FSO Editorials

How will Chinese Central Bank Gold Buying affect the Gold Price short & Long-Term?
Excerpts from GLOBAL WATCH: THE GOLD FORECASTER
by Julian D.W. Phillips. May 7, 2009

Hu Xiaolian, head of the State Administration of Foreign Exchange (SAFE) informed us last week that the country's gold reserves had risen by 454 tonnes from 600 tonnes since 2003, when China last adjusted its state gold reserves figure.

Since the days last century when Peter Fava, then head of HSBC’s U.S. gold department, visited the Bank of China to persuade them to buy gold bullion [they thought it was a simple sales pitch initially and did not buy visibly] China has been a buyer of local gold production. This includes the period before 2003.

8+ years of buying gold, not 5.

China has risen to now be the largest gold producing nation in the world at around 270 tonnes. The amount bought in by the government initially looks like 90 tonnes per annum or just under, 2 tonnes a week. Before 2003 the announcement by the Chinese central bank that gold reserves had been doubled to 600 tonnes, accounted for similar purchases before that date. Why so small an amount you may well ask? We think local and national issues clouded the central bank’s view as it was the government that bought the gold since 2003 and have now placed it on the central bank’s Balance Sheet. So we would conclude that the government has ensured central bank gold purchasing must continue.

Will China increase the amount it buys?

Now for the question of why only one third of production bought? Why not more, we must ask? Again, that has been a government issue and with the concurrence of the central bank now, it is possible [but no information is available on it] that the portion bought will be increased. Despite the inflationary implications of this road, the amount bought relative to the Balance Sheet of the central banks is insignificant. So do not be surprised if China buys more from local producers and that amount be deducted from ‘open market’ supplies in the future. Why not buy the entire amount? The times we now see ahead of us don’t look so good for the global financial system, so why should China make itself a victim of floods of paper money and not turn to gold as far as it is able to? The amount it can access without disturbing the gold price is small and very visible, so any opportunity to buy large amounts off-market will be jumped at?

Reserve Asset Implications.

The fact that China is a buyer for reserves is far more important than how much it currently holds. There is no other conclusion we can reach other than China recognizes its worth as a reserve asset!

On the bigger global screen, this revelation stops the concept of gold as a “barbarous relic” as bankers had hoped it would become in the last 50 years and brings it back into a monetary role, even if it is minor at this point. As you can see from the Table in the above section of the newsletter, gold buying by central banks is not limited to China. If China buys a larger percentage of local production going forward, then it is probable that central bank buying will overtake central bank selling in the years to come. This alone takes gold away from the perception of its being an archaic relic. More than that it brings gold back to a particularly valued asset “in extremis”, the times we are now living in.

This has to force a rethink of the role of gold by unwilling bankers and the recognition that selling it will not elevate the value of paper money any more. The confidence lost in the last two years cannot be shored up by such foolish practices. It is now time to recognize the dangers not only of today’s crises, but of the dangers that lie ahead, even if the world economy returns to the halcyon days of early 2007 [which appears to be the aim of central bankers and governments now]. The dangers that led to the ‘credit crunch’ will return, if successful. So prudence demands recognition of gold’s value when life gets painful.

Germany and Italy have recognized this, as has the States [while they keep an iron grip on their own gold?]. Russia and now China are recognizing this. More nations are bound to follow. Future large sales may well be snapped up by other central banks [Russia is currently buying 4 tonnes a month from the ‘open market’], which brings us back to the potential sale by the I.M.F. of 403 tonnes at some point in the future.

I.M.F. Gold Bought by China?

In the past both the U.S. and the I.M.F. used the auction method of selling gold and were able to dispose of 500 tonnes at one shot in this way. It is now incumbent on the I.M.F. to maximize the proceeds from the potential sale of gold it has to sell. Hence they should use the ‘auction method’ again.

If they choose to sell it in the ‘open market’ on the small-amount-per-week system, currently used by the CBGA signatories, it will take years and is not likely to achieve that aim. However, if political interference is brought to bear on the sales, this may be the route that is followed by the I.M.F?

With the policy that both China and Russia are presently using of buying gold, one or both of the two would be prime candidates as happy buyers of the entire 400 tonnes of gold. Such a purchase would confirm gold as a sought after Reserve Asset! Such a view will certainly affect other central bankers and persuade them to re-build gold reserves [as South Africa has now said it would].

Gold, as such, would still be rare enough and too expensive to take a traditional role as real money, but governments would want it to sit in their vaults, almost as collateral for paper money. The art would be to imply that gold backed paper money, but make it inaccessible to all but other central bankers and only then in a ‘default situation [as Mexico and Brazil experienced when they sold gold to the I.M.F. decades ago]. So its role would still be truncated. For it to reach down to the man-in-the-street as money the price would have to be 5 figures high. This could only happen slowly over a decade or so?

What does this mean for the gold price?

© 2009 Julian D. W. Phillips

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