While there are numerous reasons why precious metals prices rise and fall – from supply, demand, manipulation, money-printing, and jawboning – it is abundantly clear that as prices drop, Asian demand has risen rather notably. But what is the reason? Why are Asian ‘people’ and central bankers – most notably China – buying gold now? We suspect the following chart from SocGen provides considerably color when answering that question historically (and more importantly – going forward).
Chinese economic policy uncertainty and gold prices Clearly, huge negative economic developments (tail risks) like a China hard landing are hard to predict. Accordingly, economic “policy uncertainty” (rather than the actual event) is something that our SG Economists have looked at in detail and in particular how economic policy uncertainty influences business confidence and economic activity. The natural question for us, given China’s large proportion of gold demand (and to focus on just one commodity for brevity), is what is the resulting effect of increased Chinese economic policy uncertainty on the gold market?
To measure Chinese policy-related economic uncertainty, we use an index from www.policyuncertainty.com based on a scaled frequency count of articles about policy-related economic uncertainty in the South China Morning Post. Chart 17 shows that increasing and then decreasing uncertainty since 2010 have coincided with gold prices risisng then falling. For most of 2013 the two series appear to be moving in tandem.
SocGen further finds, through co-integration analysis, that there is a causal linkage where gold prices reacted significantly to policy uncertainty.
We cannot predict increases in policy uncertainty in China, but can undertake a simulation using our index and price time series, and simply ask ourselves what a change in Chinese economic policy uncertainty would do to gold prices. The model above suggests that if uncertainty in China jumps 20%, back to the level of August 2011, the flat price of gold should rise by roughly 3%, or almost $40/oz at today’s price levels.
A hard landing in China, with 2% GDP growth, would pull gold higher initially, but even before this, more policy uncertainty would also drive prices higher too.
With uncertainty over whether the PBOC and Chinese government reforms will be upheld or folded on, we suspect this rising uncertainty over Chinese policy is major factor in the safe-haven stacking of precious metals in the last month or two.