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Will China Buy the IMF Gold

Will China Buy the IMF Gold

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Published by michael s rozeff
It is unlikely that China will buy the IMF gold that is for sale. The article provides the reasons for this judgment. I judge also that the gold market does not anticipate a large China purchase, so that if it does happen, it will likely be a positive for the price of gold.
It is unlikely that China will buy the IMF gold that is for sale. The article provides the reasons for this judgment. I judge also that the gold market does not anticipate a large China purchase, so that if it does happen, it will likely be a positive for the price of gold.

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Published by: michael s rozeff on Mar 15, 2010
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Will China Buy the IMF Gold?
 by Michael Rozeff I assign a low probability to China buying gold from the IMF near or even 10-15 percent belowcurrent prices. All opinions in this article are based solely on published news reports and nothingelse. A number of reasons for my opinion are presented below.(1) To begin with, China hasn’t bought the IMF gold up to now, and it has had plenty of time todo so. Action, in this case inaction, speaks louder than words. China also has had the opportunityto buy gold in the non-China open market for years, that is, to buy gold from sources other than production within China. It hasn’t done so.(2) Chinese officials are constantly being told by Chinese commentators, economists, professors,and those with an interest in gold that it should buy more gold. The amounts they suggest are far in excess of China’s local production, so that these advisors are really telling the Chinesegovernment to go into the external market or buy from the IMF. So far, the government hasignored this advice, unless they are acting secretly. Instead, they are augmenting their gold stock in their own way by buying up local production, and at their own pace, which is gradually.Gradualness is in accord with the gradualness observed in allowing appreciation in the yuan andin opening China to capital flows.(3) When asked about their gold intentions, Chinese officials recite a litany of reasons for notgoing into the market. For one thing, they say that the price is too high. They’ve been saying thisfor the last $500 of price rise. For example, here is what one news article dated May 11, 2006wrote:“The mainland government is being urged by local economists to boost its gold reserves.But the country may find bullion too expensive to buy at current 25-year highs aboveUS$700 (HK$5,460) an ounce, traders said.“‘They won't buy at this level, it's too high,’ said Ellison Chu of Standard Bank Asia inHong Kong. ‘They might be there buying if the price were US$400 or US$500.’”Mr. Chu was listening to what the officials said, and if we search enough we can find their directstatements that prices are too high. Whether or not this reason makes any sense as a policy todirect gold investment, this is what they say. If they didn’t buy in bulk years ago at $700, they’renot going to buy in bulk now at $1,100.(4) Another reason they give is that they don’t want to drive up the price by their own buying.Then they say that no matter how much they can reasonably buy, it’s not that much compared totheir mountain of reserves. They sometimes suggest that gold is a risky investment. And they topit off by saying that gold isn’t that hot an investment over a 30-year period. Whatever the validityof these arguments is or isn’t, they trot them out all the time. Some of these arguments areexamined below.(5) When China recently announced that its gold reserves had risen, one press report told us:
“‘The public nature of today's disclosure casts doubt on whether China is aiming to buygold on the international market,’ J.P. Morgan analysts wrote in a note e-mailed toreporters late Friday.”(6) There has been one important change in the picture, and that is the sovereign wealth fundnamed the China Investment Corporation (CIC). It seems that after some internal debate or in-fighting, the Chinese decided to become more aggressive in their investment policy. They fundedthe CIC with $200 billion in 2007. In early 2010 we learned that CIC had purchased a $155million stake in GLD, the gold etf. The more gold they buy through this vehicle, the less likelythey are to buy the IMF gold.(7) There are rumors that China prefers to buy gold mines directly.(8) Then we have this Bloomberg news report from last September:“China may purchase some of the 403.3 metric tons of gold being offered by theInternational Monetary Fund, Market News International reported, citing twounidentified government sources.“China will consider the purchase to diversify its reserves if the price is right and the potential return relatively high, the report said, citing one of the sources. There is noindication China is seeking to buy all of the gold on offer, the report said, citing no one.”Since the price isn’t “right” for them and they are worrying about the return, and since there areno indications they are seeking to buy the gold on offer, even in part, we have another signal thata big gold purchase by China from the IMF at current or near-current prices is a low probabilityevent. Naturally, there is
probability that China
make this purchase. The important questionfor gold investors is the extent to which the gold market has or has not discounted a gold purchase from the IMF by China. If it has not discounted it or not discounted it fully, that is, if itdoes not anticipate such a purchase or assigns it only a low probability, then such a purchasewould be a surprise and probably send price higher. It would indicate a greater-than-expecteddegree of urgency on the part of China to amass a gold reserve. It would indicate that China has agreater-than-expected intent to speed up making the yuan an international currency. On the other hand, if the market already anticipates a Chinese gold purchase from the IMF, then the actualannouncement would probably occasion a short-lived rally followed by a decline with the goodnews being out. This would follow the adage to buy on the rumor and sell on the news. Now, some other supplementary thoughts on the matter. Big blocks of gold for sale are probablynot easy to locate in the gold market. If someone wants to buy 200 tons and has a choice of  buying in one fell swoop or dribbling buy orders into the market, which is preferable? If the big buyer attempts to buy gradually, the word will get out and the market will sense it. It will frontrun the buyer and drive up prices ahead of the buyer’s purchases. If the buyer makes a one-timelarge purchase from a private seller like the IMF, this type of price effect is avoided, although a
different kind of price effect may occur as discussed in the next paragraph. On this considerationalone, it seems to me that it’s rational to make the one-time large purchase if one can find such aseller rather than make a long series of small purchases. If China hasn’t done this up to now,what are they waiting for? They are probably not going to do it.Admittedly, it’s true that if such a large purchase is made that the market price might still rise.The market price will rise if the market infers positive information from the purchase itself. Itmight infer that more such purchases are on the way or that more and more central banks willstart competing for the limited supply of gold. Or it might infer that investment demand will bemore assured once China has taken such a step. And in that case China may be faced with ahigher price in the future. That is what their officials keep saying is the reason they do not intendto make a large purchase. On the other hand, if China merely laid back for awhile and if the IMFoffered no more large blocks of gold for sale, the market would probably settle down. Indeed,some traders might think that China had sated itself on gold for awhile and would not be in themarket again for awhile. In other words, the effect on price of a large purchase a few monthsafter it is made is ambiguous. Furthermore, China could easily dampen expectations byannouncing that this was a one-time opportunity and that it did not expect it would be repeated inthe immediate future. So if this reason for not buying is not that credible and if China still has notmoved ahead on a purchase, maybe it’s because it sees no urgency in the matter.Why might it see no urgency? If it buys a big block, it may send a signal that it distrusts thedollar more than it has already let on. This could hurt the value of its portfolio of dollar-denominated bonds if the dollar falls. Furthermore, other matters are more urgent.There is one more consideration. Apart from the CIC move, which was something of a break intradition, the reserve accumulation and management seems to have been a foot-dragging matter for some years now. Gold was not an item of concern to the economist-officials. Economistsdon’t think about gold much. They think about exchange rates and related matters like the effecton factory activity and labor. In July of 2005 we read“China should move toward a ‘managed’ yuan float rather than a ‘simple revaluation’’ or a re-pegging to a basket of currencies, state news agency Xinhua said, citing interviews by Outlook Weekly with the deputy director at the National Development and ReformCommission and an unidentified central bank official.“China’s labour costs are too low for a revaluation to have a meaningful or lasting effecton inflows of foreign direct investment or the country’s growing trade surplus, the reportcited the central bank official as saying.“Repegging the yuan at a level that eliminates China’s labour cost advantage would dotoo much harm to exporters, it said.”On May 22, 2005, we were told“China should make more varied use of its foreign exchange and try to boost investmentreturns as it deals with a weakening US dollar, the head of the nation's foreign exchange

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