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China's Golden Plans


Plus, silver's long-term and short-term trends.

When politicians talk it's always a good idea to try reading between the lines.

This Tuesday China's chief foreign exchange regulator, Yi Gang, told reporters that China isn't interested in increasing its gold reserves.


Yi's speech was accompanied by a downswing in the gold price -- they moved lower by a mere $3 within an hour of his speech but since then the market seems to have absorbed the news and moved on. On Wednesday speculation grew that accelerating inflation will force China to raise interest rates.

Investors and newsletter writers (myself among them) have long speculated that China has a pressing need to start buying gold to reduce its giant hoard of US dollars. I conjectured that China might buy the 191.3 tons that the IMF wants to sell. After all, what could be more logical than to buy the gold off-market?

But Yi, who is the director of the fortuitously named SAFE (China's State Administration of Foreign Exchange), had a few things to say that seem to put a damper on the planned Chinese gold party.

"Gold is not a bad asset, but currently a few factors limit our ability to increase foreign exchange investment in gold," he told reporters.

He noted that gold tends to be volatile and that gold's returns aren't steady enough to allow SAFE to increase investment in the yellow metal. Buying gold would cause the price to shoot up.

China realizes that it would be difficult to buy all the gold it wants without sending the price through the roof. That would be like an elephant shopping in a china shop. Let's keep in mind that in April 2009 the price of gold received a boost from China's first acknowledgment that since 2003 it had increased its reserves by 454 metric tons to 1,054 to become the world's fifth-largest holder of gold. China accumulated the gold quietly without the whole world noticing and without elaborating on where it had sourced the additional bullion. It was believed that the gold came from domestic sources and may have included refined scrap metal.

Based on data from the World Gold Council, China is the world's largest gold producer and the second-largest consumer of gold, after India. Chinese annual gold output is approximately 300 metric tons, while the nation consumes roughly 400 metric tons per year, according to Yi, who also serves as vice governor of the People's Bank of China. China's gold holdings represent only a small portion of its total foreign-exchange reserves. According to figures of Chinese holdings at the end of 2009, gold comprised approximately 1.6% of China's foreign-exchange reserves at the current market price of gold.

So, if you take Yi at his words, it would seem that China doesn't have plans to buy gold on the open market. That may well be the case, but we find it hard to believe that China is giving up its quest to increase its gold holdings. It would seem a more prudent course of action to publicly say that you don't want to buy gold, but to buy relatively small amounts on dips when no one is paying attention.

There are other possibilities and here is where we need to read between the lines and see what other Chinese officials have been saying about gold. An official from the China Gold Association told The China Daily that rather than buy gold from the IMF, China would buy gold directly by buying gold mines "abroad" thus giving China a constant and permanent supply without moving the markets.

China is in an awkward position. It can't buy gold on the open market without sending prices through the roof; neither can it unload US Treasuries without sending those prices through the floor. So what can China do?
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