The New China and Gold

London (Nov 15)  We have not analyzed the publications of the World Gold Council for a while. Let's make it up, starting with the newest edition of Gold Investor. The report is about China and its remarkable transformation in the context of the gold market.

Indeed, at the turn of this century, China was a minor player in this market. While today it is both the world's largest consumer and producer of gold, accounting for 23% of total gold demand and 13% of total gold supply. However, there are still opportunities for further development, as the investor base is too narrow, while the market infrastructure and regulations need to improve.

According to the publication, Chinese investors should optimally allocate to gold about 6 percent of their portfolios. Such an allocation would reduce the volatility of the portfolio, increase the Sharpe ratio from 0.46 to 0.54 and still keep the target return of 5% The reasons for holding gold are widely known, but let's mention them: it's a portfolio diversifier (it has low or negative correlations with other asset classes), it's an alternative currency, and it has no credit risk. Moreover, gold market is deep and liquid.

There are many concerns about the future growth of China's economy. In particular, people worry about the country's debt to GDP ratio is around 250 percent, clearly too high for an emerging market. Zhou Hao, Associate Dean at Tsinghua University PBC School of Finance, interviewed in the publication, dismisses these fears, pointing out that China is still growing at around 6% a year, so that ratio may be more sustainable than people think. Also, he argues that the central government has enormous foreign exchange reserves, while households are not highly leveraged.

We are more skeptical than Hao. True, the economy is still growing, but that growth is partially possible exactly thanks to incurring more debt. Life on credit is not stable.

Especially that, contrary to Hao's words, Chinese consumers have accumulated a lot of debt recently. Just look at the chart below. As one can see, China's household debt-to-GDP ratio jumped from almost 40 percent in 2016 to almost 50 percent in the first quarter of 2018, reaching a record high.

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