Gold has always been a safe haven asset, but in the Asia-Pacific region, particularly China, demand has risen to unprecedented levels. With China as the leading consumer and producer of gold, the central bank's accumulation of gold reserves is a response to domestic economic challenges, including the real estate crisis, the weakening yuan and stock market volatility. These factors, together with rising global geopolitical tensions, are pushing the price of gold higher and higher.
In this context, the relationships between gold and other economic factors are changing. The divergence between rising gold prices and falling ETF flows has surprised analysts, raising questions about market dynamics. If you want to know how Asia-Pacific and, in particular, China are transforming the global gold market and what it means for investors, this article offers an in-depth analysis of current trends and future prospects.
In this context, the relationships between gold and other economic factors are changing. The divergence between rising gold prices and falling ETF flows has surprised analysts, raising questions about market dynamics. If you want to know how Asia-Pacific and, in particular, China are transforming the global gold market and what it means for investors, this article offers an in-depth analysis of current trends and future prospects.
The origin of gold and its significance in the region
Gold is said to have been the earliest recorded metal employed by humans. It is still unclear when and where this precious metal was first found, but historical evidence illustrates its profound significance for thousands of years.
The Indus Valley civilization, part of the Ancient Indian civilizations, was one of the first to mine gold in history. In China, gold was used for personal ornaments in the northwest from the 11th-8th century BCE. Meanwhile, the first gold ornaments in Southeast Asia appeared around 400 to 300 BCE in the Philippines, Thailand, and Vietnam.
As of today, gold is deeply rooted in the lives of people. In many countries, the metal is of great importance due to religious purposes and can also be utilized to produce jewelry and industrial applications.
Economics-wise, some APAC countries adopted the gold standard during the late 19th century to 20th century. One of such countries was Japan whose intentions were to modernize the economy and facilitate international trade. Other nations like Malaya (currently Malaysia) and Australia were part of the initiative under the influence of British colonial rules. As of now, the gold standard has ceased to exist, yet thanks to the prestige, gold still remains at the core of the financial industry.
Gold is regarded as a prominent instrument of investment (commonly in the form of ETFs) or savings (as an intrinsic value that is passed down to generations). The keen status can be attributed to three characteristics of gold: a long enough history to gain great confidence from investors, durable enough to be stored long-term, and scarce enough to be traded.
Gold and inflation: Is gold actually a good hedge against inflation?
In the last 50 years, various studies would tend to support the belief that gold is a long-term hedge against inflation. In the late 70s and early 80s, just after the official end of the gold standard in the U.S., USD floating freely and the stagflation crisis brought about the surge in the price of gold. During the same period, a strong positive correlation could be witnessed between inflation and gold prices. However, since the 90s, the relationship seemed to have weakened. For example, in the dot com technology bubble, U.S. CPI doubled, while gold prices remained fairly stable. The slight 18% increase of gold price in late 2000 is more out of investors’ uncertainty about the new millennium than out of the higher inflation.
The relationship between gold and inflation draws controversies, but gold still holds the “safe haven” reputation thanks to several past instances.
Exhibit 1: Changes in the gold price and CPI with a 3% inflation in the last 50 years
Gold mining and Central Banks’ reserves
Although the gold standard has been eliminated, global governments still hold a large amount of gold to battle against hyperinflation and mitigate risk should economic shocks arise.
In 2023, APAC countries maintained their dominance at the forefront of global mine production, with China leading the pack as the top producer. The nation’s Central Bank was also the largest buyer of gold in 2023, adding 225 metric tons to its safe and bringing the total to 2,235 metric tons.
Exhibit 2: Top 10 mine producers in 2023
General beliefs about the relations between gold and other main economics drivers
Another widespread belief is gold price and interest rate are directly inversely proportional. Higher interest rates make fixed-income investments, like bonds, more attractive, thus causing money to move from gold to other instruments that have a higher yield. However, this belief is not backed by any empirical evidence.
It is the stock market that is more likely to suffer from the rising interest rates and consequently impacts gold. In fact, increased interest rates almost always force investors to rebalance their portfolios to lean towards bonds and under such circumstances, companies’ expenses also grow, further pushing the equity market bearish. In this situation, gold is the first alternative that comes to investors’ minds. For example, gold prices surged by over 60% between 1973 and 1974 amidst escalating interest rates, coinciding with a substantial 20% decline in the S&P 500 Index.
On the other hand, the USD is believed to have a strong effect on gold prices as gold is denominated in dollars. When the dollar is weaker, buyers using other currencies can purchase more gold, hence raising gold demand and prices.
Another widespread belief is gold price and interest rate are directly inversely proportional. Higher interest rates make fixed-income investments, like bonds, more attractive, thus causing money to move from gold to other instruments that have a higher yield. However, this belief is not backed by any empirical evidence.
It is the stock market that is more likely to suffer from the rising interest rates and consequently impacts gold. In fact, increased interest rates almost always force investors to rebalance their portfolios to lean towards bonds and under such circumstances, companies’ expenses also grow, further pushing the equity market bearish. In this situation, gold is the first alternative that comes to investors’ minds. For example, gold prices surged by over 60% between 1973 and 1974 amidst escalating interest rates, coinciding with a substantial 20% decline in the S&P 500 Index.
On the other hand, the USD is believed to have a strong effect on gold prices as gold is denominated in dollars. When the dollar is weaker, buyers using other currencies can purchase more gold, hence raising gold demand and prices.
Gold prices in light of inflation, interest rates, the stock market and uncertainty in the current environment
As mentioned in the preceding paragraph, gold serves an important role in diversifying a portfolio. In short, investors were able to use it to hedge against very different risks:
- Gold was often used to protect against inflation
- Gold protects investors from the depreciation of the US Dollar due to the inverse relationship. As Gold is priced in US Dollar, if the US Dollar depreciates, Gold becomes relatively less expensive for foreign investors. Hence gold prices rise.
- Gold prices oftentimes show a negative correlation with interest rates. Therefore, prices might increase as interest rates are lowered.
- Gold prices seem to do better in times of economic distress while stock market returns often decrease, showing a negative correlation.
However, recently some of those correlations seem to have weakened and unusual gold price movements are observable regarding these indicators. When inflation started to rise around the world in mid 2021 no increase in the gold price was visible. Even though being in a high inflation environment, gold’s yearly price change amounted to -3.51% and -0.23% in 2021 and 2022 respectively. In addition, even though inflation started coming down again since the end of 2022, we have seen an increase in gold prices of 13.08% in 2023. In 2024 we even reached new record prices despite inflation coming down to 2.4% in the Euro area, 3.5% in the US and even 0.1% in China. It is possible that US investors might see the risk of persistent inflation as the recent decline has been less than expected, however, with the Fed being determined to bring down inflation by keeping interest rates elevated over a prolonged period this rather seems unlikely. Therefore, gold prices recently do not fit the pattern of traditional inflation protection.
Furthermore, normally elevated interest rates would entail a decrease in gold prices as bonds become more attractive. This reverse relationship was visible during 2020 as gold had one of its strongest rallies after interest rates were decreased due to the COVID-19 pandemic.
However, gold prices now climbed to an all-time high in April despite interest rates being on historically high levels in the US and Europe. One could argue that the anticipation of rate cuts is fueling the gold price as eased inflation makes them more likely. This is certainly true for the recent increases in prices but seems less certain for the long run picture as the gold price started rising before rate cuts were easily predictable. In addition, rate cuts in the US now seem more uncertain due to inflation remaining high. Generally, one must consider that inflation and interest rates are not independent of each other and their effect on gold prices will always be interconnected. All in all, gold prices have not evolved as could have been predicted when looking solely at inflation and interest rate data.
Exhibit 3: Gold price vs. Interest Rates
Exhibit 4: Gold price vs. Inflation
The historic relationship between stock market returns and gold returns is less obvious as correlations with different directions are observable, depending on the index as well as the time frame chosen. Nevertheless, oftentimes gold had a strong performance in times of economic distress during which stock market returns were rather limited. It was often seen as a “safe haven” because in times of economic and political distress it performed rather well, except for a short period in 2020. In March 2020 gold prices dropped substantially in face of the COVID pandemic together with all major stock indices. However, as gold quickly recover again and experienced one of its strongest years ever in 2020 it regained some of the lost trust. Even though current stock market returns do not necessarily show signs of economic distress, considering the current market environment uncertainty might be a reason for investors to hold more of their investment in gold. Considering the war in Ukraine, the growing escalation in the Middle East and rising tensions between China and the USA, the geopolitical uncertainty is higher than ever.
In addition, the property crises in China as well as slowing economies like the UK, Japan or Germany may dampen market sentiment further. Therefore, even though there is no negative correlation currently visible between stock market returns and the gold price, some of the rise in gold prices is very likely to be attributed to rising uncertainty.
However, other aspects driving demand and supply, which are less linked to financial assets, must be considered: general supply, gold demand for jewelry as well as for industrial production and from central banks may have substantial effects on gold prices.
In addition, the property crises in China as well as slowing economies like the UK, Japan or Germany may dampen market sentiment further. Therefore, even though there is no negative correlation currently visible between stock market returns and the gold price, some of the rise in gold prices is very likely to be attributed to rising uncertainty.
However, other aspects driving demand and supply, which are less linked to financial assets, must be considered: general supply, gold demand for jewelry as well as for industrial production and from central banks may have substantial effects on gold prices.
Spot gold vs ETF divergence: a look at flows & liquidity
The recent divergence between gold prices and ETF flows has been a curious puzzle for financial markets. Historically, gold ETFs have been reliable proxies for investor sentiment towards gold, where inflows generally indicated bullishness and outflows tended to show bearishness. But this correlation appears to now have notably broken down: gold prices have rallied to new highs, while ETFs have seen substantial outflows. In 2023 alone, gold ETFs saw a net outflow of $7.6 billion, sharply contrasting with the price of gold rising over 10% in the same timeframe and has continued to rise another 10% YTD. Looking more closely at global flows, we can see that this deviation can be primarily attributed to a substantial shift in investor preference towards physical gold purchases, which is not captured by ETF flows.
Historically, gold ETFs have been a popular way for investors to gain exposure to gold without the logistical challenges of physical ownership which also can often come at a higher cost. However, since the onset of the Covid pandemic, there has been a clear change in investor behaviour: they are increasingly choosing physical gold—bars and coins—over gold ETFs. This trend is driven by a few factors, with first and foremost the desire for privacy and the physical possession of assets, which ETFs with their digital nature do not provide. In 2023 alone, while gold ETFs experienced a net outflow of $7.6 billion, the demand for physical gold has been solid, with the most up-to-date data showing purchases totaling $230 billion since the third quarter of 2020. These figures strongly contrast with the ETF data, highlighting the profound shift in how gold is being purchased and held.
There are several reasons for this shift. Firstly, as mentioned above, physical gold provides a sense of security and autonomy in possession that investors do not get with ETFs. In times of global uncertainty or economic instability such as the world has seen over the past 2 years now, owning physical gold offers a hedge that is both tangible and outside the purview of potential regulatory or market constraints that can impact ETFs. This is even more notable in different regions of the world such as China whose currency has been weakening and where both retail and institutional investors do not always have the ease of access to ETF products. Secondly, the transparency that is required by ETFs, often involving regular disclosures and reporting, is seen by many investors unfavorably as they seek anonymity. Lastly, physical gold is viewed as a safer bet against systemic risks and counterparty failures which may affect paper gold holdings.
Beyond the significant increase in physical gold purchases by retail/individual and institutional investors, major central banks have also been big players in bolstering the demand for physical gold. Some of the examples that are more extensively discussed further in the article include the People’s Bank of China (PBoC) and the Polish central bank, which have been accumulating gold to diversify reserves away from traditional fiat currencies like the US dollar, actions that are often seen in times of geopolitical stress or monetary policy conflicts. These flows compared to that into ETFs is shown below:
Exhibit 5: Cumulative gold flows by private investors and central banks
Another interesting theory on potential drivers of gold ETF outflows which has been highlighted by some is that of alternative investment flows into digital assets like bitcoin and their recently launched ETFs. This hypothesis implies that as newer investment opportunities like cryptocurrencies become available, they might attract funds traditionally allocated to gold ETFs. However, when looking at the flows and liquidity into all these products, this theory does not hold up. The launch and subsequent inflows into newly established spot bitcoin ETFs, which saw net inflows totaling approximately $10.6 billion YTD in 2024, largely represent a re-allocation within the cryptocurrency space itself—from less regulated personal wallets and exchanges to regulated ETF products. Overall, this doesn’t necessarily show a diversion of funds from gold to bitcoin but it rather illustrates the broader diversification of investors – not an interchangement between gold and bitcoin ownership. The graphs below illustrate these flows: (1 -left) cumulative gold flows by private investors and central banks; and (2 – right) cumulative bitcoin flow in crypto exchanges since spot bitcoin ETF launch in the US:
Exhibit 6: Cumulative flows into Bitcoin funds and Gold ETFs
Exhibit 7: Cumulative bitcoin flow in crypto exchanges since spot bitcoin ETF launch in the US
Who is buying Gold? The answer lies in the APAC region
The rally of gold, which has recently reached historical highs of around $2,400 per ounce, has been captivating the interest of global markets. The world’s largest consumer and producer of the valuable metal, China, is at the forefront of the reasons for this rally.
Throughout much of recent history, gold has been coined as a safe investment in times of economic and political uncertainty. In fact, recent global factors such as the possibility of a decline in U.S. interest rates, high inflation, and deteriorating geopolitical tensions, such as the recent war in the Middle East and in Ukraine, have been boosting demand for gold worldwide, leading to a substantial increase in its price. However, further uplifting this rally is a robust Chinese demand, as fund investors, the Chinese central bank, retail shoppers, and future traders are pouring money into the precious metal in search for a safe store of value in these distressed times.
China’s central bank has been purchasing gold for its reserves for the past 17 months (including March 2024), supporting the precious metal’s increase to all-time highs. Bullion held by the People’s Bank of China (PBoC), referring to physical gold and silver of high purity often kept in the form of bars, ingots, or coins, reached 72.74 million fine troy ounces in March 2024. In March, the PBoC added 5 tons to its total gold holdings, which now stand at 2,262t, representing 4.6% of its reserves. In total, China’s gold reserves increased by 27 tons in the first quarter of 2024.
According to the World Gold Council, global central banks, led by China and India, have been persisting in increasing their gold reserves in February 2024, marking a 9th straight month of growth. In particular, China’s reserve assets achieved their highest level since November 2015, with foreign exchange reserves reaching $3.2457 trillion by the end of March 2024, the highest since December 2021. In March, Chinese foreign exchange reserves rose 0.6% from February 2024, and stood up 1.9% from March 2023.
Historically, China and India have been considered the world’s largest buyers of gold, with China extending its lead over India in 2023. As depicted in the chart below, China’s bullion consumption grew around 28% from 2022 to 2023, jumping from 218.2t to 279.5t. On the other hand, India’s demand increased from 173.6t in 2022 to 185.2t in 2023, representing a growth of just 6.7%.
Exhibit 8: China vs. India Bullion Consumption
Is there still room for gold demand to grow in China?
Even though China’s economy is projected to keep growing in 2024, China is experiencing a prolonged property sector crisis, a weakening yuan, a volatile stock market, as well as limited investment options due to strong exchange and capital controls. Here is some additional data from Q1 2024 to consider when predicting short-term gold demand in China:
- The SHAUPM (Shanghai Gold Benchmark PM) in RMB (Renminbi) ended Q1 2024 with a 10% gain, outperforming major local asset classes.
- The Shanghai Gold Exchange (SGE) experienced a 124 ton decrease of gold in March 2024, yet the strongest January ever and an above-average February meant Q1 2024 wholesale demand rose to 522t, achieving its peak since 2019.
- China’s gold price premium diminished in March 2024, demonstrating weakened local demand including March in face of gold’s increasing price. Nevertheless, Q1 2024 represented the highest Quarter 1 premium ever at US$40/oz, propelled by a strong physical demand in the first two months of the year. However, considering April 2024, the premium paid by Chinese importers jumped to $89 an ounce at the start of April, compared with $35/oz over the past year and the historical average of $7/oz.
- Chinese gold ETFs sustained inflows, adding $164 million in March and pushing total assets under management (AUM) to record-high of approximately $5bn. Quarter 1 2024 inflows were $386mn, and AUM (in RMB) rose 20% thanks to a substantial gold price increase.
In conclusion, in the coming months we enter the traditional off season for gold during the year, with gold jewelry consumption likely to remain unchanged or even decrease, especially due to the high price gold is currently trading at (closing at 2,332.16 on 25/04/2024). In addition, China’s March 2024 gold data signals weakened local demand, with the 124 ton decrease of gold experienced by the Shanghai Gold Exchange (SGE) and the weakening Chinese gold premium. On the other hand, gold’s strong performance when compared to local assets with a 10% gain of the SHAUPM pushes in the opposite direction, attracting local investors who want to be part of the rally, thus potentially strengthening the country’s demand. Furthermore, sustained global geopolitical tensions and scarce investment opportunities for the Chinese market are also factors that reinforce the increase of China’s short-term gold demand.
In the longer run, with the current expectations of increased geopolitical tensions over the next months, high global interest rates and stickier that expected inflation, the People’s Bank of China potentially prolonging its gold-buying streak, and gold’s stellar local performance in Q1 2024: we can expect these elements to further boost demand for gold in China in the long-term.
By Leo Antlitz, Gianluca Battaini, Orestas Freigofas, Anh Tho Vu
SOURCES
- World Gold Council
- Biblioasia
- NASDAQ
- The Economist
- Invesco
- Investopedia
- Financial Times
- Bloomberg