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An "ABCs of Gold Investing"
Update
by Michael J. Kosares
Author, The ABCs of
Gold Investing: How to Protect and Build Your Wealth with Gold
Founder, USAGOLD-Centennial Precious Metals, Inc.
June 25, 2009
Dragon's Hoard
In one fell swoop, China profoundly alters gold market synergy
"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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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.
____________
Michael Kosares has over 35
years experience in the gold business and is the founder/owner
of USAGOLD-Centennial Precious Metals. He is the author of
The ABCs of Gold
Investing: How to Protect and Build Your Wealth With Gold
as well as numerous magazine and internet articles. He is
frequently interviewed in the financial press and is well-known
for his ongoing commentary on the gold market and its economic,
political and financial underpinnings.
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