There have been plenty of articles on how gold is moving from West to East. But since the gold price continues to flounder, does the shift really matter?
The answer to that question isn't as simple as one's timeframe. Sure, the Chinese are long-term planners compared to the West, but they also think differently about gold. They view gold in the context of its role throughout history and dismiss the Western economist who arrogantly declares it an outdated relic. They buy in preparation for a new monetary order, not as a trade they hope earns them a profit.
Consider these contrasts…
The West sees gold as an investment, and something that should be sold at the first sign of weakness, while the Chinese view it as money and as the most secure store of value.
The typical Western mainstream analyst explains the weak gold price due to a rising yuan making it more expensive in China and thus softening demand, vs. the Chinese government and citizens who explain nothing and continue to buy on every price dip.
The West wants to know how much money they'll make; China accumulates it in preparation for the inevitable global shift away from the US dollar and the various crises that will spring up from that turbulent transition.
Combine gold's historical role with current events, and we would all do well to view our holdings in a slightly more "Chinese" light, one that will give us a more accurate indication of whether we have enough, of what purpose it will actually serve in our portfolio, and maybe even when we should sell (or not).
The horizon is full of flashing indicators that signal that the Chinese view of gold is more prudent for what lies ahead. Gold will be less about "making money" and more about preparing for a new international monetary system that will come with historic consequences for our way of life.
Let's contrast some recent Western headlines with what's really happening on the ground in China. Consider the big picture message behind these developments, and see how well your portfolio is geared for a "Chinese" future…
This headline comes from mainstream claims that China is buying less gold this year than last. One report cites a 30% drop in demand during the "Golden Week" holiday period that began on May 1. Another points to net imports from Hong Kong into China being only 80.6 tonnes in March, down from 111.4 tonnes in February and 130 tonnes a year ago. "The buying frenzy, triggered by a price slump last April, has not been repeated this year," says one report.
However, these data are misleading. First, Q1 net imports into China via Hong Kong hit 275.6 tonnes, compared to 210.5 tonnes a year ago, a 31% increase. Further, you'll recall 2013 was a runaway year for Chinese imports; as much as 1,160 tonnes of gold went through Hong Kong.
But the bigger flaw in the headline isn't the cherry-picking timeframes or the comparison to a banner year. What's overlooked is that the Chinese government now accepts gold imports directly into Beijing.
In other words, some of the gold that normally went through Hong Kong is instead shipped to the capital. And these shipments are essentially done in secret.
China undoubtedly made this move so their import figures can't be tracked. It allows Beijing to continue accumulating physical gold without the rest of us knowing the amounts. This move doesn't imply demand is falling, but just the opposite.
A number of analysts (and gold bugs) expected China to announce an update on their gold reserves in April. This is because it was widely believed China reported every five years. That is not only inaccurate, it misses a crucial point.
First, Beijing publicly reported their gold reserve amounts in the following years:
500 tonnes at the end of 2001
600 tonnes at the end of 2002
1,054 tonnes in April 2009.
Prior to this, China didn't report any change for over 20 years; they had 395 tonnes from 1980 to 2001.
There is no five-year schedule. There is no schedule at all. They'll report whenever they want, and—this is the crucial point—probably not until it is politically expedient to do so.
Depending on the amount, the news could be a major catalyst for the gold market.
Almost every report you'll read about gold reserves measures them in relation to their total reserves. The US, for example, has 73% of its reserves in gold, while China officially has just 1.3%.
But this calculation is misleading. The US has minimal foreign currency reserves—and China has over $4 trillion. The denominators are vastly different.
A more practical measure would be to compare gold reserves to GDP. This would tell us how much gold would be available to support the economy in the event of a global currency crisis, something Chinese leaders view as inevitable and are clearly preparing for.
The following table shows the top six holders of gold in GDP terms (Eurozone countries are combined into one). Notice what happens to China's gold-to-GDP ratio when their holdings move from the last-reported 1,054-tonne figure to an estimated 4,500 tonnes (a reasonable if not conservative figure, based on import data).
|Value US$ B
|GDP US$ B
|*including 503.2 tonnes held by ECB|
|Sources: World Gold Council, IMF, Hard Assets Alliance proprietary calculations|
At 4,500 tonnes, the ratio shows China would be on par with the top gold holders around the world. In fact, they would hold more gold than every country except the US. This is probably a more realistic gage of how they determine if they're closing in on their goals.
If so, we might see an announcement on their updated gold reserves sometime within the next year. My estimate might be high—or maybe they won't be satisfied with 4,500 tonnes. Sooner or later, though, they'll tell us what they have, and probably at the point at which they'd be happy to see the price rise going forward.
Don't forget that China is already the largest gold producer in the world, does not export in any meaningful amount, and reportedly now has the second largest in-ground gold resource in the world.
Most mainstream analysts point to the slowing Chinese economy as one big reason the gold price has stalled at current levels. China is the world's largest gold consumer, so on the surface this would seem to make sense. But is there a direct connection between its GDP and the gold price?
Over the past six years, there has been a slight inverse relationship (-0.08) between Chinese GDP and the gold price, meaning they act differently slightly more often than they act the same. The Western belief as characterized above is thus wrong. The data signal that, if China's economy were to slow, gold demand won't necessarily decline.
The fact is, demand is projected to grow for reasons largely unrelated to whether GDP ticks up or down. The World Gold Council estimates that China’s middle class is expected to grow by 200 million people, to 500 million, within six years (the entire population of the US is only 320 million). They thus project that private sector demand for gold will increase 25% by 2017, due to rising incomes, bigger savings accounts, and continued rapid urbanization. (170 cities now have over one million inhabitants.) Throw in China's deep-seated cultural affinity for gold and a supportive government, and the overall trend for gold demand in China is up.
One lament from gold bugs is that the price—regardless of how much physical metal is bought around the world—is largely a function of what happens at the Comex in New York.
One reason this is true is because the West trades in gold derivatives, while the Shanghai Gold Exchange (SGE) primarily trades in physical metal. The Comex can thus have an outsized impact on the price, compared to the amount of metal physically changing hands. Volume at the SGE is thin, compared to the Comex.
But a shift is underway…
In just the past 30 days, China has approached foreign bullion banks and gold producers to participate in a global gold exchange in Shanghai, because as one analyst put it, "The world's top producer and importer of the metal seeks greater influence over pricing." The bullion banks include HSBC, Standard Bank, Standard Chartered, Bank of Nova Scotia, and the Australia and New Zealand Banking Group. They've also asked producing companies, foreign institutions, and private investors to participate.
The global trading platform was launched in the city's "pilot free-trade zone," which could eventually challenge the dominance of New York (and London). This is not a proposal; it is already underway.
Further, the enormous amount of bullion China continues to buy reduces trading volume in North America. The Chinese don't sell, so that metal won't come back into the market anytime soon, if ever. This concern has already been publicly voiced by some on Wall Street, which gives you an idea of how real this trend is.
There are other related events, but the point is that, going forward, China will have increasing sway over the gold price (as will other countries; the Dubai Gold and Commodities Exchange is to begin a spot gold contract within three months).
In spite of its problems, the US dollar is still the backbone of global trading. "It's the go-to currency everywhere in the world," says the government economist. When a gold bug (or anyone else) claims the dollar is doomed, they laugh.
But who will get the last laugh?
You likely read about the historic energy deal made between Chinese President Xi Jinping and Russian President Vladimir Putin last month. Over the next 30 years, about $400 billion of natural gas from Siberia will be exported to China. Roughly 25% of China's energy needs will be met by 2018 from this one deal. The construction project alone will be one of the largest in the world. The contract allows for further increases, and it opens Russia to other Asian countries as well. This is big.
The twist is that transactions will not be in US dollars, but in yuan and rubles. This is a serious blow to the petrodollar.
While this is a major geopolitical shift, it is part of a larger trend already in motion…
President Jinping proposed a brand-new security system at the recent Asian Cooperation Conference that is to include all of Asia, along with Russia and Iran, and exclude the US and EU.
Gazprom has signed additional agreements with consumers to switch from dollars to euros for payments. The head of the company said that nine of ten consumers have agreed to switch to euros.
Putin told foreign journalists at the St. Petersburg International Economic Forum that "China and Russia will consider further steps to shift to the use of national currencies in bilateral transactions." In fact, a yuan-ruble swap facility that excludes the greenback has already been set up.
Beijing and Moscow have created a joint ratings agency and are now "ready for transactions… in rubles and yuans," said the Russian Finance Minister Anton Siluanov two weeks ago. Many Russian companies have already switched contracts to yuan, due to fears of greater Western sanctions.
Beijing already has in place numerous agreements with major trading partners, such as Brazil and the Eurozone, that bypass the dollar.
You don't need a crystal ball to see the future for the US dollar; the trend is clearly moving against it. An increasing amount of global trade will be done in other currencies, including the yuan, which will steadily weaken the demand for dollars. It will be chaotic at times, as transitions this big come with complications, but the process necessitates a weaker dollar.
The upshot is that there will be consequences for every dollar-based investment. As a US-dollar holder, your hope is that this process is gradual. If it happens suddenly, all US-dollar based assets will suffer catastrophic consequences. In his new book The Death of Money, Jim Rickards believes this is exactly what will happen.
The result for citizens will be high inflation, perhaps runaway inflation—and much higher gold prices.
Only a deflationary bust will keep the gold price from going higher at some point. That is still entirely possible, yet even in that scenario, gold would "win" as most other assets crash. Otherwise, a mid- to high-four-figure price is in the cards.
But remember, it's not about the price. It's about the role gold will serve in response to a major currency upheaval that will severely impact your finances, investments, and everyday way of life.
Most advisors who look out to the horizon and see the same future China sees believe you should hold 20% of your investable assets in physical gold bullion. I agree. Anything less will probably not provide the kind of asset and lifestyle protection you'll need.
Continue to buy gold. China's got your back.
Jeff Clark is editor of BIG GOLD, and a regular contributor to the Hard Assets Alliance.
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