China: Gold Before Swine

March 28, 2013 at 09:22

truthing

Should gold traders be paying attention to Chinese pork prices? It may sound outlandish, but new research has uncovered an interesting link between global gold prices and Chinese inflation (which in turn is often driven by pork prices).

Even though China accounts for a quarter of the world’s physical bullion demand, Chinese buying has typically not been considered an important driver of gold prices, especially when compared with other factors like crude prices, quantitative easing, or the strength of demand from India, the world’s biggest gold buyer.

However, there is evidence to suggest that Chinese gold buying does play a role in steering prices, particularly during periods of falling inflation that can lead to a drop-off in investment demand for gold bars in China. Na Liu, head of CNC Asset Management, writes in a recent note that there is a correlation between bullion prices and Chinese inflation:

We have reviewed many Chinese macro indicators to detect their correlation with the gold price, and we are basically brought down to the very basics: the gold price is highly correlated to China’s inflation and real interest rate… This makes intuitive sense. Over the past few years, China’s jewellery demand shows only steady growth. The key driver for demand volatility comes from investment demand, and investment demand was driven by the need for purchasing power preservation and therefore varies as inflation expectation surges and ebbs. Last year, as China’s inflation cooled, gold demand did not increase in China at all.

So what does this mean for gold bugs? Officials have warned that China faces inflationary pressures this year, with central bank governor Zhou Xiaochuan saying this month that China should be on “high alert” against inflation. Inflation for the first two months of this year came in at 3.2 per cent, its highest level in 10 months.

The fear is that inflation could be pushed even higher by rising prices for pork, which is heavily weighted in the consumer price index because it is so widely consumed. As Rahul Jacob noted on beyondbrics, pork prices are expected to rise sharply this year, by as much as 16 per cent according to some estimates. If that happens, it could be good news for gold bugs.