LAWRIE WILLIAMS: Best Answer Yet to Great SGE Gold Withdrawals Anomaly?
There has been very considerable disagreement between the levels of Shanghai Gold Exchange gold delivery figures and assessed Chinese gold demand as estimated by the mainstream precious metals analytical consultancies. The figures have been diverging and the latest differences are enormous with SGE gold withdrawals this year running at more than double the analysts’ assessments of Chinese demand. As we have pointed out beforehand, the basic difference is in the classifications of what the analysts take into their demand calculations – it would otherwise be remarkable that the differences would be so consistent within diverse analytical consultancies – so who is right?
Various suggestions for the differential have been forthcoming, but none have to our eyes seemed to account for the huge discrepancies and all seem to smack of the analysts coming up with a theory for the differences and then providing the ‘numbers’ to support their theories. However perhaps the best answer to the huge ‘demand differential’ may have been forthcoming in a recent analysis by Bloomberg Intelligence of the huge metals ‘carry trade’ used in China to provide collateral for cheap U.S. dollar loans to then take advantage of high yuan interest rates in China. The differences in interest rates inside and outside are substantial – perhaps 1% for the dollar loans as against 8-12% in shadow banking in the yuan area. Admittedly the Bloomberg published blog on this related to the use of base metals in these transactions, but talking to Ken Hoffman, co-author of the analysis along with Sean Gilmartin, exactly the same systematic usage of metals to provide collateral for cheap dollar loans applies to precious metals as well as base metals – and the figures could be ENORMOUS.
Here’s how it works according to Bloomberg: The metals are used as collateral by perhaps hundreds of Chinese entities to borrow cheap dollars to then buy Chinese yuan-backed high-interest-carrying notes. Again, according to Bloomberg, the Bank for International Settlements reckons this trade may be as much as $1 trillion to $2 trillion – others put it even higher, perhaps double - thus tying up tens of millions of tonnes of base, ferrous and ‘other’ metals. To put these amounts into perspective, for copper about 5-10% of the BIS estimate equates to a full year’s global copper consumption.
Where Bloomberg was coming from in this analysis is that apparent Chinese metals demand as suggested by known global trade statistics is heavily in excess of what has actually been needed to supply the country’s industrial needs and that if and when this ‘carry trade’ or ‘phantom metal’ is unwound it will have a drastic effect on global base and industrial metals prices – and that day could be getting nearer as the yuan is allowed to slowly depreciate against the dollar and China lowers its interest rates to stimulate domestic demand.
The Bloomberg analysis points to the nickel market as one where this may already have occurred following the Qingdao warehousing scandal which prompted the Chinese banks to call in these loans leading to a massive drop in the nickel price. In copper and iron ore the numbers concerned would be hugely higher than for nickel.
And what about gold and silver? Hoffman and Gilmartin’s analysis was aimed to come out ahead of London’s LME Week (this past week) so looked in its entirety at base and industrial metals as that is the area in which the LME (London Metal Exchange) operates. Hoffman, who is Bloomberg Intelligence’s Global Head of Metals & Mining Research, also presented this analysis in opening the ‘Metal Markets in a New Chinese Economy’ seminar at Bloomberg’s London offices so we had the chance to ask him about whether the analysis also applied to precious metals and the answer was a very strong affirmative.
Now one of the big differences between the mainstream analysts’ ‘Chinese gold consumption’ figures and demand as expressed by SGE withdrawals (which the People’s Bank of China’ appears to equate to Chinese demand) is that the analysts’ figures ignore the use of gold in financial transactions, which have been seen as large, but perhaps not to anywhere near the extent suggested by the Bloomberg research into the metals ‘carry trade’. If the precious metals figures are on the same kind of scale as Bloomberg assesses the base metals ones to be then this alone could account for at least most of the huge disparity between SGE gold withdrawals and the analysts’ assessments of actual Chinese consumption. And logically gold would seem as likely a metal to be used as collateral against US dollar loans as any base metal – indeed probably more so.
So what happens if this carry trade assessment is accurate and it starts to unwind? It would lead to an effectively large influx of physical gold into the market place – but to an extent, price-wise these carry trade amounts may have only countered the huge paper gold trades on the other side of the coin. Furthermore the Chinese central bank could well seek to absorb any excess gold which may come onto the market as it does not appear to have an interest at the moment in disrupting the gold pricing status quo, but letting it move at its own pace with a little gentle guidance here and there.
15 Oct 2015