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Last week I referenced gold-related comments made by Ji Xiaonan, a senior Chinese official at SASAC (the Chinese body governing state-owned companies). According to China’s Youth Daily, Mr. Ji stated that China had set up a task force to look into the country’s gold reserves. According to his comments, the task force recommended that China’s gold reserves hit 6,000 tons in 3-5 years and 10,000 in 8-10 years. This week, Hu Xiaolan, a Vice Governor of the People’s Bank of China (PBOC), took a more measured approach. He cautioned that the soaring gold price in recent months resembled a commodity bubble.

Irrespective of the various statements, let’s think through the implications of what it means to have 6,000 tons worth of gold reserves and whether or not it is feasible.

First, it is nearly impossible to purchase a few thousand tons of gold each year in the spot market. As a point of reference, the current demand for gold is around 4,000 tons per year while current mine production is around 2,500 tons. While China could purchase some amount of spot gold, it can’t purchase too much without massively moving the market price.

Where else could China get its hands on thousands of tons of gold? In theory, the PBOC could purchase gold swaps from other central banks. But which central banks have that much gold? Several thousand tons per year is still a huge amount. Currently only the U.S. (8,134 tons) and Germany (3,408 tons) have sizeable enough reserves. And why would they sell?

As mentioned in previous postings, China has US$2.3 trillion in foreign exchange reserves, and roughly US$1 trillion or so in dollar-denominated treasuries. It seems logical that China would want to diversify. However, if China were to increase its gold reserves, it would likely take the form of a multifaceted approach:

(a) Domestic mining: Last year, China surpassed South Africa as the world’s largest gold producer. Many large state-owned gold companies are steadily exploring, producing, and increasing their reserves. One example: China Gold Corp, a firm trading on the Shanghai Stock Exchange, has roughly 1,000 tons worth of reserves, including the “Yangshan Mine,” the single largest gold reserve in Asia, containing 308 tons of proven reserves. Scores of other firms are mining gold throughout the country.

(b) Overseas acquisitions: Chinese firms are increasingly going outbound. This week alone, Zijin Mining announced that it will acquire ASX-listed Indophil Resources for roughly US$500 million. Indophil is an important copper-gold operation in the Philippines. Its “Tampakan” copper and gold project contains estimated mineral resources of 2.4 billion tons including 13.5 million tons of copper and 15.8 million ounces of gold. Dozens of other Chinese firms are acquiring resources in Africa, Southeast Asia, and now in Latin America.

(c) Spot market purchases: While it may be difficult for China to purchase large quantities on the spot market as mentioned above, it is not inconceivable that China could opportunistically purchase spot on the dips.

6,000 tons of gold equates to roughly 190 million ounces. At US$1,200 per ounce this is worth US$230 billion dollars—an amount equivalent to roughly half the GDP of Switzerland. A lot of money, no doubt. While it seems unlikely that China will achieve the 6,000 ton figure in the next 3 years, those of us that live here note that the country has a remarkable ability to surprise even the greatest of skeptics.

Disclosure: No positions

Source: China's Gold Reserves (Part 2)