China Greenlights Gold: The Secret and Not-So-Secret Plan

What if you learned that China was about to push world gold prices much higher? Would you believe it? Would you act now?

I wrote last year that China had been secretly building its hoard of gold reserves. As a result it had suddenly become the world's fifth largest holder of bullion. This hush-hush process had been going on for six years.

Nobody was sure how China had managed to gather more than 1,000 metric tons of gold without alerting gold bugs worldwide. After all, any ordinary purchase through the IMF would become public almost immediately.

But that didn't happen.

Beijing said it had bought all that bullion quietly from Chinese mines. But gold-watchers at the Standard Bank said no. They believed that China had been buying gold through secret government channels from South Africa, Russia and South America. You will see why that matters today in just a moment.

Gold prices have ballooned by 34% since I first wrote about Beijing's secret gold hoard in April of last year. So what would happen in Chinese demand for gold rose even more dramatically?

Well, that's exactly what's about to happen. And it's not entirely a state secret this time.

Beijing Goes for Gold in a Big Way

Imagine that every new signal China is buying gold is a green light. If so, I see more green lights flashing right now than I have ever seen before.

Green Light #1: China is actively promoting consumer investment in gold.

China is urging retail investors to buy gold. It is creating many new gold-backed products to tempt new investors.

Most recently, the World Gold Council made a deal with the world's largest bank, the Industrial & Commercial Bank of China (ICBC), to co-operate to promote gold investments in China.

Why? One reason is to drive speculators away from the overheated real estate market and into precious metals. It is working. Over the past five years, China's gold consumption has grown at a rate of 13 percent per year.

Now that is rate accelerating.

Retail investment in bars and coins jumped by 17% year-over-year during the fourth quarter of 2009. But that's not enough for Beijing. The People's Bank of China is ordering retail banks to actively develop more yuan-denominated gold derivatives and gold-backed financial products.

The central bank has also ordered the Shanghai Gold Exchange and commercial banks to engage more actively in developing a nationwide gold market. So it's not surprise that the market for new bullion products like gold savings accounts, gold bars and gold commemorative items is growing by leaps and bounds.

Green Light #2: China will now let more banks import and export gold.

Green Light #3: China will also open gold trading to foreign companies.

Why would China open its shrouded markets to the world? After all, China is already the world's largest gold producer.

Well, China obviously wants more gold. Tons and tons of it.

The total volume of gold traded on the Shanghai Gold Exchange soared to 3,100 metric tons in the first half of 2010. Turnover jumped by 59 percent. Exchange volume was triple the amount of gold known to be in the national reserve.

But China produced only 313 tons of gold last year. Yet demand is expected to top 420 tons.

China's slice of worldwide gold demand widened to an astonishing 11 percent last year. China's global share has more than doubled since 2002. And the World Gold Council says China's bullion consumption is likely to double yet again in the next decade.

Opening to global markets is essential to keep supply and demand in balance. China has no choice but to open to the world.

Green Light #4: China is going global for new gold sources.

China's central bank is now backing globalization of Chinese ownership in the gold industry. Beijing does not take such steps by half measures. Just take a look at China's aggressive push into the world's oil industry.

Now the People's Banks says it will support overseas investment plans by "large-scale" bullion companies. "Large scale" is Beijing's wording, not my own. The central bank will provide financial backing for Chinese companies looking to get into the gold business in a big way.

China will also increase the number of foreign members on the Shanghai Gold Exchange. Beijing will also "study ways to allow foreign qualified bullion suppliers to deliver to the exchange."

Stand by for buy-outs and mergers in the world's gold mining industry! China will have major mining companies and smelters on its shopping list.

China's Hidden Gold Market

There's one facet of the Chinese gold market we rarely hear about. No one outside of Beijing really knows exactly how much bullion is being poured into the nation's foreign reserves. It is a state secret.

Six years went by before China last announced its holdings of gold. Since then there has been silence on the subject except for one statement. The State Administration of Foreign Exchange (SAFE) says gold is unlikely to become a major holding in China's foreign reserves owing to the metal's big price swings and lack of interest payments.

Green Light #5: China is almost certainly stockpiling even more gold.

China has very good reason to keep quiet about its gold purchases. Any announcement that Beijing had become a big buyer of gold would drive the price through the roof. China also wants to maintain confidence in its huge U.S. dollar holdings, arguing that dollar investments provide "relatively good" safety, liquidity, and low trading costs. Hardly a ringing endorsement.

In fact, China's purchases of U.S. dollar financial instruments have been leveling off. Yet Chinese foreign exchange surpluses are on the rise. And Beijing's latest moves will make it much easier for China to acquire gold for its reserves on world markets without raising alarm (and raising prices).

One thing we can be sure of. China has not stopped adding to its gold reserves. That means China's demand is growing more quickly than we are able to track.

Increased demand from the world's most populous nation suggests higher prices are on the horizon.

Disclosure: No positions