21 October 2016
Gold's allure as a safe haven is fading as inflation pressure eases and the US dollar strengthens. Photo: Bloomberg
Gold's allure as a safe haven is fading as inflation pressure eases and the US dollar strengthens. Photo: Bloomberg

Why gold price will continue to decline over medium term

Apart from the A-share meltdown, another market news that is getting the attention of investors is the gold crash. The price of the precious metal has tumbled to a five-year low after a massive sell-off this week.

The market has attributed the price slide to its gloomy outlook in the medium and long term. The cost for holding gold is rising as US dollar is strengthening due to forthcoming interest rate hike.

Moreover, inflation pressure is easing across the world, reducing the attractiveness of gold as a safe haven. Technical analysis also points to further downside in the short and medium term.

Last week the People’s Bank of China revealed its gold holdings for the first time since 2009. Its gold reserve has jumped nearly 60 percent to 1,658 metric tons from 1,054 tons in 2009, making the Chinese central bank the world’s fifth largest holder of the yellow metal.

However, the stellar increase has lagged behind market expectations. Bloomberg estimated that China’s gold reserve had soared three times to 3,510 metric tons, making it the world’s second-largest investor of gold. As such, China’s less-than-expected official gold holding has weighed on the price.

There are two things we need to consider. First, why has the PBoC announced its gold holding at this point? Second, is the figure reliable?

China has not published its gold reserve data for six years. The announcement can be seen as part of Beijing’s efforts to push renminbi into the SDR basket.

As the world’s largest gold miner, China has produced more than 2,000 metric tons of gold since 2009. Most of this mined gold has been bought by the government. Also, China’s net gold imports from Hong Kong have increased annually from 2009 to 2013.

Its net gold import through Hong Kong reached more than 1,100 metric tons in 2013 alone. Its net import should stay around 750 tons, although the country imported less last year.

Hong Kong’s net gold export to the mainland has amounted to over 3,200 metric tons since 2009. If we assume that a fifth of that export has been bought by the government, then the government’s imports would be much bigger than the official data.

And we have yet to add the net import from Shanghai Gold Exchange through spot trading.

That being the case, the PBoC should have added far more gold than the 604 metric tons it declared. The official gold reserve has been under-reported.

One obvious reason is that Beijing intends not to push up gold price and increase gold buying costs.

If that is the case, has gold lost its luster as a safe haven? Will gold price never rebound? What is the floor price?

Historical data of cash gold price and oil price shows that the ratio has hovered at an average level of 15.8 barrels. That means one ounce of gold can buy around 16 barrels of oil since 1983.

Currently, the ratio stands at 21.8 barrels. Therefore, the gold price may have further downside of 27 percent to around US$800 if the ratio returns to the average level.

This article appeared in the Hong Kong Economic Journal on July 23.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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