When in 2008 Gold Fields Minerals Service announced that China finally caught up with South Africa as the world’s leading gold producer, the broader market largely shrugged off the news. After all, with the barrage of all the bull stories about China, a fatigue had already set in. Who cares about yet another story of record-breaking victories by Beijing? From the stellar growth statistics and mind-numbing percentage of investment to GDP ratio, through the exploits of underage gymnasts at the Olympics to the abysmal depths of environmental degradation, China had long outstripped rivals in the races of its choice. But gold production? Why bother? And what does this mean for the global supply and demand balance anyway?
Arguably, the gold market’s observers could not meaningfully counter this general indifference to the news of South Africa’s displacement by China. Far away from the white wine-sprinkled parties at Vergelegen’s Indaba parties near Capetown, Chinese gold mines have long retained an aura of virtual invisibility for all but the bravest of gold analysts. Even giant Zijin Mining’s inscrutable accounting and ludicrously self-glorifying website are of little help to outside observers of what is certainly China’s most successful gold company to date.
The question of China’s contribution to global gold supply and demand is, however, pertinent. China’s role in the international gold supply is very different from its economy’s well documented overcapacity in, say, cement, aluminum or steel. In fact, should the Chinese gold market be completely open, the developments of the last decade could be considered unequivocally positive for the gold market. China’s gold production increased by an impressive 41% between 2000 and 2005, but then it has ebbed and during the second half of the decade, its cumulative growth has been “only” 18%. Meanwhile, after years of consuming a paltry 200t of gold (or 15g per capita), the country’s role in gold demand suddenly jumped by 26% between 2000 and 2005 and a further whopping 55% in the last 5 years. As a result, in 2008, Chinese mines produced 288t of gold, but its consumers purchased nearly 400t of the product. The fact that in the meantime China has become the number one producer has more to do with the slow, but terminal demise of South Africa’s deep level mining. The country which 30 years ago accounted for over 55% of global production has now shrunken in importance to less than 10%.
And yet, China will never be able to usurp South Africa’s fading leadership in the gold market. There are at least three reasons for this: one geological, one historical and one economic. Geologically, the reefs of South Africa’s Witwatersrand Basin are unique in the world, sloping at 25 degrees to the depth of 5000m and counting. There is no other such continuous system known in the world. In the landmass coexistent with today’s PRC, there are several gold-prospective areas, with the quartz-vein systems in Shandong being the most renowned. But neither in Shandong, nor in the traditional gold mining zones of Henan, Fujian and Liaoning, or in the ever-promising regions of Heilongjiang, Yunnan or Xinjiang is there a large enough system to compete with the longevity and scalability of the mines in South Africa, Nevada, Russia or in the Andes. Still, the geology is not the only reason why China’s largest gold mine barely ticks at 200koz per year.
Witwatersrand Basin has been continually exploited since the discovery of an outcropping near Johannesburg in 1886. The very character of the labor-intensive and capital-intensive stoping required long-term planning and dividend-paying, ‘value’ vehicles available for UK and US investors. On the other hand, for many years China’s gold production remained a state secret. It went through the convulsions of various forms of state-, army- or collective ownership. The deposits were never optimized by proper drilling as the mines were built prematurely in order to provide financing for the social infrastructure on the surface. Even the most prospective quartz-vein deposits in gold-rich Shandong province were wasted in this way.
The third reason to be skeptical about the role of China’s fragmented mining industry as a game-changing factor the gold market is its relative insularity. For all the successes of the Chinese IPOs in Hong Kong (including IPOs of several gold companies), China’s gold mines are not allowed to export their product directly overseas. Instead, their doré is sent to Chinese refineries, a growing number of which are recognized by London Bullion Market Association and offer “good delivery” bars. Essentially, this means that despite the much-heralded activity of Shanghai Gold Exchange, much – if not all – of the gold mined in China remains trapped inside the country. For as long as the physical demand outstrips primary supply this does not seem to matter much. The role of Hong Kong’s secondary market should not be underestimated as a natural safety valve and, as a result, Chinese consumers have not been forced to pay premia over the global price – an unhappy experience recently endured by Vietnamese consumers.
Finally, the role of China’s central bank remains critical for the physical offtake from the domestic market. PBOC remains the chief regulator of China’s gold market, which is not surprising in the context of the country’s closed capital market. However, the central bank conflates the roles of a regulator and market participant. Early this year PBOC admitted to having increased its gold holdings by 454 tonnes over the previous 5 years. This volume is equivalent to 35% of the average annual production from the country’s mines during this period. Whatever the central banks’ comments about the “bubble” in the gold price, PBOC remains a key participant in the demand for the yellow metal – a form of hard currency that China can actually produce.
Despite its considerable aggregate size, China remains a inconsequential supplier of gold. The country’s role as the metal’s consumer appears a lot more relevant – a fascinating topic we will return to in future.
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