Gold and It's Ongoing Importance To China's

Diversification Of Their Official Reserves

 

IPM Group  - As we have indicated and written about previously, the demand from China for physical gold has literally been unprecedented this last few years. Not only is China obviously buying physical gold secretly to build (officially they have 1,054 tons) their overall allocation of total reserves to the levels of Europe and USA (9,500 Tons and 8,100 tons respectively).

 Since 2010 we have have been experiencing net buying of gold from Central Banks world wide, this has not been seen since the 1960's. Last year alone saw the 2nd largest buying spree by world CB's in over 50 years.

The simple reason why they officially 'downplay' this buying or the outright secrecy involved, is that they could not accumulate this physical gold openly without driving prices dramatically higher.

Every asset class has its day in the sun, cycle wise Gold is about to have a very bright future indeed !

 

A must read article in the Caixin, which is the Beijing-based media group providing financial and business news. You can read the article in question in its entirety here.


But to highlight a section see below....

 

Yuan and Gold: Old Enemies Should Finally Become Friends

 

…Since the global financial crisis that started in 2008, there has been consensus that an excessive issuance of U.S. dollars, driven by the U.S. Federal Reserve’s need to protect the U.S. economy, was partially to blame for causing havoc. Since the Bretton Woods system collapsed in 1971, the United States has been freed from having to restrict its money supply to the size of the gold reserve its central bank holds.

What does that say about the attitude China should take toward gold?

The boom years for gold between 2008 and 2012 were, of course, driven to a large extent by the United States’ easy monetary policy and an economic recovery in many countries. Yet, China played a part in it as well.

Its push since 2010 to promote the use of the yuan globally and diversify its foreign exchange investment away from U.S. Treasury bonds and U.S. dollar-denominated assets has made investors expect the demand for gold to rise because the Chinese central bank will need a greater reserve to support its currency.

Gold accounts for only 1.6 percent of China’s forex reserves. This is only a fraction of the figure in the United States and many other developed countries. If China ever increased the level to 5 percent, it would have an enormous impact on global demand for gold.

The price of gold started plummeting in early 2013 as the U.S. economy became stronger and the market expected the Federal Reserve to stop its policy of so-called quantitative easing. Meanwhile, China’s demand for gold soared. In the first half of 2014, imports skyrocketed, prompting speculation that the central bank was secretly beefing up its gold reserve

Buying more gold seems to be a good choice for both the government and individual investors, given the new domestic and international circumstances. The yuan has been relatively stable throughout the most troubled times of the financial crisis, but its peg to the U.S. dollar means it will always fluctuate in sync with the latter, depending on the Fed’s moves.

That is why it is extremely important that we have an “anchor” ourselves.

Gold is a currency that supersedes sovereignty issues, is politically neutral, and is not easily manipulated by monetary policy. Gold may not be able to compete with the currencies of the world’s major powers, but it can certainly be used as an anchor.

In the past year or two, enormous changes have occurred to the structure of China’s economic growth, to the degree of social wealth accumulation, and to the investment and wealth management habits of ordinary people. It is important and urgent that we revisit certain issues, including the relationship between the yuan and gold, under these new circumstances.

The party came to power not only because it won the war but also, and more importantly, because it represented the right thing to do economically and financially. The relative advantages of its monetary system back then have been fully demonstrated, but it will not be long before they turn into obstacles to progress if the authorities reject reform and refuse to evolve along changing times.

The emphasis on material goods over gold and silver in the yuan system may have been superior in wartime and when supplies were insufficient, but it has increasingly become incompatible with today’s needs.

If it was necessary to use all means necessary to secure enough supplies of goods in the old days, today’s priority should be how to fairly distribute them. The emphasis should be on developing a fair market and protecting the ownership of private assets.

In a 1966 essay, former Fed chairman Alan Greenspan wrote that gold is “a protector of property rights.” This is true, but only in times of peace and in an open environment. The old wisdom of hoarding gold in troubled times is applicable only to eras of strife and war. In China in the 1960s, in Nazi-controlled Europe and in the Soviet Union under Stalin, gold could not buy one food, let alone protect property.

So instead of trying to peg the yuan somehow to gold to increase its credibility internationally, the government might as well work to establish rule of law and create a system where private property ownership is respected and the public believes in the strength of the monetary system. Confidence is more important than gold.

But that does not mean the yuan system does not need gold. It can be an anchor that stabilizes the yuan and increases people’s confidence in it. It can also serve as a check to the power of any one major currency.

Increasing private savings and investments of gold, or – as the Chinese government likes to call it – “storing gold with the people,” is not only about the diversification of investment channels. It is also an inevitable path that the yuan must take from being a currency supported by reserves of material goods to one based more on credit.

The government should be pleased to see this trend gaining momentum. Increasing its gold reserves at the same time can also strengthen the public’s confidence in the yuan and promote its use globally.


 posted by Li Sheng, hedge fund manager