EDITOR'S NOTE: Chinese gold demand increased tremendously in 2021 and it’s likely to continue well into 2022. What’s driving it? There are a number of potential factors. A decline in GDP, a real estate crisis, low-interest rates, and a dip in gold prices are likely prompting investors to accumulate more of the yellow metal across different forms (from jewelry to bars and coins to ETFs). The Seeking Alpha article below lays out a detailed breakdown of China’s rising accumulation. Considering how China’s investing public has been a bit more cognizant of the benefits of “sound money,” perhaps their actions might better inform our own strategies toward dealing with our current economic environment.
- Chinese gold demand will likely remain strong in 2022.
- Despite the strong performance of H1 2021, China’s GDP growth slowed in the second half.
- Gold bar and coin demand might be higher in 2022 than its pre-pandemic level.
A healthy outlook for China's gold market in 2022
In 2021, the 56% y-o-y rise in China's gold consumption marked a strong comeback from 2020.
And Chinese gold demand will likely remain strong in 2022. Our quantitative analysis, based on our Chinese gold demand models and inputs across various scenarios from Bloomberg, Oxford Economics and QaurumSM, supports this view, despite concerns around a potential slowdown in China's economic growth.
Additionally, there are qualitative factors that might provide further support: an increasing interest in gold jewellery among young consumers, greater pricing transparency and the endeavour of local commercial banks to sell physical gold products.
Chinese gold demand rebounded strongly in 2021
China's gold consumption witnessed a strong 2021 compared to 2020 (Chart 1). Gold jewellery demand reached 675t, a 63% rise y-o-y and 6% higher than 2019, driven by the economic recovery and a pullback in the gold price from its 2020 record high. It was a similar picture for Chinese bar and coin demand: the 2021 annual total of 284t was 44% higher than 2020 and 35% higher than 2019. One stand-out in the key drivers of this sector's growth was local commercial banks' increasing efforts in selling physical gold products due to restrictions in their other gold businesses.1
Consequently, the local gold price premium trended up in the year, averaging US$6/oz, in sharp contrast of the 2020 discount of US$25/oz (Chart 1). Meanwhile, 2021 gold withdrawals from the Shanghai Gold Exchange (SGE) - a proxy of China's wholesale physical gold demand - rose by 45% y-o-y, reaching 1,746t.
Chart 1: Strong recovery in China's gold consumption during 2021
Annual gold consumption and average premium*
*As of December 2021. Gold consumption refers to demand for gold jewellery, bars and coins. And the local gold price premium is based on daily Shanghai Gold Benchmark Price PM and the LBMA Gold Price AM.
By the end of 2021, collective holdings in Chinese gold ETFs stood at 75t (US$4bn, RMB28bn), a record high in tonnage terms. Over the year, there was a net inflow of 15t (US$787mn, RMB5bn) despite the gold price weakness.2
Compared to previous years, the data suggests that Chinese investors seem to have become more tactical in gold ETF allocation (Chart 2). For instance, in the first quarter of 2021, total holdings in Chinese gold ETFs increased by 12t as the local gold price fell by 9%. And Q2 saw a modest outflow of 4t when the gold price rebounded: Chinese investors may have capitalised on their previous allocations. The local gold price fell by 4% in 2021 and this, among other factors, played a key role in pushing up total Chinese gold ETF holdings.
Chart 2: Chinese gold ETF investors seem to have become more tactical in 2021
*As of December 2021.
2022 could be a challenging year for China's economic growth
Looking ahead to 2022, we expect:
China's GDP growth could slow
Despite the strong performance of H1 2021, China's GDP growth slowed in the second half. By the third quarter, the y-o-y growth in China's GDP had fallen to 4.9% from 7.9% in Q2. And it decelerated further in Q4 with a 4% y-o-y GDP growth - the lowest on record.
Challenges facing China's real estate sector - which had accounted for over 13% of the country's GDP in 20193 -weighed heavily on the economy. To stabilise housing prices and avoid systemic risks, China introduced measures such as setting secondary home guidance prices, imposing ceilings for banks' home mortgage loan ratios, and tightening controls over developers' debt levels in 2021, all of which helped drag down the real estate sector's growth.
And it seems the real estate sector could remain a downside risk factor to China's economic growth in 2022. In its annual conference in late January 2022, the Ministry of Housing and Urban Development reiterated general principles of "houses are for living in, not for speculation" and "not using the real estate sector as a short-term economic stimulus"4. Also, China is focused on the long-term economic transition from a fast-growing, industry-led path to a tech-driven, high-quality one. As such, despite the marginal relaxation in the sector in late 2021 which meant to cushion shocks instead of spurring growth5, the structural downtrend in the housing market is likely to extend.
Meanwhile, uncertainties of the pandemic remain a risk factor for the local economy. China has adopted a "zero tolerance" policy to the pandemic and periodic lockdowns are likely to persist, potentially slowing the nation's economic growth.6
Interest rates in China are likely to stay low in 2022
The annual Central Economic Work Conference held in December 2021 set an easing tone for China's monetary policy in 2022 in response to potential challenges. And the People's Bank of China (PBoC) has acted: following cuts in the required reserve ratio for financial institutions and the one-year Loan Prime Rate (LPR) in December 2021, the PBoC lowered its Medium Lending Facility rate in January 2022. prompting further cuts in LPRs.7
We believe China's monetary policy will remain accommodative in 2022, keeping local interest rates and bond yields low.
Chart 3: Downstream sector margins are being squeezed
2021 profit growth in different sectors*
*Not all sectors are included. Data as of December 2021.
The Chinese currency might face pressure.
There is a possibility that the RMB might weaken in 2022 due to:
- A possible slowdown in China's economic growth
- A narrowing China-US yield spread as the US Federal Reserve could start to hike rates sooner and more steeply than expected8(Chart 4)
- Rising money supply in China, driven by the nation's accommodative policies
Inflation concerns could remain to the fore
Margins across Chinese industry sectors are imbalanced. Chinese upstream sectors saw their profits surge due to markedly higher commodity prices while downstream industries' margins are being squeezed (Chart 3). And with higher costs gnawing away profits, retailers have had no option other than to increase their product prices to avoid losses. For instance, listed companies in sectors such as condiments, cooking oil, and home decorations have been announcing a stream of price hikes over recent months.9 This seems unlikely to end until the downstream sector margins recover to reasonable levels, potentially fuelling 2022's inflation in China.
Other factors could also create inflationary pressure in 2022 - such as uncertainties over the pandemic-related global supply chain disruptions and the possible initiation of another hog cycle which might lead to higher pork prices.10
Chart 4: A narrowing China-US real rate spread could weigh on the CNY
The USD/CNY and the China-US real 10-year government bond yield spread*
*Based on weekly averages of the USD/CNY, the Chinese 10-year government bond yield less the CPI y-o-y growth in the month and the US 10-year TIPs yield between December 2016 and December 2021.
Our analysis shows that China's gold consumption11 is closely linked to the local economic performance (Chart 5). The 8.1% y-o-y GDP growth in 2021 was key in supporting the 55% y-o-y rise in Chinese gold consumption. Gold jewellery demand is also impacted by the gold price whereas factors such as households' income and consumer inflation could influence bar and coin investment.
Chart 5: China's gold demand exhibits a close link with local economic performance*
China's quarterly GDP growth and gold consumption between 2001 and 2021
*Gold consumption refers to the sum of quarterly jewellery demand and bar and coin sales in China.
China's gold consumption in 2022 might rise further
Our quantitative analysis of China's gold demand allows us to determine historical drivers of jewellery consumption, as well as bar and coin demand (Appendix I). These quarterly models, in turn, provide a framework to determine how gold demand may perform across various macroeconomic environments.
Assumptions for key model drivers
Based on perspectives for the Chinese economy in 2022 discussed in the previous section, we used inputs from two relevant economic scenarios supplied by Oxford Economics based on their Global Economic Model updated as of 29 November 2021 and one scenario we named "Moderate growth" based on Bloomberg's median of various institutions' projections:
This corresponds to the medians of various institutions' forecasts from Bloomberg's "Economic forecasts" function. And this is a scenario broadly in line with our previous 2022 Chinese economic outlook.
This corresponds to the "Baseline" scenario from Oxford Economics. In this scenario, China is likely to witness similar GDP and income growth as the "Moderate growth" scenario. However, China could also see higher-than-expected inflationary pressure and relatively higher bond yields in 2022.
With China's "zero COVID" policy remaining in place, the "sticky" pandemic and related lockdowns or social and traveling restrictions could further clamp down the local economic growth and prompt more stimuli, resulting in lower GDP growth and personal income than in previous scenarios.
We based our quarterly RMB gold price estimations on the performance that our web-based valuation tool, QaurumSM implies under the two Oxford Economics scenarios and Bloomberg projections from the "Commodity price forecasts" function for the "Moderate growth" scenario. For more details, see Appendix II.
Model-based Chinese gold jewellery demand outlook
We used historical data from Q1 2009 to Q2 2019 to construct the Chinese gold jewellery demand model. This model produces a directional accuracy of 88% and a root mean squared error (RMSE) of 15% in-sample. For out-of-sample estimation between Q3 2019 and Q4 2021 (excluding the first two quarters of 2020 as they were distorted by the pandemic), the model achieves a directional accuracy of 100% and a RMSE of 12% (Chart 6).
Chart 6: Actual gold jewellery demand changes and modelled changes (green line)*
*Based on data between Q1 2010 and Q3 2021. The first two quarters of 2020 were excluded as demand was distorted by the COVID-19 pandemic.
Applying our parameter assumptions to the model, we expect the y-o-y growth in 2022's Chinese gold jewellery demand under these scenarios to be12 (Chart 7):
- Moderate growth: 14%
- Recovery continues: 16%
- Long COVID: 8%
Chart 7: Various scenarios of Chinese gold jewellery quarterly tonnage demand forecasts*
*Based on our modelled q-o-q changes in 2022 and the Q4'21 gold jewellery demand in tonnage terms.
Our modelled results suggest that even though the slowing GDP growth and continued declines in marriage registrations might limit the sector's increase, local gold jewellery consumption could receive strong support if the gold price goes lower in 2022.
While quantitative models are a useful tool, they may not capture the nuances of real-world market dynamics. Other factors such as the rising desirability of fine gold jewellery as an investment among Chinese young consumers, greater pricing transparency, and the rising popularity of Heritage Gold jewellery products13 might provide further support for China's gold jewellery demand in 2022. However, unexpected COVID-related lockdowns and slower-than-expected economic growth might result in negative impacts (Focus 1).
Model-based Chinese bar and coin investment outlook
As for gold jewellery, we created a Chinese bar and coin demand model (Appendix I) based on historical data between Q1 2010 and Q4 2021 due to their data availability. The model has a directional accuracy of 81% and RMSE of 23% (Chart 8).
Chart 8: Actual bar and coin demand changes (gold) vs modelled changes*
*Based on data between Q1 2010 and Q4 2021.
Under the three different scenarios, our model's estimation of the y-o-y growth in 2022's Chinese bar and coin demand are14(Chart 9):
- Moderate growth: 3%
- Recovery continues: -2%
- Long COVID: 12%.
Results show that relative to 2021, expectations for higher inflation, lower bond yield, and a weaker currency across the three scenarios might be key in driving 2022's Chinese bar and coin investment. Meanwhile, the long-term saving demand could stay reasonably stable and be limited by slower GDP growth. Overall, China's gold bar and coin investment in 2022, based on our model in different scenarios, could remain well above the 2019 level.
Chart 9: Various scenarios of Chinese gold bar and coin quarterly tonnage demand forecasts*
* Based on our modelled q-o-q changes in 2022 and the Q4'21 gold bar and coin demand in tonnage terms.
And we believe that factors our model cannot capture - such as the increasing efforts of commercial banks in selling physical gold products - will continue to play a key role in encouraging local bar and coin demand this year (Focus 1).
Focus 1: Not all drivers of demand are quantifiable
Quantitative models have their limitations. Our model cannot capture the positive impact on gold jewellery demand from the surging popularity of Heritage Gold jewellery products, for instance. This was evidenced in late 2020 when our model underestimated gold jewellery demand in China.
We have studied qualitative factors which might impact China's gold jewellery demand in 2022, in particular the changing attitude to gold consumption among young consumers and the rise of Heritage Gold jewellery products. Social media analysis tells us that today's young Chinese consumers are paying increasing attention to wealth management and often treat a gold jewellery purchase as an investment.15 Many prefer well-designed chunky 24K products - so long as labour charges are reasonable and transparent - because these trendy designs fit their tastes and heavier weights could mean higher profits should the gold price rise in the future.
And our nationwide gold jewellery market survey in 2021 found that Heritage Gold jewellery products have become a major sales focus in local jewellery stores mainly driven by young consumers' increasing interests in traditional Chinese culture embedding fashion and lifestyle products as the "Guochao" trend intensifies.16
In the meantime, retailers are focusing more efforts on promoting heavier products that could carry higher margins under the per-gram pricing method which are increasingly adopted by jewellers.17
We believe retailers' return to the "per-gram" pricing is well-timed. The rise of "Guochao" and an increasing focus on the financial aspect of gold jewellery products among the young have been driving up sales of well-designed weighty 24K items. Greater pricing transparency under the "per-gram" pricing model should encourage even further growth.
In retail investment, we believe the focus of Chinese commercial banks on selling physical gold products is likely to continue as other retail gold businesses remain restricted, and this could further stimulate 2022 bar and coin demand.
But it is not all positive news:
- sporadic outbreaks of COVID-19 and its variants could lead to lockdowns and social restrictions in the face of China's "zero COVID" policy, damaging consumption as a whole
- slower-than-expected Chinese GDP growth might put pressure on consumer income and this could translate to lower budgets for gold jewellery as well as gold bars and coins.
2022 is likely to be a challenging year for China's economy. Almost all of our scenarios assumed slower GDP growth in 2022, coupled with the possible downward trend in Chinese marriage registrations, could limit China's gold jewellery consumption. What's more, the combination of China's "Zero COVID" policy and possible sporadic outbreaks could lead to periodic regional lockdowns, unexpected economic damages and gold consumption restrictions.
Despite these setbacks, we would expect gold jewellery demand to rise in 2022 if the local gold price falls or stays reasonably stable. And the changing attitude of the young towards gold jewellery as an investment, along with retailers' increasing adoption of the "per-gram" pricing method could provide further support.
Gold bar and coin demand might be higher in 2022 than its pre-pandemic level. While the possibility of rising inflation could play a key role, weakness in the local currency and the lower opportunity cost of holding gold under our scenario assumptions may also serve to stimulate demand. And if commercial banks continue to prioritise physical gold products sales, bar and coin investment in China could end 2022 higher than our projections.
Originally posted on Seeking Alpha.