Two reasons why China’s demand for gold looks set to rise

Julie Brownlee, Fsp Invest, 06 May. 2014

Tags: gold, china, chinese demand for gold, gold demand, industrial demand, dollar, currency, demand for gold, foreign exchange reserve

China is now the top consumer of gold. This means that what China does with gold has a bearing on the gold market. A growing middle class and strong demand for gold jewellery are a couple of the reasons propelling China’s demand for gold higher. But there are another couple of factors adding to China’s demand. Let’s take a closer look at what these are…

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Factor #1: Growing industrial demand for gold

Industrial demand takes second place behind demand for gold jewellery, but it’s certainly growing. As China’s GDP grows, so will its industrial demand for the yellow metal.

The World Gold Council (WGC) says the main source of this industrial demand is in the electronics industry. Mobile phones, computers, circuit boards and the vehicle industry use gold.

Gold may seem like an expensive option, but sometimes there are no suitable replacements. And as the WGC highlights, when performance or safety are at risk, you need to pay for gold.

Factor #2: China is diversifying away from the dollar

Last year, China had $3.8 trillion in foreign exchange reserves. As you can see from the chart below, this is a huge increase from the 90s.

Chart of China's foreign exchange reserves

So how does China’s foreign exchange reserves drive gold demand?

The WGC says that most of the growth in China’s reserves has been in dollars. In the past, China bought US debt securities, Frank Holmes in Money Morning US explains.

But since the financial crisis struck and the US Federal Reserve started pumping billions of dollars every month into its economy, China has been reducing its exposure to the dollar.

Bud Conrad, chief economist at Casey Research, says that back in 2000, 55% of all foreign exchange reserves were in dollars. Now that’s down to 33%. He predicts that figure to be down to 20% by 2020.

China is following this global trend.

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Why gold is the perfect foreign exchange reserve

Gold is a hard asset. And this makes it the perfect prime currency choice for China.

As the WGC says, gold can’t “be created out of thin air at the whim of central banks. Nor can it be manipulated for the benefit of its issuer”.

So there you have it, two reasons why China’s demand for gold looks set to rise.

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