Is China Controlling The Gold Price?

From The Maven Letter: 27 March 2024

An article by Jan Nieuwenhuijs, published late last week, has taken the gold investor world by storm. Everyone is talking about China Has Taken Over Gold Price Control From The West. Many have asked me what I think.

Before diving into his article, let me state that I have a lot of respect for Jan. I’ve never met him but he started writing about gold about the same time I started Resource Maven. He initially focused on China and he figured things out about that opaque gold market that no one had figured out before.

He now writes about all things gold for many outlets and I often read his articles. And he continues to be his own person, which is to say that he often contradicts common gold bug thinking.

When I first read his latest argument, I was skeptical. It seemed too easy. But the deeper I dove, the more likely his argument became for me.

His argument is that dramatic increases in Chinese gold buying, by both the People’s Bank of China (PBoC) and retail Chinese, are the force that has driven the gold price in the last two years. This marks a major change, in that Chinese buyers have always been very sensitive to price: they buy when gold is cheap or the price is falling and step back when the price is rising. Jan’s argument is that they are now buying more than ever before, even though the price is at all-time highs.

My first thought was: well that would explain this strangeness:

The black line shows gold held in GLD, the main gold-backed ETF in the west, continuing to fall as the price of gold shot higher at the start of March before bouncing ten days later. That GLD’s gold holdings did not turn up until well after the gold price ran, it’s clear Western investors responded to gold’s price move; they didn’t create it.

The thing is, it usually is western buying that fuels a rising gold price. This chart backs that up by showing the price of gold against Western gold ETF inventories. They track closely: western buyers add to their gold exposure when the price is rising, propelling the move, and they reduce their holdings when the price falls.

Chinese buying, by contrast. has always been price sensitive – the Chinese have long bought when gold prices are weak or falling and have stepped back from the market when the gold price runs.

Jan wrote about this in an earlier article:

Whilst it’s considered normal in the West to keep all of one’s wealth within the banking system, people in the East are still accustomed to keep their savings partially in physical gold. Their ancestors saved in precious metals and so have they been taught…

The welfare state and financialization have slowly removed gold from Western people their day-to-day lives. People don’t pay much attention to gold when they feel financially confident… Simplified, when investment confidence tapers off, for example due to rising inflation expectations, gold is bought, and when trust is restored, metal is sold.

In the East they don’t mind taking the other side of this trade. Close affinity with gold as a store of value makes Easterners price sensitive. Gold is bought in stable markets, but especially when the price goes down. Profits are materialized when the price is high. The West thus sets the price, and the East dampens volatility. Such are the dynamics that have transpired in the gold market over the past century or so.

That’s how it long has been. But that is not what is happening today. The month-ago price surge happened without Western gold buying. There is no noticeable gold excitement in Western markets, in media or the stock market (gold stocks are doing fine but certainly are not rocketing up).

So this month-long gold move is different. But the setup has been developing for two years.

I’ve talked a lot over the years about the tight inverse relationship between the price of gold and the real interest rate. This chart shows it well – for decades, gold gained when real interest rates were falling and gold fell when real interest rates were rising.

But that tight, reliable relationship fell apart two years ago. Through 2022 and 2023, real interest rates (the fed funds rate minus inflation) mostly ran higher, often sharply, but the price of gold did not fall, instead holding its ground and occasionally rising.

I’ve been watching this disconnect and wondering why it was happening. I had already concluded that Western investors must have become less important in gold, because it’s Western investors who created this connection. As Jan put it, Western investors buy gold when growth is slow or uncertain and when inflation is rising, which are precisely the conditions that create falling real rates.

So I had concluded Western investors have become less important…but I hadn’t definitively determined who had replaced Western investors in driving the gold price higher.

This is where Jan’s article fills the gap.

Jan starts with the World Gold Council’s numbers on central bank gold purchases.

This chart shows reported central bank gold purchases in red and total central bank gold purchases in blue. The difference is gold that central banks bought but did not disclose (and did not allow the WGC to disclose).

It’s clear that undisclosed central bank gold buying ramped higher starting in mid-2022. This is a trend I’ve highlighted before as one of the key reasons that the price of gold held up so well despite the rate hike cycle.

Why is undisclosed gold buying increasing? De-dollarization and de-deglobalization. These ideas have been around for a long time but they become real, current factors with COVID and the invasion of Ukraine. COVID laid bare the risks of our global supply chains, amplifying a concern that had already been on the rise with protectionist policies and resource nationalism. And the Ukraine war had two important impacts: it amplified the weaponization of the US dollar and it turned an east-west fracture into a chasm.

The thing is, those reasons do not explain why central bank gold buying would shoot higher so dramatically in mid-2022. They might carry a gradual increase in central bank gold purchases, but not an overnight tripling, with most of it suddenly undisclosed.

The reason Jan’s article is getting so much attention is that it answers this question. Jan says he was told by two sources that 80% of the new, undisclosed central bank gold buying is from China.

He then created charts of gold buying by the PBoC by talking 80% of the undisclosed buying from that World Gold Council chart and adding the purchases PBoC discloses. Here’s the result.

When I first read Jan’s article, I was skeptical. It seemed too convenient that the very patterns that substantiate his argument only exist because of this 80% assumption. And he is upfront that it’s an assumption, based on information from two sources.

But after examining the data from all angles , asked for others’ insights, and trying to come up with alternate explanations, I ended up deciding his 80% assumption is reasonable, for these reasons:

1. Jan originally wrote this article about China driving the gold move without the 80% assumption. He based that initial argument on the clear absence of Western buying, visible data on gold import/export levels from the UK, Switzerland, Hong Kong, and India, and changes in the relationship between the price of gold and the premium paid for gold in Shanghai (long an inverse relationship – premiums fall when gold price rises – but not inverse in the last two years). He then updated the article last week when he got this ‘explosive’ new information that PBoC is responsible for 80% of the undisclosed central bank buying.
2. Jan has been one of the leading experts on the China gold market for almost a decade. He knows the market and has a lot of connections. It’s absolutely reasonable to think he knows two people who know what the PBoC is doing.
3. Who else is doing all the undisclosed central bank buying? The increase in buying was sudden and sharp. It is more likely that stemmed from one central bank than from multiple central banks, unless they all decided covertly to suddenly start buying way more gold…but why would they do that? And even if it were several countries deciding together to really lean into gold, the overall conclusions would stand because what other countries have the cash to buy so much gold and could suddenly start spending so much public money on gold without telling their populations? No Western countries; only Middle Eastern and some Asian countries. So even if Jan’s intel is off base and the surge in central bank gold buying is actually coming from several nations, the conclusion still stands that control of the rising gold price has moved, at least in this moment, from west to east.
4. The price of gold has diverged from the real interest rate and that needs explaining.
5. The price of gold is rising without any noticeable gold excitement in western markets, so it’s not western buying that’s moving it up.

So I don’t see a lot of problem with Jan’s argument. It answers questions that otherwise remain perplexing, I can believe he has sources that would know what the PBoC is doing, and the overall thesis that gold is being pushed higher today by eastern buying, not the usual western push, likely stands even if 80% by the PBoC isn’t totally accurate.

The only problem I end up having with the article is in his conclusion. Here I’m getting into the weeds…and giving you some insight into my degree of skepticism! He concludes with his assessment of why the PBoC is doing this. His general thesis is similar to mine: PBoC is stockpiling gold in the face of de dollarization and de globalization.

But he reaches a very specific conclusion that I don’t support: that the PBoC’s biggest concern is that the US is going to let inflation run rampant as their escape from the debt spiral. Inflate away the debt, as this option is often described.

I do not think this will happen. It is politically untenable – voters would revolt – and it also only works if you get real hyperinflation. Imagine this: even 8% inflation (!) for ten years would only cut the debt in half, and that’s only the current debt, without accounting for all the new debt that would get added over that decade.

There isn’t enough political will for a solution that’s only that effective. I just don’t see any politician choosing that. Instead, I see a lot more can kicking: keeping the debt load crazy high and managing it through negative real rates. As my friend Brien Lundin wrote to me in a recent email: “The value of the dollar has to depreciate (inflation) more quickly than the rate of interest on the debt. If real rates run positive, then the debt spiral accelerates and bad things happen.”

Usually, a conclusion pointing to negative real interest rates being the norm going forward would have me excited about the potential for gold…but now that rates-gold relationship is broken!

This brings me around to a bigger concern, not with Jan’s article but with gold in general: what will make Western investors care about gold stocks? Western investors are not needed to move the price of gold higher, but they are needed to move gold stocks higher. And so far they are not particularly interested in gold’s ascent.

If it is price-insensitive buying by the PBoC that’s held gold up in the last two years and driven it higher in the last two months, then the price of gold will continue to be strong as long as that buying persists. If the price rises notably from here, at some point gold will be shiny enough to attract investor attention away from the many other investment arenas that are handing out strong returns. And such levels gold stocks will also start showing up on traders’ screens as insanely cheap relative to their cash flows or profits, which would also pull some attention to this sector.

Perhaps I’m too skeptical. I might just need to have more faith in the attractiveness of the yellow metal when it starts to shine. What do you think?