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China Tightening Its Grip on the Precious Metals Market


As the country increases its gold reserves, silver may be approaching its bottom.


In What's Next for Gold's Brutal Sell-Off?, apart from commenting on the current situation and suggesting that gold didn't reach a major bottom yet, I also examined the situation in China. I wrote the following:

Considering the high savings rate in China (mostly in the 30% to 40% area in the previous years), gold is a logical investment for the Chinese and it's possible that billions of dollars in Chinese private investment could move into gold in coming years.

Already there's talk of China overtaking India as the world's largest consumer of gold.

It was only in April of this year that the world found out that China had increased its gold reserves by a whopping 76% to 1054 tons since 2003, moving from 10th place to 7th in terms of global central bank rankings. The Chinese government now owns 30 times the gold it held in 1990. And China is believed to be a leading candidate to buy some or all of the gold the International Monetary Fund still has to sell, after India bought the other 200 a few months ago.

Keep in mind that as China's reserves continue to grow, it will have to purchase gold just to maintain the small gold-to-reserves ratio of 2% that it currently has, let alone increase it. Therefore, the country must continue buying gold.

Even with the increase in its gold holdings, as a percent of China's total reserves (about 2%), gold is still a pittance, mere pocket change. Compare that with the international average of 10.2% held by central banks worldwide and you can understand why China is so eager to catch up. Last year China overtook South Africa as the world's leading producer of gold and apparently a good portion of this gold is finding its way into its central bank vault.

If the newspaper reports in the China Youth Daily are accurate, China plans to increase its gold holdings by another 5,000 tons over the next three to five years. That's more than double the total annual global production. Keep in mind that the total annual global gold production is only about 2,500 tons per year, and obviously China can't buy the whole lot. With current prices, buying 5,000 tons over the next three to five years would cost about $180 billion -- still a small portion of China's dollar reserves.

This is just speculation, but let's consider what would happen to the gold price if China increased its gold reserves from 2% to just 5%.

At a bargain price of say, $1,000 gold, it would cost $55.3 billion to push China's gold holdings to 5% of reserves.

Chinese reserves are about $2.3 trillion, and of that, $1.6 trillion, or 70%, are denominated in US dollars. The cost of pushing its gold reserves to just 5%, which is still 5% lower than the global average, would be a pittance compared to the amount of money China holds in its hands that's losing value every day.

China's problem is that it can't buy all that gold without moving the market. I'd expect China to buy on the dips, creating a solid floor for the yellow metal and eventually pushing the price of gold higher -- much higher.

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