Why China is Gold?s Best Friend
The good news is that you don?t have to be crazy, paranoid, or delusional to own gold (GLD).
However, the ?hundreds of individual investors I know who absolutely love the barbarous relic may not know exactly why.
They originally filled safe deposit boxes with old jewelry, American Eagles, and bullion bars as a hedge against the return of the double-digit INFLATION we endured during the 1970s.
Then gold became a DEFLATION hedge, as yielding nothing outperforms the negative interest rates offered by paper currencies, still -0.35% for the Euro and the Swiss Franc.
They are joined by what I call the tin hat, black helicopter, conspiracy theorists who eternally believe in the collapse of the US dollar and a default of US Treasury debt.
After all, it's always handy to have a few krugerrands in your pocket to bribe the border guards and escape the country (I never understood to where).
Recently, a new crowd of gold buyers has emerged.
Investors are soaking up the yellow metal as a hedge against a Trump presidential win. He has promised a crash of both the debt and equity markets.
Gold should soar.
However, few are aware of the true fundamental reasons for the long-term appreciation of the barbarous relic.
That would be the unrelenting accumulation of gold as a reserve asset by emerging market central banks, especially China.
The Middle Kingdom has long kept any information regarding its gold holdings a state secret.
Individual gold ownership was punishable by death, originally by firing squad, and more recently through organ harvesting.
That changed in June, 2015 when Beijing reported that it owned 1,658 metric tonnes. That is 56.7% higher than the last figure reported in 2009.
Since then, it has added another 165 metric tonnes. Its total holdings are now 1,823 metric tonnes worth $78.6 billion. This compares to the 8,134 metric tonnes, or $350 billion worth of gold owned by the US Treasury.
From these numbers, it is safe to assume that China will continue to add at least another 120 tonnes of gold to its reserve annually for at least another decade.
This should exert upward pressure on prices until we see a serious spike upward in global interest rates.
With ten year Treasury bonds (TLT) yielding 1.61% today, don?t hold your breath for that happening any time soon.
In addition, all of China?s domestic gold production is thought to go into a secret internal account not included in the nation?s central bank reserves.
Apparently, organ harvesting still applies to any release of statistics about THIS gold.
China?s gold buying is only part of an effort to recycle its massive trade surpluses back into the world economy, which last year ran a staggering $593 billion. Of this, $365.6 billion was with the United States.
Run a chart of China?s merchandise trade surpluses against the price of gold and you get an almost perfect match.
China isn?t loading up on gold because of any value or inflationary considerations. It is desperately attempting to diversify away from the US dollar, on which it has become overly reliant due to the massive size of its reserves.
As of July, China?s foreign exchange reserves totaled $3.23 trillion (see table below). America?s only ran to $120 billion, putting it only 14th in the world after the United Kingdom.
China owns $1.4 trillion worth of US Treasury bonds, notes, and bills, making it the largest holder after the Federal Reserve (which still owns $3.4 trillion left over from its quantitative easing programs).
In addition China owns trillions more in dollar cash, banks deposits, and other cash equivalents.
As long as the world remains a gigantic love fest, this is all fine. But what happens if Trump captures the White House?
China isn?t the only country engaging in a gold strategy.
When Iran was subject to trade sanctions and was banned from dollar clearing, it transacted a significant port of its business through gold barter transactions. Russia has lately been very active in the gold market for the same reason.
Other countries running big trade surpluses, like Germany, Russia, South Korea, the Netherlands, Taiwan, and Singapore, are doing the same.
And here is the number that will blow your mind.
For China to raise its gold holdings to the 17.4% of total reserves typical for developed countries, it needs to buy an incredible 10,101 metric tonnes worth $471 billion.
Add in gold purchases by other high surplus nations, and the total amount of net buying to come is truly mind boggling.
It all sounds like a prolonged bull market in gold to me, especially if interest rates stay lower for longer as I expect. This explains why the gold miners (GDX) had such a hyperbolic move early in 2016.
So you really don?t have to be crazy to own gold.
Well ?. maybe it helps a little bit.
China Trade Surplus 2004-2015
China Foreign Exchange Reserves
