platinum & Silver Exchange indicates the forming of silver spot market.
In 1999-2003, silver production and consumption mounts up
Statistics released by the National Bureau of Statistics show (see Table 1) that in 1999 when China’s silver market had not been opened, China’s silver production was 1,500 tonnes and consumption was 1,244 tonnes. In 2003, the silver production and consumption surged to 4,500 tonnes and 2,000 tonnes, up by 200% and 60.77% over 1999, which mirrored the influence from the opening up of silver market. In 2004, China’s silver production and consumption is expected to reach or exceed 5,000 tonnes and 2,000 tonnes, continuing the growing momentum.
During the period of China’s silver industry development, there emerged some model silver producers, here we list the top five silver producers in 1999 and 2003, from which we can see how fast the silver production growth is. In 1999, the accumulative output of the top five producers was 700 tonnes while in 2003 it reached 1,420 tonnes, jumping by 103% (see Table 2).
The increase in silver production is the result of the following:
Rapid growth of base metals production
Lead output increased 79% from 900 thousand tonnes in 1999 to 1.58 mln tonnes in 2003. The output this year is expected to reach 1.7 mln tonnes.
Copper output jumped 52% to 1.75 mln tonnes in 2003 from 1.15 mln tonnes in 1999. The output this year is forecasted to be 1.85 mln tonnes.
Zinc output grew 32% from 1.7 mln tonnes in 1999 to 2.24 mln tonnes last year and it is estimated to be 2.45 mln tonnes this year.
Recycling industry improved, secondary silver output increased largely
With the development of China’s marketing economy, base metal producers have experienced accelerated growth, whilst China’s silver consumption has risen year-on-year. Accordingly, the silver recycling industry has also grown quickly. Many recyclers have developed from small workshops into large ones, their production increasing from several tonnes per year to several hundred tonnes per year, becoming important silver suppliers in China. Currently, Yongxing in central China’s Hunan Province and Xianju in east China’s Zhejiang Province are the country’s two major silver recycling bases.
In Yongxing recycling base, the annual production is about 1,000 tonnes. Anodes, used bricks from smelters and imported crude lead are the main raw materials. Most of the silver yielded is primary silver. Those smelters are mainly engaged in lead production. But lead output is very small. The number of producers is very big. Two major producers are Yongxing Electrolytic Lead Plant and Chenzhou Jingui Smelter.
Xianju recycling base: the annual silver production is about 500 tonnes. Raw materials are mainly used waste developer, contacts, solder, etc. The enterprises are in small scale but the number is very big. Most of the products are secondary silver. One of the major producers is Xianfeng Previous Metals Co., Ltd.
Increase of associated and primary silver production.
After the liberalisation of the silver market, output from associating and silver mines also rose – examples include Jinchuan Nonferrous Metals Group Co., Shandong Zhaojin Group, Hebei Fengning Silver Mine.
The increase in silver consumption can be attributed to the following reasons:
In 2003, China consumed more than 2,000 tonnes of silver, up by 60.7% over 1999. This year we estimate China will consume more than 2,200 tonnes of silver, driven by the following factors.
A sharp increase of silver demand from industrial field
With massive investment increase in heavy industry, China’s consumption of silver alloy, soldering and silver paste has also soared in recent years.
During 1998-2002 period, China’s GDP, which in 2002 was RMB10, 314.9 billion yuan, has seen an average growth rate of 7.6%. In 2003, China’s GDP growth rate stood at 9.1%, reaching a peak since 1997. At the same time, GDP per capita breached US$1,000 barrier for the first time in China in 2003.
Electric power industry
During 1998-2002, China’s electric energy production, which stood at 1,654 billion Kwh in 2002, saw an annual average growth of 9.1%. And China’s newly commissioned capacity of power suite amounted to 91 million kilowatts during the same period. In 2003, domestic electric energy production surged 15% over the previous year to 1,900 billion Kwh; newly commissioned capacity added up to 30 million kilowatts and newly constructed capacity reached nearly 30 million kilowatts. By the end of 2003, domestic electrical generating capacity surged 7.8% over 2002 to 384.5 million kilowatts. Moreover, China was forecasted to invest RMB 1,700 billion in power station construction during the 2003-2008 period, with an average investment of RMB 242.8 billion. National year-to-date electricity production till 5 May 2004 stood at 170.899 billion Kwh, up 20.07% over the corresponding period of the previous year, and daily average production reached 5.513 billion kilowatts.
From 1998 to 2002, China’s average annual growth of automobile output and sales stood at 18.88% and 19.31% respectively, of which car reached 21.11% and 22% respectively. In 2003, China’s combined automobile output grew 36.6% over 2002’s 1.19 million to 4.44 million. As a result, China has exceeded France to rank fourth in worldwide automobile production after the U.S., Japan and Germany.
Chemical industry and home appliances industry
China consumed 134 million tons of refined oil in 2003. In the first quarter of 2004, China processed 66.635 million tons of crude oil with a year-on-year growth of 17.1%. At the same time, China also increased production and improved the quality of home appliances such as colour TVs, computers and refrigerators. The establishment of home appliances corporations, such as Changhong, Haier and TCL has offered a broad space for silver consumption.
Furthermore, the foreign manufacturing industry has also begun to transfer to China, with Snyder, Siemens and many others establishing branches.
Silver demand growth in other fields: In addition to the above-mentioned industries, diamond, silver products and photographic material fields also maintained an average annual growth rate of 10% in silver demand, while demand in the photographic material field is expected to slow in the future.
- International silver trade is brisk: With the opening of the silver market, China’s silver exports in 2003 jumped 11.6 times from 1999 (see Chart 3). In 2003, China exported 2,891.5 tons of silver while which in 1999 stood at only 249.54 tons. At the same time, China’s silver powder imports saw a year-on-year increase in recent years as well.
- Development of China’s silver market to have global influence
Chinese silver producers quicken steps towards the international market
China’s annual silver export growth has breached 800 tons since 2001, while global silver supply fluctuated among 100 tons per year during the same period. We can see that China has been playing a vital role in global supply and demand balance (See Table 4).
In addition to the increase of output, China’s domestic silver consumption has also seen a more than 10% annual growth thanks to rapid development of economy. The stable consumption of silver and some other base material increase has encouraged the international silver market despite a slumping economy in U.S., Europe and Japan.
China stabilised international silver price
Under circumstances when most metal prices hit a record high, silver price began to rise, with a maximum increase of 70% since the second half of 2003 as well. The increase in China’s silver supply closely followed the price surge.
Developing trends in China’s silver industry
- China’s silver output will maintain its growth trend while the amplitude will decrease.
- Fuelled by the flourishing economy, China’s silver consumption will strengthen further.
- Chinese silver companies will have a good chance of cooperating with international silver groups during the next 3-5 years following the increase in silver production and brand influence worldwide.
Chairman - Martin Murenbeeld, President, M Murenbeeld & Assoc Inc
President, M Murenbeeld & Assoc Inc
Welcome to the last session of the Conference. This session is entitled “Forecasting the Future”, and to get the ball rolling let me very briefly outline my bias with respect to the future of gold. You all know that gold and the Dollar are closely correlated. My comments concern the US Dollar.
The US current account deficit is near 5% of GDP, and not unlike 1985-87, this deficit is undermining the Dollar. For the Dollar to remain stable or rise in the face of the still growing US current account deficits, there have to be enormous foreign capital inflows. If these foreign capital flows are hard to come by the Dollar cannot rise.
The latest balance of payments data show that more and more “foreign capital inflows” are coming from foreign (Asian) central banks. These banks purchase Dollars in the foreign exchange market to stop the Dollar from falling against their own currencies. They then redeposit these Dollars back in the US bond market. The resulting lower interest rates and higher Dollar keep US consumers consuming, and importing foreign (Asian) goods!
If the Dollar isn’t allowed to decline further, our models project that the US current account deficit could reach $1 trillion by 2007-08. On a cumulative basis the US will then need to take in just over $3 trillion foreign capital between now and then just to keep the Dollar stable. No one knows where this money will come from! Here’s what Greenspan said recently, “At some point … international investors … faced with a concentration of Dollar assets … will seek diversification, irrespective of the … returns on Dollar assets.” (May 6, 2004) Our bearish view of the US Dollar is one factor underpinning our bullish view of gold!
Let me now introduce our panel of speakers:
- Dennis Gartman
- James Kynge
- Kamal Naqvi
The Gartman Letter
Emerging Markets Editor and Associate Editor, Financial Times
People living in Beijing have had an unusually wet summer. But the strange thing has been has been that the countryside around the capital has remained desiccated by drought. How has this happened? Have the clouds been obeying some secret Communist party directive to hold their rain until directly above the capital?
Of course not. In fact, the rain has been caused by an immense cloud-seeding programme. More than 30 modified aircraft, 6,900 anti-aircraft guns and 3,800 rocket launchers have done battle with the heavens to squeeze more moisture out of the sky. But why have clouds directly above Beijing been seeded, why not in the surrounding countryside? The answer, apparently, is that the prime object of this rainfall has not been to ease a shortage of water but to alleviate a dearth of electricity. The more it rains, the cooler it is and the less people use their air conditioners.
I tell this story not because being British I am obsessed with rain, or because I want to make a point about China's environmental challenges. I only wish to say that in economics, as in meteorology, China is often not quite what it seems.
And it is rarely what the national bureau of statistics would have us believe – more of that later. Let me first tell you where I am coming from. I am not one of those that believes that China is badly overheated and heading for a crash. I think there will be a soft landing this year, with GDP growth coming in at somewhat above 8.5 per cent, compared to an official 9.7 per cent in the first half and 9.1 per cent last year. The slowdown now under way will become more pronounced next year. But it is likely that even at the end of 2005 growth will still be around 8 per cent.
I want to briefly take you through why I think that, and then spend a bit longer on some of the long-range issues that will shape China's destiny.
So in what sense is China not badly overheated? Official figures show that fixed asset investment contributed 47 per cent of GDP last year and has been growing so far this year at over 30 per cent. These admittedly are scary figures - way above the long-term trend line for China and above any sustained experience in other countries like Japan and Korea.
But the official figures give slightly the wrong impression. They include land sales, something that is not usually included. Second, they include not only investment in property by developers but also retail purchases of property. These figures are inflated by a big one-off shift; about five or six years ago, the houses and apartments of people in China were not really traded commodities. But reform of the housing market – which in my opinion was the single biggest source of wealth creation in China in the last decade – has meant that homes are now freely traded, the mortgage sector has taken off and property prices have risen sharply. So, if the concern about China's fixed asset investment figures is that China is building too much capacity, then the fact that the buying of houses is included in the investment figures should bring some solace, because these purchases are an expression of demand, not supply. The other point here is that as house prices rise from an anomalously low base five years ago, the asset appreciation shows up too in the fixed asset investment statistics, thereby inflating those figures further.
My third point about fixed asset investment is more contentious and more personal. As somebody who travels in China every month and has reported from every province, the economy does not look terribly overheated or overbuilt.
I have a theory about why the figures seem out of sync with observable fact – which is that consumer spending – and especially spending on services – is quite a bit higher than the official statistics show. This inability of the statistics bureau to capture the real level of consumer spending makes it look as if the contribution to GDP from investment is higher than it really is. The biggest difference that I notice in the small towns and villages that I revisit after an absence of five or six years is that shops have sprouted everywhere. In places where the only shop five years ago was a store selling peanuts and nails, there are now typically a motorbike sales outlet, a restaurant, a hardware store selling agricultural pumps, a garbage collection point, a place selling building materials and, without fail, a place offering foot massages. Well, I suppose there are 2.6 billion tired feet out there.
This boom in services is very striking, but it does not show up in official figures. The stats bureau says that services still contribute only about one third of GDP. While the tax bureau complains bitterly about service sector companies dodging taxes, statistics bureau officials deny the possibility that the same service companies may be under-reporting to them too. “We have complete confidence in the accuracy of our figures,” the head of the stats bureau said recently.
The truth, I think, is that the service sector forms the bulwark of a large and established underground economy that remains beneath the radars of the tax and stats bureaux.
I have spent some time on the issue of investment because I regard it as crucial to understanding that China is not badly overheated. But it is equally important to realise that it is a bit overheated.
The steel, aluminium, cars, cement and property markets have grown considerably faster than their historical trends and what has been observed as sustainable elsewhere. The average price of a dwelling in 35 Chinese cities is now 10 times the average urban wage - this statistic does bear scrutiny. I don't think that it portends a crash, but I do think it means that property prices will not rise half as quickly as they have been, and they may fall in some cities. This will dampen demand for steel and aluminium, undermine the wealth effect being felt by homeowners, restrain speculation in the housing market and curb consumption. As this happens, much of the investment that was predicated on investment demand - for example, the expansion of steel, aluminium and cement factories will be mothballed and a mildly vicious circle will emerge in these sectors.
I suggest that such a scenario will come to pass naturally. But if it doesn’t, then government action will probably precipitate it. Officials in Beijing have been telling me recently that the property market is now regarded as the source of China's over-investment troubles. Beijing’s aim is to reduce house price appreciation to around one or two percent a year from an average of 10 per cent in 35 cities recently. They will use the various weapons in their armoury to bring this about.
The outlook for property forms the foundation of my prediction that a GDP slowdown is in prospect. In addition, other areas are showing signs of growth fatigue - car prices are falling and sales growth has slowed dramatically from last year. Corporate earnings are starting to moderate. Inventories are climbing. The signs of a slowdown are evident.
This fact makes it both more interesting and more challenging to predict the future, which is what I have been asked to take a stab at today. First, a disclaimer. I am not an expert on precious metals. I will confine myself to looking at some of the big trends that are shaping China's future. I want to focus on demand, to study the anatomy of the dragon’s appetite, to take a look inside the belly of the beast.
China's appetite has become the theme of this year – and with good reason. From being a significant but not spectacular buyer of base metals, China in 2003 transformed itself into the overwhelming factor in global markets. It accounted for 100 per cent of the growth in world copper demand, 99 per cent of the growth in nickel demand, 95 per cent of the growth in steel demand etc. The drama of China's arrival in global markets was matched only by its speed.
And what just happened to the base metals market may be about to be repeated in many other areas. Take tourism, for example. China's outbound tourists numbered 20m last year, are growing at around 20 per cent a year, and are now more numerous than Japan’s. There are expected to be 100m outbound Chinese tourists by 2020, and that in my view is an exceedingly conservative estimate. When they arrive at their destination, they are not afraid to open their wallets; in Hong Kong, mainland tourists spend an average of US$772 a night, about $100 more than an average American.
So where has this sudden projection of Chinese buying power come from? And more importantly, where will it go from here?
The first element in the anatomy of appetite is population. This issue is divided into three main chunks. The first is its absolute size, estimated at 1.4bn but almost certainly greater. The second is its growth rate, about 14m a year. The third – by far the most important – is its mobility. In the old days 25 years ago, Chinese were basically tied to the places that they lived. Now there are by official reckoning about 120m workers that have migrated from villages to urban areas. Some are temporary; many will become permanent urban dwellers. By 2020, there will be 300m more urban citizens than there are today – meaning that there will be an urban population of 900m people in China just 16 years from now. That is up from 484m urban dwellers in 2003.
This migration, the greatest by far in human history, is both a consequence and a catalyst of the other big driver of Chinese demand: an industrial revolution unfolding at warp speed. It took centuries for China to attain its status as the world's economic superpower in the mid-1700s, when it produced about one third of the world's GDP. But in the eyes of some, it will only be 30 to 40 years from now before it regains that position. China’s emergence, spurred on by the globalisation of trade, technology and capital, is evolving at a far greater pace than the similar transformations that took place in Japan, Korea and the other Asian tigers.
The other point about China’s emergence is that its appetite will be more enduring than anything we have yet seen. When, and if, China overtakes the US as the world's largest economy, its people on a per capita basis will only be one sixth as wealthy as Americans. They will still be hungry, still cost competitive.
It is the scale and speed of China's transformation that makes it unique. Many people had heard the predictions of what would happen when the world’s biggest market took off, but it was last year that the world really began to feel it in earnest. When you travel inside China and witness what is happening, it is breathtaking. John Steinbeck wrote in his 1930s Depression-era classic, The Grapes of Wrath, that, "there were one million people on the move, another million preparing to move and ten million more starting to feel the fear of movement", but the scale of human drama that Steinbeck describes would not capture the events on display even in a single Chinese province.
These factors – the movement of people and the industrial revolution – together form part of the dragon's yearning to be fed. Other drivers are more subtle, but no less important. Among these, the emergence of the middle class is key. My forecast is that the middle class will grow more quickly than GDP each year - which is another way of saying that the gulf between rich and poor will widen each year.
First, let’s define terms. Who qualifies as middle class? I have set the bar quite low because, according to the rules of purchasing power parity, a little cash goes a surprisingly long way in China (unless you are staying in a hotel in Pudong). In 2002, there were 28m people who earned more than RMB 4,500 a month, or in US dollar terms, more than $6,500 a year. This category I call wealthy. Another 168m people earned between RMB 2,776 and 4,500 a month. This category I call well off. Together they make up a middle class, which in 2002 totalled 196m people.
By 2010 there may be 560m people belonging to the middle class, and 154m of them will be in the category I have called wealthy. You may quibble with my categorisation, but I believe the trend is clear. The reason that I think the middle class will grow more quickly than GDP is that China is now capitalist, and in capitalist societies, the rate at which capital appreciates outstrips the rate at which wages rise. That was Karl Marx's bugbear.
But it won’t only be the capitalist class that gets richer. Life is about to get considerably better for Chinese workers too. The ascent of factories along the east coast up the technology ladder has meant better wages for workers in the medium- to high-tech segment. Workers’ pay in the Pearl River delta around Guangdong is about double what it is in Anhui, an inland province about 8 hours drive west of Shanghai. That has two big implications: first, that low-tech factories are being forced to move inland. Second, that factories along the coast must move up the value chain and pay more to their workers.
This is a good thing for China. It will increase the contribution of consumer spending to GDP, helping to rebalance the current investment-dependent model of development. At the same time, it is almost beyond doubt in my mind that independent or semi-independent trade unions will spring up in the years to come, creating greater wage bargaining powers and therefore higher wages.
This trend will coincide with another basic re-alignment – that from a manufacturing-led to a service-led economy. At the moment, the shape of the Chinese economy is highly anomalous. It is a continental country with a pretty much maritime economy. Total trade amounts to about 60 per cent of GDP, compared to about 30 per cent for big continental economies such as the US. At the same time, services in China contribute only one third of GDP, compared to over 60 per cent for most western economies. But China, as it matures, will start to resemble its type. Trade will amount to a much smaller portion of GDP and services will start to drive the economy.
A services economy is, by its nature, a knowledge economy. And a knowledge economy is brand conscious, fashion conscious, argumentative and high tech, at least in parts.
When this services economy starts to take hold, and let’s be clear that it is already growing fast, the nature of China's appetite will start to change. Maybe people will become even keener on adorning themselves with precious metals.
There is another reason why I think a services economy will emerge: the current model of development is unsustainable.
There are plenty of problems on the horizon. They are not of the type in my view that will cause China to collapse, as some authors have predicted. They are the type that will create volatility in growth and slowly sap China's manufacturing energy. The two main problems are environment and demographics.
Environment first. About one fifth of humanity lives in China, and although the country looks big on the map, only half of it is habitable. So these people live on and around 7 per cent of the cultivatable land. There is already intense competition in land use; the local governments generally want to use it for factories and the central government, worried about China's ability to feed itself, wants to ensure that enough is left over for crops.
Chronic water shortages in the north of the country add another very physical limit to industrial development and to China’s appetite.
Air pollution is so bad, and getting worse, that the health care bill incurred through factory emissions will one day start to exceed the value created from new factories. In addition, China already has too much stuff; more than 90 per cent of manufactured products are in oversupply and the thin or negative margins gained from selling them are a prime cause of the mountains of debt in the banking system.
The last inhibitor of development and appetite is demographic. China may grow old before it grows rich. The part of the population over 60 will rise from a current 11 per cent to 28 per cent by 2040 – creating an elderly segment in society of about 400m people.
That will place a huge burden on savings, pensions and the capital markets. The burden is all the starker because few of China's welfare liabilities are funded at this point.
So in summary the type of China that I see emerging 10 years from now is one in which manufacturing is still king, but services are creating more depth and balance to the economy. Its appetite for base metals, food and probably also luxury items will strain the world’s ability to produce them. But its people, tired of the pollution and the daily ferment, will be travelling abroad, buying property abroad and educating their children abroad in numbers that will shock the world. The government in Beijing will at times resent this dependence on the outside world, but they will have no option but to accept it. The dragon’s hunger will make it tame.