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China's explosive growth is the real reason it is Buying Gold...
IF INTEREST RATES go up, will demand for gold automatically go down?
Other things equal, the answer should be yes. A higher return on cash raises the opportunity cost of Buying Gold, thus dampening demand.
Alas, other things are seldom as equal as economic theory likes to assume, writes Ben Traynor at BullionVault.
The evidence from China, for example, suggests that while higher rates certainly have the potential to dent gold demand, far more important drivers are inflation and growth.
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China's experience may not be typical, but it's certainly worth examining. China is the world's second biggest gold market after India. The latest World Gold Council data show that China accounted for one quarter of global gold consumption by tonnes in the first three months of 2011.
In fact, gold consumption was 47% up on the same period last year, even though interest rates have risen four times since then. Indeed, if you look at the last five years, Chinese gold consumption has pretty much ignored changes in official interest rates:
Six months ago, as the People's Bank of China (PBoC) began a series of rate hikes, market watchers predicted that Chinese gold demand would fall as a result:
- Higher interest rates would "give gold a decent correction", reckoned Frank McGhee, head dealer at Chicago's Integrated Brokerage Services, last October.
- "When you talk about the interest rate rise, you are talking about a tumble in the gold market," Mike Daly, a senior gold broker, said in November.
- "Fears of further interest rate rises in China [would] have an impact on buying," said Citigroup analyst David Thurtell in the same month.
Since these predictions were made, the PBoC has continued to raise interest rates. And Chinese gold demand - measured as total Yuan expenditure on gold - has shot up...along with the Gold Price.
This is not to say interest rate policy has no impact at all. If we look at real interest rates - the nominal rate minus inflation - we can see that higher real rates have tended to coincide with slowdowns in gold expenditure:
So what matters is not the nominal rate of return, but the real rate. When real returns are poor - either because the nominal rate is low, or because inflation is high - people tend to Buy Gold.
Therefore while higher Yuan deposit rates may have a short-term impact on gold demand, if they fail to bring down inflation the effect will be short-lived. And how often does monetary policy do what it says on the box?
