I don’t want to pick on Societe Generale analyst Robin Bhar, as this was
representative of most of the commentary around China’s gold reserves
announcement, but the statement that the 1,658 tonne figure “was not
unexpected. If anything, it was slightly surprising that it wasn’t more, the
market was looking at a figure north of 2,000 tonnes” makes the mistake
of assuming that Central Bank announcements are about communicating facts.
As Ben Hunt says, Central Bankers “are all playing the Common
Knowledge Game as hard as they can … if you don’t listen to what is being
said in the context of game-playing, then you are placed at a disadvantage
versus those who do. You will not understand the WHY that exists behind the
public statements.”
So what is the WHY driving China’s gold reserves announcement? This note from Ben argues that “Chinese political stability
under the unified coalition formed by Deng Xiaoping depends on robust and
real domestic economic growth” and that “will depend on developed
world export markets in the US and Europe”. That objective is not
advanced by having a strengthening currency, making China’s exports more
expensive, or as some goldbugs fantasise, “withdrawing from the system or
blowing the system up” by reverting to a gold standard. But China cannot
also dramatically weaken its currency lest it provoke Western governments
into an overt currency war.
In terms of the why I think the timing, or WHEN, of the announcement was
also significant.
It is also important to understand the audience the message is directed
at, in other words the WHO. Ben notes that political linguistic game-playing often
involves messages directed at multiple audiences, otherwise known as dog-whistling.
In the case of the China gold reserves announcement, the choice of the figure
revealed and how it was explained would have been a delicate, strategic
balancing act considering the different perspectives of the players involved.
Lets consider each of these audiences.
WHO – Foreign Governments and Central Bankers
Jim Rickards summarises the message China was sending to this audience in
this simple tweet “China reveals enough gold to be respectable,
but not enough to disrupt. Consistent with idea they want to join the SDR
club, not destroy it”. Mark O’Byrne from GoldCore also makes the point that China “could be low balling their total
gold holdings – official central bank reserves and non official holdings – in
order to maintain confidence in their substantial US dollar holdings and to
aid their bid to join the IMF.”
As news agency Xinhua noted, “China looks to advance its currency’s status
as a key international reserve currency, which is now a prime candidate for
the International Monetary Fund’s (IMF) special drawing rights (SDR)”.
It is also interesting in terms of “join not destroy” that the article made
the point that “countries have long abandoned the gold standard as the
basis of monetary systems” before acknowledging that “gold reserve
volume remains an important factor in market assessment of a country’s
currency”.
I also find it interesting that the Xinhua included this quote from a
researcher with the Shanghai Academy of Social Sciences: “China’s
increasing gold reserves will strengthen yuan holders’ confidence, which will
help stabilize the exchange rate and facilitate the internationalization of
the yuan”. While directed at other central bankers, possibly it was also
meant to encourage domestic investors to retain their yuan, rather than
buying Australian or Canadian property, for example?
In terms of not disrupting, consider the chart below which shows the
Chinese gold reserves additions as a monthly average rate of accumulation.
The recent 604 tonne addition is just a bit over 8 tonnes a month, which
is similar to the rate of accumulation during 2001 and 2002. The message
China is sending from this chart is that they are officially accumulating
gold in a predictable and slow manner.
The steady as she goes message was reinforced by the People’s Bank of
China saying, as reported by Reuters, that “on the premise of not
creating disturbances in the market, we steadily accumulated gold reserves
through a number of international and domestic channels” and would “remain
flexible when deciding whether or not to adjust gold reserves in the future”
with those channels being, according to Xinhua, “domestic scrap gold, production
storage and trade in domestic and overseas markets.”
The consistency on China’s accumulation is better demonstrated by charting
China’s reported reserves (in red) and filling in the gaps between the
reporting points (in green) with assumed monthly additions, as I have done
below.
The trajectory of the gold reserves growth is so bureaucratically
predictable that I feel confident in extending the chart beyond today and
saying that the next Chinese reserves announcement will fall on the my
forecasted official reserves line depending on the date of the announcement.
Any figure greater than this predictable path would, as David Marsh of the
monetary forum OMFIF said, “risk unsettling the world gold market” and
“might be interpreted as an unfriendly move against the dollar at a ‘delicate
time’.”
WHO – Domestic Stock Market Investors
Zero Hedge argued that “China had to wait until its stock market
was crashing to present the ‘systemic stability’ bazooka: gold. Because in
revealing a surge in its gold holdings, the PBOC is hoping to finally provide
that final missing link that will boost investor sentiment, and get people
buying stocks all over again.” Ross Norman from Sharps Pixley noted this argument but then said “but that makes no
sense either, because they [gold reserves] aren’t!” sizeable.
Michael Kosares of USAGOLD provides a counter argument, noting that a “strong number would have propelled
gold and the yuan higher – not what you might want having just thrown
everything but the kitchen sink at the crashing Shanghai market. China in the
end is an export economy, much like Japan. It’s stock market value relies on
exports.”
I agree with Ross and Michael. Consider that the previous gold reserves
announcement was in April 2009 when the amount increased from 600 tonnes to
1054 tonnes. The announcement prior to that was December 2002, which
makes for a gap of 77 months. This increase being in June 2015 is a period of
75 months from the last, so one could consider this announcement should have
been in August (assuming there is something special about the 77 month
period). More relevant is the fact that the IMF meeting regarding the SDR
will be in October, which means an August/September announcement would have
sufficed.
So arguably the announcement in July about a gold reserves increase in
June was early. I do not think it is coincidental that the announcement
occurred shortly after China’s stock market fall. As the Chinese authorities
would have been aware that market expectations were for a larger number, the
reporting of a modest number sent a message to Chinese investors that while
gold is important, it is not a major asset class and certainly not more
important than the stock market. Reporting a large number would have sent the
message that China was favouring gold and was the better asset to invest in.
Knowing that a lower than expectations figure would likely be negative for
gold prices, China may well have considered it fortuitous that the gold price
was weak at the same time they wanted to encourage people to invest in the
stock market. As Jim Rickards tweeted “China is still buying gold and favors a
lower price. So, timing the big ‘reveal’ for when gold prices are weak anyway
makes perfect sense”, both for the State Administration of Foreign
Exchange (SAFE) in terms of acquiring more gold and for discouraging domestic
investors from shifting money from the stock market to gold.
WHO – Domestic Gold Consumers
For those without the wealth to invest in the stock market or property,
gold represents a culturally familiar way to save. For this average consumer,
the Chinese government would want to send a message that gold was still an
acceptable investment, which the increasing of gold reserves achieves.
As mentioned above, the announcement also ensured that the gold price
would not increase dramatically. The Chinese government would consider
essential, as a high gold price limits how much gold domestic consumers can
accumulate, and could be seen by them as breaking the deal where the
government can retain political power in exchange for individual economic
improvement.
In this SAFE Q&A from 2010 they say that gold “has a
very limited market capacity” and “if we buy gold on a large scale,
the international price of gold will definitely be pushed up” which
would “end up hurting the interests of our domestic consumers”.
This position was reiterated by Huang Guobo, Chief Economist at SAFE, in
2014 in this answer to a question about whether SAFE is “gold
bargain-hunting”:
- “China now has a rational structure with both
official gold reserves and active holding and purchase of gold among the
people. Hence, the policy of ‘gold held by the people’ has been well
achieved”
- “investment of foreign exchange reserves will have a
significant influence on the gold market … if the price of gold is
pushed up, then people will have to pay more for gold … which will be
unfavorable in terms of our high consumption of gold”
- “when planning to invest foreign exchange reserves
in the gold market, we must take into consideration its influence on the
market and whether it will be beneficial for consumer groups in China
that import a large quantity of gold”
Finally, consider what the PBOC itself said on Friday: “with an
on-going policy of encouraging gold ownership by private individuals. It’s
important to continue and consider the future of private investment demand as
well as keeping international reserve asset allocation a flexible operation.”
As Adrian Ash of Bullion Vault commented, “private gold demand … remains a key
consideration for the People’s Bank when deciding its own gold-buying
activity”, a case of “the state growing its own involvement, but
letting private citizens take the lion’s share”.
With such a policy encouraging domestic gold accumulation, the gold
reserves announcement helps to modestly reaffirm gold’s role and maintain a
“favourable” gold price.
WHO – Foreign Gold Investors
As the Chinese government wants its population to accumulate gold (as
well as itself), it would have been interested in coming under market
consensus of how much gold it had. For the less game theory savvy Westerners
who took the figure on face value, it would be read as bearish. For others, like
- Joni Teves at UBS Group: “China hasn’t been very
open about its strategy, so what matters now is whether the market
believes they intend to continue buying … They do appear to leave the
door open to further purchases, which should limit the downside for
gold”
- Georgette Boele at ABN Amro Bank: “Their motivation
is reserve diversification, and they’ll probably keep buying”
the lower figures, while confirming that China will still be in the
market, would not necessarily be bullish as these analyst and professional
market players would have already incorporated that information into their
calculations. The result is that there was little downside for China to
report a lower figure given a higher figure may well have resulted in a large
amount of retail Western investor buying.
WHERE – location and encumberance
The above discussion covers the Why and Who but I’d like to finish with
some comments on the Where. Ronan Manly notes that there are two questions that no one has raised
about the gold reserves announcement: “the storage locations of China’s
official gold reserves and whether the gold is unencumbered”.
In respect of the encumbrance question, this is how gold is described in
SAFE’s Template on International Reserves and Foreign Currency
Liquidity (my emphasis):
Gold (including gold deposits and, if
appropriate, gold swapped) – 623.97 [note
this is in US$100 millions)
Volume in millions of fine troy ounces – 53.32
While no indication is given about the extent of Chinese deposits, lending
or swapping, this wording does leave the door open to the possibility that
China holds gold overseas, either as unallocated or allocated, or is involved
in “actively managing” (as it is euphemistically referred to) its gold
reserves.
As most analysts agree that China does hold more reserves than it
announced last week, the question is where is this gold held? It does not
mean that China was lying about its gold reserves, as costata001 tweets: “China could have bought that gold at any
time in the past 30+ years. IMF rules only require reports when gold is
classified as reserves i.e. monetary gold.” However, I do not think it
is a case of the PBOC just changing the classification of gold it holds as
monetary, given this definition by SAFE (my emphasis):
“4. Reserves assets refer to external assets that can
be used at any time and are effectively controlled by the PBOC,
consisting of monetary gold, special drawing rights (SDRs), the reserves
position in the Fund, and foreign exchange.
4.1 Monetary gold refers to the gold held by the PBOC as
reserve.”
So once gold becomes “effectively controlled” it becomes reserves. This
means for the Chinese government to keep gold out of reserves it needs to
keep it off the books of the PBOC. China is not unique in this regard. As
Chris Powell notes, “Saudi
Arabia pulled a similar trick in 2010. In June that year the World Gold Council
reported that Saudi Arabia’s gold reserves had increased by 126 percent, from
143 to 323 tonnes, since 2008″ but later revealed that it “had
possessed that additional gold all along, holding it in what he called ‘other
accounts’ but not reporting it”.
GoldCore have pointed out that in addition to the PBOC and SAFE,
there are other Chinese government owned entities that may have also been
buying gold, such as the China Investment Corporation or the “China National Gold Group Corporation or
China Gold, China’s largest gold conglomerate with primary interests in
mining and also refining”. Another location could also be the state
owned banks active in the bullion market.
So when China decides that it wants to increase its gold reserves officially,
it can acquire it from any of these entities. On Monday I will update this analysis from 2012 to estimate how much gold the
Chinese government unofficially holds and how much the population holds, for
what it is worth.
