Wednesday, March 10, 2010

Is China Bluffing About Being Wary About Gold?

Although a recent article appeared to indicate that China was looking to reduce its aggressive gold acquisition program while reaffirming its commitment to the purchase of US government-issued debt, the actual reality in the market may be significantly different. Given the perceived risk of long-term investment in US Treasuries, it is likely that their purchasing activity will continue to put positive pressure on gold prices in the future. See the following post from Expected Returns.

This is one of the more amusing articles I've read in some time. From the headline of the Reuters article, China says committed to U.S. debt, wary on gold, I was sure China announced some kind of monumental shift in policy. But alas, upon reading the article, I realized China was playing the same game Soros did when he called gold "the ultimate bubble"- before, of course, doubling his holdings of gold and investing $75 million dollars on a gold mining company. From Reuters:
"The U.S. Treasury market is the world's largest government bond market. Our foreign exchange reserves are huge, so you can imagine that the U.S. Treasury market is an important one to us," Yi Gang, head of the State Administration of Foreign Exchange (SAFE), told a news conference.

Yi dampened hopes of gold bulls that China might be itching to add to the 1,054 tonnes of the metal in its reserves.

On a 30-year horizon gold was not a great investment, he said, and China would simply drive up prices if it piled into the market.

"It is, in fact, impossible for gold to become a major investment channel for China'sBold foreign exchange reserves. I have 1,000 tonnes now, and even if I doubled that holding, according to current prices, that would be about $30 billion," Yi said.
Yi Gang is actually wrong. Gold was a horrible investment for a 20-year period, not 30. He should know, since China has increased their gold reserves from 454 to 1054 tons since 2003- a period in which gold has risen from $340 dollars an ounce to $1,120 dollars an ounce. Indeed, what a "horrible" investment.

I don't know what Yi Gang told us that we don't already know. Of course gold, which currently makes up 1.5% of China's forex reserves, can't make up a significant portion of China's portfolio. (For some perspective, France and Germany hold over 64% of their reserves in gold). But that's exactly what makes the outlook for gold so bullish, since even a modest increase of gold's allocation in China's portfolio would send gold prices to the stratosphere.

It's interesting that people are so quick to latch on to what China says, and not what it does. China is not only adding to its gold reserves, but it has pared its holdings of U.S. treasuries. No one in their right mind would own U.S. debt for the long run. It's going to be pretty clear in the years ahead that gold trumps U.S. Treasuries as an investment.

This post has been republished from Moses Kim's blog, Expected Returns.

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