In one fell swoop, China profoundly alters gold market synergy
by Michael J. Kosares
We've got a situation where Geithner is smiling and has no choice but to stress the credibility and stability of the US financial and economic system, while the creditors [such as the Chinese] smile back and say they believe him, while at the same time giving hand signals to their reserve managers to get rid of these things [U.S. Treasuries]." - Neil Mellor, Bank of New York-Mellon
When China recently expressed its interest in purchasing $80 billion in gold (about 2600 tonnes), it profoundly altered the gold market's long-standing synergy in three significant ways:
First, it used to be that the threat of central bank gold sales would damage market sentiment. Now the threat of significant sales has been met with the threat of significant purchases.
Though the dragon hoard depicted by our good friend, Ed Stein, is not yet a reality, China can back its desire to own gold with plenty of cold hard cash. At nearly $1.4 trillion in dollar-based assets, and almost $2 trillion in total reserves, $80 billion would consume a paltry 6% of China's dollar reserves. At the same time 2600 tonnes translates to roughly one-third the U.S. gold reserve -- a significant ambition by any measure. To give you an inkling of how this new synergy might work, when the International Monetary Fund announced recently it would like to sell about 400 tonnes of gold, China joined India in publicly pressing the IMF to sell its entire 3200 tonne hoard. On that news the gold market, which had been in a slow slide as a result of the IMF's announcement, turned and took another run at the $1000 mark.
Second, by becoming gold's most prominent champion, China mounts an aggressive defense of its domestic gold mining industry, and by proxy the rest of the industry as well.
Few people know that over the last few years China has quietly become the world's leading gold producer. Most of that production never leaves China's borders, but goes instead to the national reserves as a hedge against its currency holdings. China, by the simple expedient of defending its own interest, accomplishes much for the gold mining industry as a whole. By posing as a gold buyer of last resort, ready, willing and able to scoop up any sizable offer, China may have very well put a floor under the market price, though we are too early in the game at this juncture to predict what that price might be. There is no question, however, that China has put a floor under long-term gold market expectations.
One would have to go back to the first Central Bank Gold Agreement in 1999, which strictly limited the sale and leasing of central bank gold, to find an equivalent organized effort in defence of the long term price trend. Many feel that the original CBGA launched the current bull market in gold, and time will tell whether or not China's bold entry onto the gold scene will launch its second leg.
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A little USAGOLD history. . . . Pictured are News & Views hard copies from 1999 just before gold began its secular bull market. News & Views first made its appearance at a time when gold-based publications were few and far between. The "Big Breakout" headlined in the November, 1999 issue refers to a price jump from $260 to $330 per ounce. Your editor sees a good many similarities between that period and now.
Third, by elevating gold to prominence in its national reserves, China lays the groundwork for the yuan's future use as a prominent reserve currency.
There is little doubt that China would like to make the yuan the currency of choice in the East, and a strong measure of gold in its reserves would do much to enhance that possibility. For a comparative history, one would have to go all the way back to the late 1960s and the time of French president Charles DeGaulle. "The Last Great Frenchman" thought it best to hedge the national interest and elevate its future economic prospects by purchasing gold. A substantial amount of metal subsequently left U.S. coffers for European national balance sheets including that of France. DeGaulle was later vindicated when gold rose twenty five times in dollar terms over a short ten year period from $35 an ounce to $875 (1971 to 1980). Some of that same gold would later play a key role in the establishment of the European Union, the European Central Bank and the euro, Europe's currency. China, by its recent actions, appears to have similar intentions both in terms of gold and the yuan.
In one fell swoop China has done much to alter the standing gold market synergy. When Congressman Mark Kirk announced China's desire to purchase gold during an interview with Fox News' Greta van Sustern, he noted "across the board - in private - substantial, continuing and rising concern." Chinese leaders, he added, were sharply critical in private of the US Federal Reserve's policy of "quantitative easing," the modern equivalent of printing money. Kirk went on to say that rising concerns about the dollar and anticipated inflation had prompted China to: "[fund] a second strategic petroleum reserve and they plan to buy $80 billion worth of gold. . . Both of those investments only make sense if you expect significant dollar inflation."
In the years to come, China will continue to steadily build its gold reserves through domestic production. It will also attempt to purchase whatever gold it can on the world market through official sector purchases or whatever additional means it finds at its disposal. In the process it will become the fire-breathing dragon in the gold market's living room - ubiquitous and formidable, a presence that cannot be ignored. At the same time, it will find itself in stiff competition for the available physical gold with an international public which harbors the very same concerns for their own portfolios that Chinese officials expressed to Representative Kirk. Few among gold's growing legions would disagree with China's logic, or its now publicly-voiced desire to hedge a potentially disastrous collapse of the dollar.