Gold Demand Higher as Driven by China

Crude oil retreats after the rally over the past 2 days. Yet, price continues hovering around 82 ahead of US' inventory report. Concerning dataflow, the market will focus on the ADP and services PMI in the US. The ADP will probably report +36K addition in employment in July after an increase of +13K in the prior month while ISM services Index is expected to have eased to 53.3 in July from 53.8 in June. Any disappointment should weaken oil prices.

In the Eurozone, the services PMI rose to 55.8 in July from 55.5 in the prior month. A composite index surveying purchasing managers in both the services and manufacturing sectors improved to 56.7 in July from 56 in June. In Germany, accelerated growth was also seen in both sectors with the services and manufacturing PMI soaring to 57.3 (June: 54.8) and 61.2 (June: 58.4), respectively in July. However, these data were upstaged by worries over a US slowdown. Stocks in Asia and Europe dropped with the MSCI Asia Pacific Index losing -0.6% and Stoxx600 Index down -0.7%.

Gold price continued to be boosted by China's deregulation in gold market. The benchmark contract touched 1200.2 for the first time in 2 weeks. The liberalization in gold trading should boost both private and public demands, though effect from the latter should be rather gradual.

Yu Yongding, member of the state-backed Chinese Academy of Social Sciences and a former central bank adviser, expressed concerns over the safety of US Treasuries in the medium- and long-run as a 'scary trajectory' of budget deficits and an increasing supply of dollars may depreciate their values. In mid-July, Yu warned that China should reduce its USD holdings to diversify risks of 'sharp depreciation'. While these comments were in contrary with what SAFE mentioned last month that US government bonds have 'relatively good' safety, liquidity, low trading costs and market capacity, suggestions of reserve diversification do trigger speculations of higher official demand for gold in China.

Although China is the world's largest gold producer and the second largest consumer, its gold market is in deficits and it still depends on external sources to satisfy the needs. Currently the Chinese central bank is the 6th largest gold holders, with 1054.1 tons as of June 2010. However, the holdings only represent 1.6% the country's total reserve. If it's to increase its holdings comparable to other Asian counterparts, it will need to increase holdings by almost +50% (eg, Singapore has gold holdings 2.4% of total reserve).

Rising production cost in Australia is hurting profits in the countries' mining companies. As unveiled at the Diggers & Dealers conference, the cost to produce gold in Australia, the second largest producer after China, was running at around $1000/oz, compared with $400-500 in West Africa. Some large producers in the country admitted they are looking for opportunities in West Africa and other low-cost regions. Should gold price fall below 1000, Australian producers are likely to cut production and they should help support price.

From Oil N' Gold Focus Reports

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