December 01, 2010
Is China driving gold prices up or down?
Just last week, commentators everywhere on the planet were unanimous. Chinese anti-inflation measures were driving prices down - so said many major news sources including Bloomberg.
Certainly, gold has taken a tumble over the past two weeks. Gold prices plunged more than five percent, from a record high of $1424 an ounce to $1352. The slide came as China raised interest rates and upped bank reserve ratios.
It does make some sense to suppose that inflation-fighting measures in China have put pressure on gold prices. After all, China is the world's biggest consumer of gold after India. High inflation typically increases demand for investment hedges like gold, and China's inflation rate has risen above four percent.
That's well above official targets.
With its latest moves, Beijing has shown real determination to wrestle inflation down. Reserve ratios have been raised twice to date and interest rates were jacked up by half a percent. Even more interest rate hikes are expected this year as China's anti-inflation battle continues. And, every new inflation-fighting move from Beijing will put some downward pressure on gold prices.
But new figures also show that China and India are still buying gold faster than ever no matter what the price. India especially loves gold jewelry. And, after a heavy monsoon season, India's consumers were in a buying mood. They bought nearly 50 metric tonnes, or 36 per cent, more gold jewelry in the third quarter of 2010 than they did in the same period a year ago.
(A metric tonne is 1,000 kilograms...more than 2,200 pounds)
Gold Demand with a Difference
Greater China also lifted its gold consumption, with demand rising by 16 per cent. But the Chinese are seeing gold in a new light.
Gold-buying in China, Taiwan and Hong Kong shows an important difference from India. Look more deeply into Chinese trends and you'll see what I mean.
The increase in China's jewellery consumption was only nine percent. But investment demand shot up much more. Retail sales of gold for investment rose by an astonishing 39 percent. A government push to encourage people to buy more gold is apparently having the desired effect.
This isn't a blip on the horizon. Chinese investors tend to move in waves. A trend toward gold-buying for investment will continue to be fed by ongoing currency wars and fears of a trade war. (As I've mentioned in previous articles, many countries are driving down the value of their currencies in hopes of boosting exports.)
An unexpected rise in the U.S. dollar last week was probably a more important than China in driving down short term gold prices. As the Irish debt crisis deepened, the euro slumped. That drove the dollar up. And, as an inevitable result, gold fell by 5 percent, ending a seemingly non-stop climb.
Now that the Irish crisis is easing, we can expect the dollar to resume its decline. If so, gold should start moving in the opposite direction once again. Industrial demand for gold is also on the upswing. The Gold Council says industrial consumption levels have now fully recovered from the global recession. Consumption in that sector is up 13 percent from last year and expected to continue rising. Gold's industrial recovery was driven by improving demand for consumer electronics goods, in particular from emerging markets such as China and India. Innovation is also driving the industrial market. There is an increased range of new technology products with gold components including the iPad and a variety of smart-phones. That trend is expected to continue ramping up industrial demand for gold.
Hoards of Gold in Reserve
China should also emerge from the shadows as a major buyer of gold for its currency reserve stockpile. China has more than $2.5 trillion in reserve and dollars are its biggest asset. Some in Beijing want to change that in a big way. Because the press is carefully controlled in China, it's important to note what's being said in official publications. A recent story in a newspaper run by the powerful Ministry of Commerce says China should radically increase its store of gold. The report notes that China holds far less gold in reserve than the United States. The U.S. has more than 8000 tonnes of gold in reserve. China has only 1,054 tonnes. If China wants the yuan to become a global reserve currency, holdings of gold should be increased to match the U.S., according to the Ministry commentary. You heard me correctly. China is considering increasing its hoard of gold eight-fold! To buy that much gold, China would have to scoop up the entire world's output of gold for more than two years. Even stretching Chinese purchases of gold over many years would tend to drive prices up.
Going Abroad For Gold
Production by the world's mines increased only three percent last year. That means new demands from industry, consumers and governments will put continuing pressure on prices. China has encouraged its gold mining companies to go abroad and buy up large foreign mines. Now it appears that the first Chinese gold mine buyer is searching the market. China National Gold Group Corporation, the country's largest gold producer, is shopping for overseas resources. The company says it is looking for new gold sources in Congo, Brazil, Russia, Venezuela and Mongolia. Within five years the firm expects to produce more than a third of its gold outside of China. That means creating substantial new sources of gold to feed China's appetite. More Chinese gold companies are sure to follow. While the U.S. continues to devalue its currency through strategies like quantitative easing, it makes sense to hold a portion of your portfolio in gold. If that feels like speculative investing to you, consider what has happened to the cash you have held in reserve. The dollar has become a speculative commodity like any other. In a world with fewer and fewer safe havens, holding a reserve of gold makes sense to Beijing. It should be on your radar too.
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