What is China Really Doing in the Gold Markets?


"China is believed to be the world's largest gold producer, but do the announced statistics include gold production from small mines outside the general reporting framework and/or the byproduct gold from the country's huge smelting and refining sector?"

Perhaps the biggest conundrum facing gold investors is China. What is it really doing? Is it building gold reserves surreptitiously? Is it buying gold on the dips thus creating a floor price? The answer is that we don't know for sure as the giant Asian economy plays its cards pretty close to its chest. So all we are left with is informed speculation gleaned through trying to pick up guidance from public utterances by senior Chinese officials and, in trying to make sense of the gold import statistics via Hong Kong, believed to be the primary route for gold coming into China. However, one does not know for sure if perhaps there are other channels through which gold is imported as well. We are reliant wholly on what China actually tells us, but Chinese data is not exactly reckoned to be transparent and the general belief is that the statistics only tell the outside world what China's powers-that-be want us to believe.

So, what are the 'facts' as we know them? First and foremost, China is believed to be the world's largest gold producer, but here again we do not know for sure whether the announced gold production statistics includes those from a host of small mines which fall outside the general reporting framework, or whether it includes the byproduct gold from concentrate imports for the country's huge smelting and refining sector. On gold imports we really don't know how much of this, if any, goes into government warehouses and how much is actually bought by individuals. There is plenty of anecdotal evidence of strong demand from the Chinese public, but actual figures setting out the total amount purchased by this sector are somewhat lacking. Likewise, we do not know how much of China's own gold production is taken up by government and how much enters the general markets, if any. All we know is that China does not export gold—it only imports it thus soaking up a significant element of global gold output like a sponge. What comes in doesn't come out again!

If we take Chinese statistics at face value, then all this imported and home produced gold is taken up by individuals as the country's official gold reserves, as reported, have not risen at all since 2009 and total only 1,054 tons—less than 2% of China's foreign reserves, a minuscule amount in relation to the gold holdings of the world's biggest global economies like the U.S. and Germany both of which hold over 70% of their reserves in gold. But, and this is indeed a big but, in April 2009 China raised its official reserve figure by over 450 tons (by transferring it from a non-reportable pot into its official reserve)—is it doing the same again and raising its reserves without reporting any increase to the outside world? The likelihood is that it is, and it is possible that the increase in the reserve is substantial.

So what would be the reason for China not reporting any increase in its official reserve figure? The Chinese hold a huge amount of U.S. dollar related paper in its total forex reserve—estimated at around $3 trillion. If one follows the occasional statements from senior Chinese officials they feel that these dollars are devaluing through the U.S. Quantitative Easing programs and will continue to do so, so are keen to diversify out of dollar holdings into 'currencies' that, as they see it, maintain their value—like gold. If China announces a big gold reserve increase, the price of gold would likely rise sharply on the news, which would mean it would cost China more and more to increase its gold reserve. It thus makes sense for it to build its gold reserves at reasonable prices rather than have to buy at far higher price levels which would prevail if it was officially announced that its gold reserves had doubled, trebled, or even more.

If this is indeed the case, what level of gold in its reserve is China seeking to reach, and how quickly can it get there? There have been pointers to this in various statements by senior officials and it is thought there could be an initial target of around 5,000 tons—which would still only bring them up to around 8% of its forex holdings. And, perhaps a long term target of double this which would at least bring the figure up to around the same level as a country like Switzerland as a percentage of forex reserves. With its own annual gold output at around 350 tons, assuming all this is taken into reserves, it would take ten years or more to achieve the initial target alone. But there is a feeling that its gold reserves may, in fact, be growing faster than that by taking in some of the imported gold as well. But how much?

Another factor which demonstrates China's gold thirst is the number of Chinese companies moving into buying offshore gold producers—and given that, in effect, all these companies are state-owned or controlled (as is virtually any significant company) it does also demonstrate the overall official policy on gold. Some feel that China is building its reserves far faster than many think with a long term aim to allow the yuan eventually become the world's reserve currency replacing the U.S. dollar, with all the trade advantages such a change would bring. And to do this, so the pundits argue, it feels that its currency needs a strong gold backing. This day may be some years ahead but China, with its autocratic political system plans for the long term, while Western democracies seem mostly to only plan for the time until the next election.

Lawrence Williams

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