Why are the Chinese buying gold?

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From FTAlphaville today:

When it comes to China’s gold purchases, there is one other important aspect to consider. It is not clear at all that these purchases are PBOC led. This is important because the meaning of gold purchases by private hands is very different to the meaning of purchases by state hands.

State purchases make sense when the official currency needs debasing relative to the gold price, i.e. when the fiat currency of the land is getting too concentrated and deflationary. By squeezing the gold market, you create a Gresham’s law effect that worsens your money, and forces it into circulation. Gold on the other hand gets hoarded.

Private gold purchases, however, make sense when the official currency is unlikely to be supported by the state anymore, for example when the fiat currency is likely to be floated and when it is unclear that it will be able to maintain price stability off its own accord.

In China’s case, of course, state gold purchases could also be motivated by the state’s desire to back their currency with something more neutral than foreign reserves, reflecting a step towards greater economic autonomy.

…As Freya Beamish at Lombard Street Research notes on Wednesday, if it was really about substituting out of UST and into gold in a move towards greater autonomy, there hasn’t been anywhere near enough imported to make a dent in its dependence on foreign reserves:

Even if all the production and imports were to have gone into the PBOC this would still total little more than 6% of China’s foreign exchange reserves. China’s huge foreign reserves mean that as a percentage of M1 for instance, this higher figure is nearly 5%. In relation to US reserve gold holdings, it is easily over 50%.

 

…But, again, she concludes — like us — that this is unlikely to be the key motivation. Much more plausible is the theory that private hands are buying gold because they fear that if and when the RMB floats — i.e. when the PBOC stops backing RMB with USTs — the RMB will lose a lot of its purchasing power because it lacks the seigniorage power of the US. This also explains China’s fascination with Bitcoin and all sorts of other competing stores of value (from Rolex watches to London property).

As Beamish notes:

What we can say at this stage is that the ferocious Chinese appetite for gold in all its forms is a clear signal of lack of faith in Chinese liabilities and in the RMB, which we have argued on numerous occasions is overvalued. China is the epicentre of global excess savings so it’s hard to explain the punishingly high nominal and real interest rates without concluding that liquidity is trying to flee the system.

This has become obvious within the country as the conventional part of the banking system loses deposits to the unconventional part. In 2012, it also began to be clear that liquidity is more than happy to flee China given the chance, as the country saw private capital outflows of around $300bn on a four quarter rolling basis.

It is no coincidence that gold imports from Hong Kong really took off in 2011, when we estimate the RMB first entered overvalued territory. Not only does RMB overvaluation make it directly sensible for Chinese investors to dump the currency in favour of gold, it also brings Chinese liabilities into question in general.

With the RMB this overvalued, China now seems incapable of growing without debt injections and that is a situation that can only end in crisis or RMB depreciation or some combination thereof. Gold is a natural hedge in any of those scenarios. The trade data tells a similar story on the RMB. Annual export growth reached a peak of 33% in January 2011 and has slid to a low of 7.2% in January 2014. Part of this is attributable to generally weak global demand but it’s clear that China has suffered a major loss of competitiveness.

Australian assets fit this profile as well if you believe that a float of the Chinese currency would not hit the Australian dollar. But liberalising the Chinese capital account also means floating interest rates and that would accelerate rebalancing away from commodity-intensive Chinese growth and towards more productive enterprise. I still think Chinese buying Australian assets are making a mistake of they think it’s a hedge.

David Llewellyn-Smith
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Comments

  1. “..Chinese buying Australian assets are making a mistake of they think it’s a hedge.”

    I think it’s more a case of laundering and moving captial out of the reach of the PRC (Chinese Govt.)

  2. “In China’s case, of course, state gold purchases could also be motivated by the state’s desire to back their currency with something more neutral than foreign reserves, reflecting a step towards greater economic autonomy.”

    May be this could be rewritten:

    In China’s case, of course, state gold purchases could also be motivated by the state’s desire to back their currency with something other than their countries assets, their countries land, their countries businesses, an open and accepting culture and a fair and consistent rule of law for those that invest in the country.

  3. “Chinese appetite for gold in all its forms is a clear signal of lack of faith in Chinese liabilities and in the RMB”

    Chinese government has been promoting precious metals as an investment for citizens through state owned media channels since 2009. They have policies that align with strengthening the local Gold market, protecting investors and trying to entice foreign investment:

    http://www.ingoldwetrust.ch/the-chinese-governements-gold-policy-from-the-horses-mouth

    They are encouraging the appetite for Gold, it’s not a loss of faith IMO. What benefit would there be for China to promote Gold this way if the appetite is a reflection of faith lost in liabilities or RMB?

    • There IS a loss of faith in all teh USD they hold and they have voiced that pretty clearly. It isn’t only Gold they are buying. They are buying resource assets, including farmland, all over the world. They are buying industries, houses, office buildings…almost any real asset that lets them get rid of USD and UST.
      The evidence IS that they have stopped buying UST and are trying to divest themselves.
      GOLD is just one alternative but it is one the general population in China, as per BB’s posts, really believes in. They have had a fundamental faith in Gold since back forever. It’s going to stop because we westerners don’t like it?

      • Sorry mig…can’t remember. Where? I run a business in my spare time I’m not trying to make the world see reason! 🙂

      • @flawse: not you mate BB 🙂

        BB your missive on Links yesterday — it was good but now I need closure ha ha.

      • Sorry I missed that follow up yesterday…

        “And on India and gold wouldn’t they have been a lot better off allowing gold accumulation instead of letting the Rupee get raped?”

        You might have to expand a little more so I can see what you are asking.

        I don’t have a solid grasp of all the economic/monetary cogs to the situation, but my understanding was the Rupee was declining in part as a result of India’s increasing CAD, which the (Gold) tariffs were introduced in order to improve. We have seen an improvement in India’s CAD (& more stability in Rupee) so now there is talk of reducing the tariffs. In what way would have allowing Gold accumulation to occur at the higher pace stopped the decline in the Rupee?

    • @BB I could be wrong but I’m pretty sure it was when the Rupee was appreciating that RBI was running around telling everyone to buy fixed income instead of gold. No?

      • Last year they were trying to get citizens away from buying Gold to improve their CAD and were talking about inflation indexed bonds, but this was at a time the rupee was weakening (against the USD), not appreciating?

  4. well, I dont get it – the RMB is undervalued, not overvalued.

    they are slowly letting it APPRECIATE!

      • well – what is this nonsense:

        “It is no coincidence that gold imports from Hong Kong really took off in 2011, when we estimate the RMB first entered overvalued territory. Not only does RMB overvaluation make it directly sensible for Chinese investors to dump the currency in favour of gold, it also brings Chinese liabilities into question in general.

        With the RMB this overvalued, China now seems incapable of growing without debt injections and that is a situation that can only end in crisis or RMB depreciation or some combination thereof. Gold is a natural hedge in any of those scenarios. The trade data tells a similar story on the RMB. Annual export growth reached a peak of 33% in January 2011 and has slid to a low of 7.2% in January 2014. Part of this is attributable to generally weak global demand but it’s clear that China has suffered a major loss of competitiveness.”

        ?

      • All the big exporters over the last 40 years (West Germany,Japan,Taiwan,South Korea etc) since currencies became fiat, have held their currencies down by printing large amounts of fiat currency in the following manner:

        Chinese merchant sells US$1Mn of bolts to the US and exchanges that amount at the PBOC for the equivalent in freshly printed yuan.
        The PBOC sends the US$1Mn to the US to buy US Treasuries and Bonds.

        This becomes a problem called the Triffin Dilemma.

        Another very important point here is that these big exporters have printed US$ equivalent of $9.7Trillion fiat over the last 41 years in this process.

        In the Plaza Accord Sept 1985, the US organised agreement to devalue their currency against the German and Japanese currencies as per Trade Weighted US Dollar Index:Major Currencies (DTWEXM), such that the US$ went from 148 to 87 from 1985 to 1988.
        China has been similarly affected with the US$ going from 112 in 2003 to 77 now.

        The best way for these Asian exporters to protect the value of their US Treasuries and Bonds is to now buy gold while the US is so desperate to manipulate its price as low as they possibly can.

  5. from mining.com

    A year ago, the big news was that the Bundesbank, Germany’s central bank, would begin the process of repatriating a portion of its foreign gold reserves, including 300 metric tons stored at the New York Federal Reserve Bank.

    The controversy really started in late 2012, when Germany simply wanted to audit its gold reserves at the Fed. They were denied this access, so the Germans switched their approach. If they weren’t allowed visitation with their holdings, they would instead demand full custody. In response, the Fed said it would oblige – within seven years!

    As of the end of 2013, a Bundesbank spokesman reported that only 5 tons had been transported from New York to Germany so far, leaving the repatriation far behind schedule.

    “But wait,” some might argue, “the repatriation process might be delayed, but we know the gold is there. Central bank holdings constitute the most visible gold in the world. These institutions report their holdings to the world regularly. The gold at the Fed isn’t dark gold at all!”

    If this is a true and certain fact, then why was the Bundesbank denied a third-party audit of its gold in the Fed’s vaults? The closest we’ve seen was an internal audit by the US Treasury last year. Of course, the US government holds the sovereign privilege of answering to no one but itself, but that hardly makes for reassuring statistics on which to base one’s investments.

    Golden Distractions

    The truth is that we have no clue of the official gold reserves of any central bank in the world. All the Fed has to do to convince me otherwise is let an outside party into its vaults and count the gold. They’ve shown lots of paper; now show us the money!

    It is very simple to count bars of gold where they exist. And it is clearly moral (and generally good business) to return assets that are held in trust when the creditor demands them. The Fed’s reluctance on both counts suggests that there is more to this story than meets the eye.

    Fortunately, the veracity of the Fed’s claimed gold holdings has little bearing on the long-term precious metals investor. It’s the same with gold futures contracts and the daily spot price. These have no effect on whether or not you have a chest of real money buried in your backyard.

    So why is it important that intelligent investors do keep some gold “buried” in their possession? Germany’s repatriation scandal begins to answer this question. The maneuverings of the New York Fed are like the patter and flourish of a magician – it distracts you from the real trick being played.

    Or, in this case, where the most impressive piles of dark gold reside.

    China Going For Gold

    I’d bet that Western central banks are very pleased that the media has latched onto the dustup between Germany and the Fed. It means they are paying much less attention to the massive unreported stores of gold that many observers believe China has been accumulating, and which could have dire repercussions for the US dollar reserve system.

    China last reported its gold reserves in 2009, clocking in at 1,054 metric tons. In the official rankings, this makes China’s reserves the sixth largest in the world. Germany comes in second with 3,387 metric tons (or so they hope), and all nations trail the United States’ claimed 8,133 metric tons.

    Many speculate that China’s reserves have grown far beyond its official number in the past five years. However, the People’s Bank of China (PBOC) is playing its cards close to its chest.

    Last year, a deputy governor of the PBOC tried to convince the world that its reserves have not changed much since 2009. He explained that the Chinese government is keeping a limit on its gold reserves, because “if the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers.”

    But a quick look at the numbers coming from the Chinese government shows that they just don’t add up.

    China is the largest producer of gold in the world, pulling an estimated 437 metric tons of gold from the earth in 2013 – way more than runner-up Australia, with only 259 metric tons.

    On top of this, China imported far more gold than any other country in the world in 2013. Via Hong Kong alone, China imported 1,158 metric tons of gold last year – a more than 107% increase from 2012.

    This gold is not leaving the country in large quantities. Sure, China is the biggest exporter of gold jewelry to the Western world, but the value of these trinkets is negligible compared to the thousands of tons of bullion they are creating and importing.

    Jim Rickards has estimated that China has probably added at least 1,000 metric tons to its reserves every year since 2010, meaning it has well over 4,000 metric tons today.

    This is a conservative estimate. Wikileaks documents claim that China actually imported more than 2,000 metric tons from Hong Kong in 2011 alone.

    If this is the case, when China does finally reveal how much gold it’s holding, it will leap from the sixth largest reserves in the world to the second, easily surpassing Germany in a single bound.

    They might even give the US a run for its money.

    Out From Under

    It’s no longer a secret that China would prefer a “de-Americanized world.” Whether it’s the PBOC or average Chinese consumers hoarding all this dark gold, the effects will be the same when China decides it is fed up with the funny-money central banking system long dominated by the US dollar.

    It certainly seems like the East is preparing for this endgame. Several new physical gold vaults have opened in Singapore in the past year, Moscow recently launched a spot gold exchange, and Dubai is planning a new spot gold contract for this year. Let’s not forget that the Hong Kong Exchange bought the London Metals Exchange in 2012, and there have been rumblings of physically moving it to Hong Kong.

    If China were to initiate a gold-backed currency attractive to international trade partners, its government and citizens are poised to become extremely wealthy and powerful overnight. Americans, on the other hand…

    Are You Afraid of the Dark?

    Some investors avoid the gold market because of its innate unofficial nature. But in a time when governments are in a race to tax anything that moves and inflate anything that prints, gold’s privacy becomes the difference between preserving wealth or facing destitution.

    I challenge my readers to worry less about the short-term movements in the gold futures market, or even which central bank has what holdings. Understand that gold is a deep, global market that has witnessed the rise and fall of countless empires. Your decision is simple: you either own it, or you don’t.

    • Thanks Q4 good run down.

      I would note that I have read somwhere(?) that the Germans allowed the Fed to rent out (rehypothecate?) their gold & that’s why the delay……… be that true or otherwise I can’t say!

  6. I believe the author may be confusing India and China? India’s rupee is depreciating, therefore Indians are stockpiling gold as a hedge. Chinese stockpiles gold because jewelry is far easier to put under the mattress than sacks of 100 Yuan notes. (The largest denominated notes in China is 100, which is < $20 AUD). Similarly, Chinese buying Australian assets to a hedge against confiscation by the Chinese government. There is always the danger of anti-corruption officials knocking on your door at night, and the next time your family sees you is your confession on TV.

  7. + 100 Great post Quant4

    It’s no longer a secret that China would prefer a “de-Americanized world.”

    We should ALL want a “de-Americanized world.” China has NO record of invasion of any Country outside its own historic map.

    The Yanks on the other hand – – – – – – – – –

    Back to Gold. It is over 60 years since the USA has allowed an audit of Gold supposedly held at Fort Knox & other installations.

    Many knowledgeable commentators have speculated that USA Gold holdings are fabricated – – long ago used to wage Wars & lent out many times over to support the manipulation of a TRUE Gold price. A very good reason why NO AUDIT will be permitted.

    Having followed & invested in Gold closely for the past 14 yrs the past 18mths have been hard to watch.
    The next 2-3 yrs should bring about a massive break out in the price as manipulation gets overwhelmed.

    +500% – — you either own it, or you don’t.

  8. “We should ALL want a “de-Americanized world.” China has NO record of invasion of any Country outside its own historic map. ”

    was Japan on this map?

      • I think that he’s making a funny about what constitutes the map of China in Chinese minds. Like disputes over islands, etc.

        As far as Chinese lack of aggression, tell that to the Vietnamese and the Dalai Lama. Their neighbors are all scared of China and want more Western influence. Leave it to the silly Aussie 5th columnists to placate the Chinese. I never understood the mentality. It’s akin to wishing that the driver of a car that you’re in goes off a cliff.

  9. The Chinese are not dumb. They are buying gold with toilet paper money. They have totally abused their own fiat currency along with western world and are using the fake cash to buy real assets.

    The winner when all fiat currencies collapse in the not too distant future will be the holders of real assets.

    The Chinese know that full damn well. While reserve banks / commercial banks try to push down gold prices with short futures to maintain the ridiculously priveledged position in economies, the Chinese are saying, lets’ create enormous amounts of credit and exchange it for gold at low prices. Great smart play.

    The Chinese know that all economies including their own are a mirage built on the faith in commercial and central banks which will disappear overnight.

  10. Again and again, financial commentators ignore the fact that the PRICE of gold can be reset.

    Sure, at current prices it would only back 6% of the Chinese cash market. But if they announce they are moving to a 30% gold backed system, then the price must change 5x fold.

    Furthermore after everything else seems to be manipulated to a degree, can’t see why PMs are not either.

    Of course whether this move by China happens is another thing.

  11. Perhaps the author has absolutely not a fig of an idea of the importance of gold in world economies since the United States of America defaulted the Bretton Woods Agreement on 15th August 1971.