Why China Wants Its Citizens to Buy Gold

Includes: FXI, GLD
by: One Eyed Guide

Ed Steer, in his September 17 column, pointed out Simon Black's report that China was urging citizens to buy gold as an indicator that gold demand was building. Well, this certainly will build demand for gold but the Chinese government is probably not doing it because of any fundamental belief that the dollar will devalue or gold will skyrocket in price.

From an economic and budget basis, getting their citizens to buy gold instead of putting money in banks or government bonds is a way of getting zero interest financing for their stimulus programs. This is also an excellent way to soak up excess cash and head off a mania in real estate or stocks. Currently the Chinese people save approximately 20% of their income and if they invested this in real estate or stocks, there would be a tremendous bubble. The Chinese market has already gone up 54% in the last year vs. the S&P500's negative 11%.

So, China is pushing citizens to buy gold to finance their deficit and pull money out of the real estate and stock market, not for any other reason. As China mines all the gold that it sells, the net effect should be a reduction in global supply but the sales should not increase demand outside of China. While this is long-term bullish for gold, it will not affect the short-term market dynamics, which seem to be more dependent on cash flows from hedge funds and bullion banks.

The Chinese government's gold play may also be a way of hedging against a fall in the dollar without selling the government's US bonds, which would send the dollar into free fall and increase China's export problems.

The Chinese government gold actions are probably negative for the dollar, negative for the Chinese stock market, neutral for short-term gold demand outside of China and long-term positive for gold by reducing supply outside of China.