China's Gold Purchases Another Wild Card in Market
June 8, 2009 by Brien Lundin
It wasn’t long ago that I was noting how the Federal Reserve’s sudden embrace of quantitative easing, combined with the orgy of spending in Washington and international calls for the usurpation of the dollar as the world’s reserve currency, had sent gold soaring.
In more recent days, the trend has accelerated. This time, Washington’s increasing involvement in the economy, and the politicization of American business, has sent overseas investors fleeing the dollar. Capital goes where it is safe and well-treated, and right now there are safer alternatives than the U.S. for foreign capital.
In short, investor sentiment has shifted from fear of financial collapse to fear of rampaging inflation and a dollar collapse. And gold has been the beneficiary, as it has taken off on a dizzying rally back toward $1,000.
While the long-term picture for gold remains very bright as the global supply of fiat currency is multiplied over the coming months and years, there has been another recent development with important implications not only for gold, but the entire world. To wit: China has announced that it has been secretly buying gold since 2003.
In an interview published by the official Xinhua news agency, Hu Xiaolian, head of the State Administration of Foreign Exchange, revealed that China had purchased 454 tonnes of gold since 2003, raising its gold reserves by about 75 percent, from 600 tonnes to 1,054 tonnes.
That ranks China fifth in official gold holdings among nations, although the IMF and the SPDR Gold Trust ETF (GLD) still hold more than the Middle Kingdom.
The gold bulls seized upon China’s revelation as having tremendous bullish implications for the metal.
After all, the nation increased its gold holdings by three-quarters, siphoning hundreds of tonnes from the market. But the gold bears were quick to assert that China’s gold purchases weren’t a big deal, since their foreign currency reserves grew at about the same pace. As a percentage of its overall foreign reserves, gold stayed virtually constant from 2003 to today, averaging around 1.6 percent to 1.7 percent.
I think both sides are missing the point here. The significance of China’s purchases is more bullish than the bears would admit, and less dramatic than the bulls would like. In short, the importance of China’s admission isn’t what it has done, but what it can now and likely will do in terms of gold purchases.
Prior to this announcement, analysts could only guess as to China’s intentions as far as gold purchases. Many bulls hoped the nation was buying, many bears dismissed the idea… but no one simply assumed that China’s inscrutable leaders were accumulating gold along with U.S. dollars.
Now that they’ve come clean, the outlook for global gold supply and demand is fundamentally changed, for a number of reasons.
First off, when you take this announcement in context with the recent, repeated calls by China’s leadership for the ouster of the dollar as the global reserve currency, it seems likely that the stage is being set for a reduction of their dollar reserves in preference for, well, gold.
The upside posed by such a development is significant, but not earth shattering. It’s true that Western nations hold an average of 15 percent of their reserves in gold, and an increase in China’s gold allocation to that level would set the market afire. But, from a practical standpoint, that just won’t happen, at least not in anything short of a glacial time frame.
China simply couldn’t buy gold in the quantities, or at the prices, appropriate to lift gold to 15 percent of their reserves. Still, it appears that China’s leadership is quite motivated to reduce their dependency upon the U.S. dollar, and increase their holdings of gold and other tangibles.
In fact, if there is any open secret regarding official Chinese purchases recently, it is their stockpiling of strategic commodities, particularly copper. Copper prices have benefited greatly from China’s aggressive purchases this year.
One can rightly ask, is gold next on the shopping list? And has the official chatter regarding gold and the dollar simply been Beijing’s warning to Washington and the rest of the world of what is coming?
Good questions. And we’ll get the answers when China wants us to get them, and not before. You can bet any announcement will come after their major purchases are done.
A second interesting point regarding China’s purchases is that all of the supply/demand analyses of the past six years have been wrong. Because China’s purchases were unknown, and therefore couldn’t be credited to that nation or official purchases in general, other demand categories were credited with the 454 tonnes China was buying.
Hu stated that the purchases came from domestic production, but it seems likely that some significant percentage had to come from outside the local market. Regardless, assuming that aggregate global supply and demand figures over the time period are accurate, then it makes no difference whether the purchases came from gold inside or outside China’s borders.
So we can assume that global jewelry and investment demand totals since 2003 weren’t as high as originally envisioned — because we can subtract 454 tonnes, in some mix, from these categories.
One can argue that this is bearish. I’ll take a more optimistic viewpoint: It shows that these demand sources have been less significant so far, and therefore have more room to grow.
And if China’s purchasing program accelerates, or even if it remains constant, then increases in other demand categories will have a much more pronounced effect on the overall market.
All in all, it has to be encouraging that China has been buying gold, and is likely to continue doing so, while the nation publicly bashes the dollar.