China Gold ETF Investing

Written By Briton Ryle

Posted June 12, 2013

If anyone thinks gold buying in China is slowing, think again. China has just approved not one but two gold-backed ETPs (exchange traded products) this week.

As gold holdings in other ETPs around the world have fallen, China may be moving in to soak up the outflow. China is on the hunt for gold, and this could drive prices higher in the near future.

China’s New Gold Funds

The China Securities Regulatory Commission gave two Chinese companies – Huaan Asset Management Co. and Guotai Asset Management Co. – permission to list yuan-denominated gold funds on the Shanghai Stock Exchange (SHCOMP), which will track spot gold on the Shanghai Gold Exchange. This seems to be intended to protect these two gold funds from gold ETF volatility in other parts of the world.

Another purpose for these funds is to give Chinese investors a cheaper and safer alternative to coins and bars which are heavily laden with commissions and premium given the current buying frenzy in China.

“Gold ETFs should help boost gold demand as they will make Chinese investments in the bullion much easier,” Zhang Bingnan, secretary-general of the China Gold Association, informed Bloomberg. “The dumping recently of holdings in gold exchange-traded products by overseas investors may not prove to be a wise move.”

Bingnan is absolutely right about that. Whenever a rapid sell-off pushes a product into deeply extended oversold territory, the smart money ends up buying what the foolish money is panicking to unload. China is outplaying the rest of the world in gold investing as it buys what the rest of the world is carelessly tossing out, and these two funds will make that move ever more pronounced.

China Wants In Now

While China’s gold consumption in 2012 was estimated by Thomson Reuters GFMS at 776.1 metric tons, total global gold ETP sales in 2013 so far have reach just a few units shy of 500 tons.

As long as so much selling continues, it is doubtful China’s new gold ETFs will have much of an impact on the gold price. “I don’t think this product will help bring back the gold fever we saw five years ago,” Mathieu D’Anjou, senior economist at Desjardins Economic Studies doubted to Forbes.

But what these funds will do is help Chinese investors get in before prices rise, now that the risks are the lowest they have been in years.

“We think the timing is pretty good after the recent decline because gold prices have got close to the cost of production, limiting downside risks,” Liu Jianqiangat, spokesman for Huaan Asset Management, explained in a Bloomberg interview.

The average all-in production cost among the majority of gold producers is estimated at $1,200 to $1,250 per ounce. This includes such costs as labor, land leases, taxes and royalties imposed by local authorities, etc. With gold at around $1,375 as of Tuesday’s close, there isn’t much mark-up left that can be squeezed out of the price.

This production cost serves as something of a safety net underneath the gold price, making further sharp falls from here less likely. Should gold fall to or below that average production cost, miners would scale back operations. Not wanting to sell at a loss, they’d be better off just leaving the ore in the ground until higher prices come back around – which would come quickly on the back of a curtailed supply.

Is Now A Good Time For You?

If the cost of production is indeed putting a floor under the gold price, might this be a good time for average investors to jump back into gold?

Taking into account the reaction of gold to even the slightest good news, with oscillations of $25 to $30 on any given day, it seems as though a bottoming may be taking place. High volatility is usually a sign that more and more traders are changing their minds. They are not as unitedly bearish as before, with more bears transforming into bulls by the week.

Another buy signal is the still pessimistic tone toward gold. A headline on Bloomberg Television overnight stated, “Gold slumps as investors weigh stimulus curbs”. My question is: What stimulus curbs? The U.S. has not curbed. Japan has not curbed. I do not know of any country in the world that has reduced any stimulus measures.

Economic reports are not strong enough to warrant reductions in stimulus, let alone any cessation. Economic weakness persists, government stimulus remains, and physical purchases by central banks and investors continue at near-record levels.

So, then, does the gold bull still have some life left? The camp is divided. Bears points to the absence of inflation as a reason to sell gold, while bulls point to the absence of strong economic data as a reason to buy, given the assurance of continued stimulus and low interest rates.

Moreover, though inflation may not yet be here, currency devaluation is. Gold is always affected by currency weakness first, then by inflation.

The common recommendation analysts give gold traders is to consider gold producers with substantial reserves which they can readily tap into once the gold price recovers. But they also need to be earning substantial profits now to ensure continued expansion then. The four top ranking profit generators among gold producers are:

                                       2013 YTD Profit                                      Reserves
Freeport McMoRan (NYSE:FCX)                          $3 Billion 32.5 million
Newmont Mining (NYSE:NEM) $1.8 Billion 142 million
Goldcorp (NYSE:GG) $1.7 Billion 81 million
Newcrest Mining (ASX:NCM.AX) $1.1 Billion 205 million

Remember the importance of cash flow. New mines are expensive to build. Excess profit and cash enable the continued tapping of reserves, which keeps the profits rolling in.


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