Why China Wants a Higher Gold Price Later, Not Sooner.
The Chinese are as gold hungry as ever.
If you saw the news this week, you’ll know that’s true despite the current small dip in the price. ‘Gold has soared past coal as Australia’s second most valuable physical export to China, with sales up a whopping 900 per cent for the first eight months of the year,’ reported The Australian on Thursday.
What’s remarkable about this is that China is already the world’s biggest gold producer, and all of it stays in China. But China needs all the gold it can get. Big time. Preferably on the cheap. News like this confirms the thesis of our colleague Greg Canavan, who explains why here.
But it also ties in with some other news. Despite being responsible for the biggest debt load in history, can you believe the US Treasury actually got lucky this year? That was the conclusion of a Sober Look article this week when it summed up the biggest buyers of US Treasuries so far in 2012.
The fact that there is still a healthy demand right now for US Treasuries is what puzzles everybody. You get hardly any return, with a pretty big risk of inflation wiping you out and, mmm, possible default in one way or another. But that’s been known for a long time.
Money Morning chief Kris Sayce told us about going to a conference in the States when almost every speaker said US Treasuries were an obvious sell. That was back in 2010. In the meantime, US bonds have kept going up. Why?
The land of the rising sun has now brought its holdings of US government paper to just behind China. At first glance there is nothing remarkable about this. For a long time, Japan has run a trade surplus with the United States and recycled those earnings into US bonds.
But Japan has a problem.
It has one of the strongest currencies in the world. The yen is almost at an all-time high against the US dollar. This obviously hinders rather than helps its exports. To help stop the yen going higher, Japan is buying US dollar assets and intervening in the currency markets.
But why is the yen so strong anyway? After all, Japan has a debt to GDP of over 200% and low growth under 1% at home.
The yen is rising because of the eurozone crisis. Global capital has been panicked out of the euro and into the yen. Japan, like Australia, has seen capital flow in as a ‘safe haven’ country.
Here’s the twist in the tale. The second biggest increase in US Treasuries came from Switzerland. You probably recall Switzerland stunned everybody in September last year when it effectively devalued the Swiss franc.
The Swiss National Bank declared it would peg its currency to the euro by allowing it to go no higher than €0.83. One way it would do this was by buying euros and selling francs.
But that left the Swiss building up an enormous liability to the value of the euro. Take a look at the chart below…
As of 29 June 2012, 60% of the current Swiss foreign exchange reserves were euros. The solution? Diversify into the US dollar (and to other currencies, to a lesser extent).
This inadvertently helps the US finance its trillion dollar deficits and keep the 30 year bull market in US Treasuries going. At one time, the euro seemed like a credible alternative to the US dollar. Not anymore.
So is there a credible alternative?
This brings us back to China’s lust for the yellow metal.
Now China’s foreign exchange reserves are normally described as a healthy asset. Das, who used to trade currencies, described a different picture. We looked up the transcript of his speech to show you why:
‘It’s a vast sum of money, except it’s worth nothing because you cannot monetise it because it’s invested in US dollars, US Treasuries, euro, eurozone bonds, yen, Japanese government bonds. You only have two choices if you’re Chinese. As the Chinese government, you’re either going to have to write that off at some stage or you’re going to sit there pretending these are assets of real value, see them diminish in value as all of those countries devalue their currency to nothing against the renminbi. And that is a massive wealth loss for the Chinese.’
A bounding mine, he said, doesn’t explode when you step on it. It explodes when you step off it. ‘China has stepped on the world’s largest bounding mine. It’s called a US dollar, it’s called the euro, it’s called the yen.’
In other words, China has bought dollars, euros and yen, and now it’s stuck with them. If China tries to sell out of these currencies quickly, the whole currency market could explode.
That’s not good news for China. It knows it’s stepped on the mine. But,as Greg has detailed, gold gives it a way out. If China can accumulate gold, at some point the rerating in the gold price will help offset its foreign exchange losses.
But first it needs the gold. As the Australian article we mentioned at the top points out, ‘China’s foreign currency reserves of gold are low and its move to build them up will provide an important base demand for gold, analysts said.’
Like any buyer, China wants a cheaper price now. It’s banking on a higher price later. The dips in gold are a signal to buy.
Co-Editor, Scoops Lane
This article is contributed by Money Morning. Click Here to Subscribe to their free newsletter.