Shanghai ETFs flop, premiums plummet: China simply cannot absorb wave of gold selling

The emergence of the gold ETF industry has been a big factor in gold's uninterrupted 12-year bull run, because ETFs make it so easy to invest in the yellow metal.

When the first gold-backed ETF was introduced in Australia in 2003, the price of gold was around $320 an ounce.

This week gold-backed ETF holdings fell to the lowest levels since May 2010 – a staggering 653 tonnes worth of redemptions since December 2012.

The outflows equate to more than $60 billion wiped off the value of the world's more than 140 gold-backed ETFs.

The selling has been cited as a major factory factor behind gold's dramatic fall this year.

The conventional wisdom has been that everything investors are selling in the West is being bought in the East.

Stories about Chinese housewives going on 300 tonne bullion shopping sprees, Indian gold lovers swamping jewellery stores and Vietnamese traders willing to shell out $150 more than the ruling price to get their hands on precious metal, followed gold's dramatic April decline.

There was talk of a structural transformation of the global market for gold with Asia sparking a new bull run.

But there are limits to how much gold Asia can absorb.

This week China's first gold-backed ETFs to list fell way short of expectations.

The two funds attracted $195 million and $66 million on the Shanghai Stock Exchange respectively, enough to buy around six tonnes of gold. The asset managers were "conservatively" targeting more than $800 million Bloomberg reports:

Buyers who snapped up jewelry, coins and bars in April when bullion slipped into a bear market, are holding back now as prices fall further and as government bonds offer higher yields, according to China Galaxy Securities Co. China is top producer and second-biggest consumer of the precious metal.

“Enthusiasm is ebbing with prices dropping further than people expected when they bought in mid-April,” said Zhang Yifan, a strategist at China Galaxy in Shanghai. “Most of them now are taking a wait-and-see attitude before committing to buy any more.”

Another indication that demand in China is not as robust as hoped is evidenced by the premium traders on the Shanghai Gold Exchange are willing to pay for the metal.

Before April's dramatic $200 fall to $1,400 over two trading days SGE premiums stayed below $10 an ounce, but then shot up to more than $20. Gold's second gap down in late June to $1,200 following Bernanke's comments about QE saw Shanghai premiums top out at $37.

In a research note on Friday, South Africa's Standard Bank said the premium Chinese investors were willing to pay has now fallen back to $22, down a fifth just this week, adding that physical buying is "especially thin on approach of $1,300/oz."

Buyers in India  have also stopped coming to the party.

Historically the globe's number one importer of gold,  the country's imports are now predicted to fall more than 29% in the second half of the year to 372 tonnes compared to the first six months of 2013 as bargain hunters exit the market.

The Indian government is also trying everything to discourage its people from buying gold. And it seems to be working.

Authorities have hiked the gold import tax from 2% to 8% and at the same time adjusted the way it is calculated to make bullion more expensive, banned traders from importing gold on margin and even barred consumers to buy on an instalment basis with credit cards. India may stop state-run entities which are huge players in the market from importing gold at all.

On top of all this, Indians also have to cope with a rupee that continues to hover near record levels, negating much of the impact of cheaper dollar gold.

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There is another theory out there put forward by Ned Naylor-Leyland of Quilter Cheviot Investment Management which says the relatively rare occurrence of backwardation in the gold futures market means that physical demand is about the overwhelm the over-leveraged bullion banks and an imminent short squeeze of epic proportions will send prices soaring again. Click here for more.

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