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"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.
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.
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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 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 J. Kosares
USAGold - Centennial Precious
Metals, Inc.
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