China may have 1,000 tonnes of gold tied in financing : World Gold Council

Singapore – Chinese firms could have locked up as much as 1,000 tonnes of gold in financing deals, an industry report said, indicating a big slice of imports has been used to raise funds due to tight credit conditions, rather than to meet consumer demand.

The financing-related buying in the world’s top gold consumer means prices could come under pressure if imports are hit by a broader crackdown on using commodities for finance.

The report – issued by the World Gold Council (WGC) on Tuesday – and other sources in China said gold was not as widely used for raising money as copper, which saw prices drop to a 3-1/2 year low in March on fears that those deals would unravel.

“Imported gold is being used via gold loans and letters of credit (LC) to raise low cost funds for business investment and speculation,” the report said.

“The use of gold for purely financial operations is a form of demand that represents a small part of the much wider growth in shadow banking. It is feasible that by the end of 2013 this could have reached a cumulative 1,000 tonnes.”

That accounts for almost a third of annual global production and is worth about $43 billion at current prices.

The estimates come from Precious Metals Insights, a Hong Kong-based consultancy commissioned for the survey on China.

“If that number is accurate, it is significant because an unwind of that is equivalent to a year’s worth of (Chinese) imports,” said Victor Thianpiriya, an analyst at ANZ Singapore.

“Having said that, it’s unlikely that it would flood the market in one go, and over time I think there is enough demand in China to absorb it.”

The practice of importing gold simply to raise funds is being conducted by wealthy individuals and firms for cheap short-term financing either for business or speculation to circumvent capital controls, the WGC report said.

It can be used for real estate purchases, or to speculate in higher yielding assets, and interest rate or currency arbitrage.

Other than using gold only for funding needs, the metal is also used widely by bullion producers and jewellery makers as collateral for loans.

Most of the gold in financing had been built up since 2011, the report said, with borrowers typically hedging the gold risk.

Data from Hong Kong shows that China’s gold imports started rising dramatically from 2011.

“We think that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 to 2013 (from below $5 billion to roughly $70 billion) is most likely driven by gold financing deals,” Goldman Sachs said in a note in March.

The WGC report forecast Chinese gold demand would grow by 25 percent to at least 1,350 tonnes by 2017, though growth in 2014 could be limited after record amounts of buying last year.

NOT AS BIG AS COPPER

Chinese firms have been using various commodities to obtain credit after restrictions on traditional sources. Copper, iron ore, rubber, soybeans are all being used alongside gold.

China has up to $160 billion of outstanding loans using commodities as collateral, about 31 percent of the country’s short-term foreign exchange loans, according to Goldman Sachs.

Last month, copper and iron ore prices took a hit on concerns that an increasing crackdown on such financing models could release a huge amount of stock into the market.

Goldman estimates that up to 1 million tonnes of copper and 30 million tonnes of iron ore is tied up in financing deals.

“I do not think there is large scale gold trade-financing deals like in copper,” said Jiang Shu, an analyst with Industrial Bank, one of the few gold-importing banks in China.

Import quotas and a limited number of banks allowed to import meant gold would not be a popular choice for commodity financing deals, he added.

The People’s Bank of China (PBOC) strictly controls gold imports through quotas, with only 12 banks allowed to import.

China imported a record 1,160 tonnes of gold from main conduit Hong Kong last year, in addition to about 428 tonnes of local production. The WGC has said Chinese demand in 2013 was about 1,066 tonnes, leaving the industry guessing about the “surplus” of about 522 tonnes.

The report said that the surplus in the market could either be from official sector purchases such as central bank buying or the extensive use of gold for financial operations.

“While there is some uncertainty about whether there have been official purchases of gold in the domestic market, such doubts do not exist when it comes to the large-scale use of gold for purely financial operations in China,” the report said.

“Unless either the PBOC cracks down more severely and effectively on commodity financing or the credit allocation and pricing system in China is improved, substantial amounts of gold may continue to be imported and tied up in financial operations.”