The world reacted cautiously after S&P downgraded America’s long term from AAA to AA+. Among them, China, the largest foreign US debt holder, offered the harshest criticism, scolding the US for its reckless spending behavior and warning that the “Good Old Borrowing” days are over for the US. China is rightfully worried about the devaluation of its US debt holdings, which are valued at more than $1.1 trillion. China has been gradually reducing its US debt holdings and increasing the eurozone bond holdings since October 2010. Government data showed that in the first five months of 2011, China reduced its holdings marginally by $300 million. During the same period, Standard Charting Bank estimated that China purchased $24 billion worth of German and France AAA grade bonds and $72 billion worth of European Corporate bonds.
Many analysts believe that China might not have any other alternative than to continue to buy US debt. China’s foreign reserves approached $3.2 trillion at the end of June, a 30% yoy increase. Both euro and Japanese debt markets are just not big enough or liquid enough to accommodate China’s foreign reserves. The ongoing eurozone crisis and sluggish Japanese economy have made things worse. As long as China continues its currency sterilization policy and the US is China’s biggest trade partner, the Chinese’s hands are tied.
How about gold? In spite of being the largest foreign reserve nation, China's gold reserves rank sixth in the world. China only holds 1,054 tons gold, 1/8 of the US’s. It accounts for only 1.6% of the total Chinese reserve assets when comparing to a typical 60-70% of a developed nation, and 74% for the US. It makes perfect sense for China to pull away from US treasuries and bump up its gold reserves. Many analysts believe that it is inevitable for China to add more to its gold reserves, especially since China aims to become a reserve currency.
Then again, it begs the questions: Why now? Why not earlier? US debt issues have been raised for many years. China has been talking about diversification of its reserves for many years as well. The gold price is currently at its all-time high, closing in on the $1,700 mark. Almost all the bad news, such as the US downgrade, possible double dip, incoming inflation and eurozone crisis, are already baked into the price. Furthermore, any aggressive movement from China will push the price much higher. So is China too late in the gold rush?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.