No investor could deny that 2009 was a very good year for gold. It shot up from $880 per ounce in end-08 to an historical high of over $1,220 in December. Even though the price pulled back to below the $1,100 level by end-09, it still made its record-breaking ninth consecutive annual gain with a 27 percent surge last year. After such a long bull run, there are still reasons to believe that gold may be up for another gain in 2010, with China being one of the many reasons that support the strong gold price.

It has long been debated whether China should increase its gold reserves in an effort to reduce its US dollar exposure in its foreign reserves. In April 2009, China shocked the market by announcing that it had already raised its gold reserves from 600 tons to 1,054 tons over the period from 2003-2009 through buying in the domestic market and from domestic producers.

However, China's gold reserves accounted for only around 1.5 percent of its foreign reserves, an extremely low figure compared to 70 percent for the US and double-digit figures for the major European countries. In the meantime, US dollar assets still account for 70 percent of China's foreign reserves portfolio.

A growing number of Chinese officials and scholars recently voiced their view that China should increase its gold reserves in a gradual and systematic way. Ji Xiaonan, a senior official at China's State-owned Assets Supervision and Administration (SASAC), said in November that China should boost its gold reserves to 6,000 tons within 3-5 years and 10,000 tons within 8-10 years.

These figures are extremely aggressive, given that China, the world's largest gold producer, had an output of only 282.5 tons for the first eleven months of 2009. According to the World Gold Council (WGC), global mine output for 2008 was 2,415 tons. Even including gold scrap and sales from central banks, the total supply of gold in 2008 was only 3,508 tons, while total demand for the year was 3,805 tons.

Even though Beijing is not publicly showing its interests in gold at the moment, its citizens are. According to UK-based precious metal consultancy GFMS, gold consumption in China went up 12 percent year-on-year to a historical high level of 120.2 tons in the third quarter of 2009, driven by a 30 percent increase in investment demand and an 8 percent increase in jewelery demand. The country accounted for 18 percent of the world's total consumption demand in that quarter, compared to 11 percent a year ago.

Despite a pullback of the price of gold in December, many Chinese remain bullish on the long-term gold price and see the retreat as a good buying opportunity for investment or just to hedge inflation. GFMS believes that China's gold consumption will reach 432 tons in 2009, replacing India as the world's largest gold consumer.

The growth potential for the China private gold market is huge. According to the China Gold Association, China's average gold holdings per resident stands at less than 3 grams per person, much lower than the India average of 15 grams per person, so there is still plenty of room for catching up.

The potential gold purchase by China and other central banks in the emerging markets will undoubtedly serve as a strong support for gold. On the other hand, the easing monetary policy will continue to drive gold higher in the first half of 2010, as chances of a rate hike in the US are slim.

Thanks to strong consumption growth in China as well as the economic recovery in India and the Middle East, gold may retest the historical high of over $1,200 in the first six months of this year amid the easing monetary policy. However, the direction of gold in the second half year will be harder to predict, subject to the exit strategies of the central banks. Our gold price assumption for 2010 is $1,150 per ounce, which is 18 percent above the 2009 average of $974.

Eric Yuen is Head of Research and Becky Yuen is a research analyst at GuocoCapital. Opinion expressed in this article are entirely those of the contributing authors.

(HK Edition 01/14/2010 page4)