Playing The Long Game: How Big Are China's Real Gold Reserves?

by: Lawrence Williams

There is much speculation over the quantification of China's gold reserves. Are they only 1,054 metric tons as the official figures would have us believe? Or are they considerably higher as many gold analysts suggest? And what game is China playing if they are? The Chinese impact on global gold demand is key to likely gold price performance in the months and years ahead and thus of major significance for the investor in gold bullion, ETFs and gold stocks. China is already almost certainly the world's largest consumer of gold this year and is likely to absorb at least 1,500 metric tons of the yellow metal purely through imports through Hong Kong plus its own gold output - it is currently the world's No. 1 producer with 2013 output estimated as likely to be in the order of 430 metric tons by the China Gold Group.

Deep down the Chinese are great believers in gold and its role in both defining and protecting wealth. Now the country is the world's second biggest economic power and it is both keen to move into first place, as it undoubtedly will in a few years at its current growth rate. In China status and face are very important in the national psyche and what better way of showing its place in the world order by the two parallel achievements of building the world's biggest gold reserves and, by doing so helping it usurp the U.S. dollar as the global reserve currency. I would suggest that both these aims are achievable by the end of the current decade, if not earlier.

Recent analysis by Bloomberg's research department and by Philip Klapwijk, former joint chairman of GFMS before its purchase by Thomson Reuters, both suggest that this year China will be taking around 600 metric tons of gold into its reserves, although not reporting this to the IMF, thus keeping its official reserve status at the 1,054 metric tons it has been stated at since 2009. Indeed the Bloomberg research suggests that between 2009 and the end of 2012 China had accumulated a further 1,034 metric tons, and that by extrapolation of the most recent figures the country would be able to match the U.S. officially-stated gold reserve level in around ten years. The Bloomberg research also indicates that China will, by the end of the current year, have a total gold reserve of 2,710 metric tons - but still only amounting to a tiny fraction of its overall current account surplus.

But China is not transparent with the statistics it releases, particularly as far as gold is concerned. The only available official gold import figures are a throwback to the British colonial era when Hong Kong was a Crown Colony. Since China took over in 1997, Hong Kong has continued to report export and import statistics for gold and the net gold exports via Hong Kong into mainland China are heavily reported in the media - and considered as a proxy for total Chinese gold imports. But, is Hong Kong the only route by which gold finds its way to the Chinese mainland? Given China's huge land boundaries and other major entry ports such as Shanghai and Beijing it would seem unlikely that Hong Kong is the only port of entry for gold into China.

If this is indeed so then what the West seems to believe is the sum value of Chinese gold imports, for want of any other figures, may be substantially out of sync with reality and the detailed research figures by analysts such as those at Bloomberg and Thomson Reuters GFMS, who rely heavily on the Hong Kong figures, may substantially underestimate the true gold inflows into mainland China and thus the real rate at which Chinese gold reserves may be being expanded. Indeed some other analysts surmise that Chinese gold reserves may already be at the 5,000 metric ton level, or more. We just don't know for sure and won't know until the Chinese decide to announce a new total holding, whenever that may be.

How does China hide its Central Bank holdings and continue, with a straight face, to insist that it only has 1,054 metric tons in its gold reserves? Simple. It puts the newly acquired gold into some other government controlled account and then, at one fell swoop, moves it into its official Peoples Bank of China reserve holdings when it is considered politically expedient to do so and only then reports the new gold reserve level to the IMF. This is exactly what happened back in April 2009 last time it announced an upgrade to its gold reserves, quite happily then saying that this gold had actually been accumulated over the previous five years, but had not been taken into its official reserves until the new 1,054 metric ton current official level was announced to the world. This subterfuge allows government officials to continue to claim that its official reserve figure is unchanged.

What other evidence is there that China is surreptitiously building its gold reserves? Since 2009 there have been numerous statements by officials and academics that China should be building up its gold holdings to match those of the U.S. - and such statements are seldom made without being sanctioned by the government in such a controlled society. One can thus assume that this is indeed government policy and perhaps makes more sense of the huge known gold import figures into China this year in particular. Mineweb recently published a table detailing month by month net gold imports via Hong Kong so far this year and noted that the country has taken in over 100metric tons of the yellow metal in six of the nine months reported so far this year.

The latest such statement, which has raised some eyebrows in the west was in a commentary in the state-controlled Xinhua news agency - again the kind of comment that is unlikely to have been made without being sanctioned by government officials given its anti-American content and its call for a "de-Americanized world" and for the dollar to be deposed from its role as the global reserve currency, with all the trading advantages that come with that position. For those readers who have not yet read what is largely a diatribe against the U.S. and its foreign and financial policies I suggest you click here and read it in full.

Perhaps the most significant paragraphs in relation to the potential policy to replace the US dollar as the global reserve currency was as follows:

"What may also be included as a key part of an effective reform is the introduction of a new international reserve currency that is to be created to replace the dominant U.S. dollar, so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil in the United States."

That this heavy criticism of the Obama Administration's policies has appeared in a state-controlled media outlet at a time of a new leader taking over the top slot and guiding future policy in China in President Xi Jinping is, I would aver, unlikely to be coincidental. It suggests perhaps a less harmonious relationship between China and the U.S. during his Presidency which, if he is re-elected after his initial term, could last for ten years.

So what position would a much larger gold holding play in helping dethrone U.S. financial hegemony imposed by the dollar's principal reserve currency role? China sees gold as the ultimate currency and that holding the world's largest gold reserve will put it in prime position to topple the dollar from its current status - maybe not wholly at first, but over time.

What will this mean for the price of gold and for investors in gold related stocks, derivatives and bullion? As Chinese holdings of physical gold - private and government - get bigger and bigger and those in the West continue to diminish, China will soon effectively be able to move the global gold price to its advantage given government control over virtually all corporate financial entities including the banks and precious metals exchanges. Given the Chinese people's clamor for gold, partly state-induced, over the past few years and if the government wishes to raise Chinese middle class wealth it would thus be capable of enabling the price to rise globally if that is felt to be politically expedient. However, in the meantime it may well be happy to let prices remain weak so that it can continue to build up its gold reserve holdings as cheaply as possible.

If we are correct in our assumptions, and much of the available evidence suggests we are, then be prepared for an extended period of effective Chinese dominance of the gold price as it builds its holdings and moves toward replacing the dollar with the yuan as the principal world trading currency. It has already entered bilateral yuan-based trade agreements with some countries as the precursor to this. It could get to a stage that if it feels politically expedient to do so it could use its gold holdings to aid in bringing the dollar crashing down and destabilizing the U.S. and other Western economies. China plays a long game and gold looks like being one of its most significant financial weapons.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.