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We’re watching China with one eye on the gold price.

Two recent events offer insights into China’s future gold plays... China has stopped buying US Treasuries and started to dump them, and China has started accumulating gold positions.

China looks to diversify

On Tuesday, 16th February, the U.S. Department of the Treasury released Treasury International Capital [TIC] data for December 2009. It revealed that China sold over $34 billion Treasuries in December ’09. By effect, Japan overtook China as the biggest foreign holder of US Treasuries.

It’s not clear if China has been accumulating Treasuries via a different, overlooked method, and it should also be noted that this is one month... it cannot be taken for a trend until further months reinforce it.

However, the implications are already circulating the markets. It has long been predicted that a time will come that the reliance of China on the US dollar will force their hand to diversify into other currencies and assets [see our article China’s lack of gold reserves and its young gold mining industry].

With competing foreign reserve currencies all under strain, including the euro and sterling, the dollar has had a brief rally which looks set to continue for the immediate future. But, as we’ve noted before, the dollar rally is usually measured against other weaker currencies like the euro. This creates an illusion of strength. If you look at it in terms of stronger currencies such as the Canadian dollar and assets such as gold, it has hardly moved.

The point is the dollar, whilst undergoing a resurgence, still faces an uncertain future. It’s looking good because alternatives are looking weak. Now China, and other countries holding dollars, must bet on whether the dollar will rise, and decide when to use that to buy gold.

The IMF gold sale

Last week, the IMF announced plans to sell 191.3 tonnes of gold bullion in a second leg of a grander plan which will see it offloading 403 tonnes of its reserves. The initial sale was announced to India back in October ’09.

With the dollar positions of many countries taken into account, the recent announcement by the IMF to continue its second leg of a gold sale should have spurred a competition between countries. This is likely to be one of the only times they will be able to get their hands on such a large quantity of the physical commodity in the near future.

There are other, cheaper ways to accumulate gold and gold positions. Gold mining companies can produce gold typically at a cost of between $400 to $550 per troy ounce... which means Chinese owned gold miners can add to their reserves at a considerable discount. But this IMF sale is a chance to accumulate a sizeable hedge against their dollar positions with one move.

So far nothing has happened, but will the average Joe ever be part of the information feed?... Not whilst it’s happening. The news will no doubt filter through once everything has been decided.

We believe China will accumulate more gold positions going forward. And in recent weeks events have signified that they are doing just that... China has increased its exposure to the gold price by buying positions in gold ETFs and gold leveraged mining companies.

China buys into SPDR (NYSEARCA:GLD) ETF

Last week it was revealed that China Investment Corp., the nation’s sovereign wealth fund, took a 1.45 million share stake in the SPDR Gold Trust worth $155.6 million. This is the equivalent of 145,000 ounces of bullion.

Recently CNCG (China National Gold Group Corp), a Chinese, government-owned mining conglomerate, announced plans to transfer several of its gold mine assets to Jinshan Mines (OTCPK:JINFF), as well as promising to acquire more projects through its Vancouver based subsidiary.

Both the move into ETFs and the promise to acquire more gold based mining companies signifies strength in the gold price.

We’ve long held the opinion that it will be countries looking to diversify into gold that will trigger the next gold rally, and this looks likely to happen over the coming months and years ahead.

How, therefore, will a dollar rally influence the gold price?

As we’ve noted before, there is a strong inverse relationship between the dollar and gold. This is likely to be tested over the next few years. If the US economy recovers from the situation it now faces, and economic conditions in alternative markets sour, then inevitably the dollar could continue its rally. And typically this would signify a bearish gold price. However, in times like these it could also be plausible that gold will also benefit from problems in global markets given its role as an alternative currency.

The most bullish case for gold is against the euro and sterling. In this scenario there is a possibility of gold and the dollar rising together as both attract interest from sovereign funds, central banks and private investors.

If the dollar continues to gain strength as a result of further economic woes from Europe, and continues to display weak economic conditions itself (as seen in high unemployment and a weak housing market) countries with large dollar reserves are likely to consider cashing in on the dollar’s rise.

With few alternatives to compete with, gold looks likely to be a beneficiary of current economic conditions in the long term.

We look to see what will happen as the price of gold moves forward with the problems of Europe and America still in the forefront of investors’ minds. It promises to be an unclear but exciting time for bullion investors.

Disclosure: No positions

Source: Insights Into China's Future Gold Plays