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by Michael Rozeff I assign a low probability to China buying gold from the IMF near or even 10-15 percent below current prices. All opinions in this article are based solely on published news reports and nothing else. 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 to do so. Action, in this case inaction, speaks louder than words. China also has had the opportunity to 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 Chinese government to go into the external market or buy from the IMF. So far, the government has ignored 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 and in opening China to capital flows. (3) When asked about their gold intentions, Chinese officials recite a litany of reasons for not going into the market. For one thing, they say that the price is too high. They’ve been saying this for the last $500 of price rise. For example, here is what one news article dated May 11, 2006 wrote: “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 above US$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 in Hong 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 direct statements that prices are too high. Whether or not this reason makes any sense as a policy to direct gold investment, this is what they say. If they didn’t buy in bulk years ago at $700, they’re not 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 to their mountain of reserves. They sometimes suggest that gold is a risky investment. And they top it off by saying that gold isn’t that hot an investment over a 30-year period. Whatever the validity of these arguments is or isn’t, they trot them out all the time. Some of these arguments are examined 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 buy gold on the international market,’ J.P. Morgan analysts wrote in a note e-mailed to reporters late Friday.” (6) There has been one important change in the picture, and that is the sovereign wealth fund named the China Investment Corporation (CIC). It seems that after some internal debate or infighting, the Chinese decided to become more aggressive in their investment policy. They funded the CIC with $200 billion in 2007. In early 2010 we learned that CIC had purchased a $155 million stake in GLD, the gold etf. The more gold they buy through this vehicle, the less likely they 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 the International Monetary Fund, Market News International reported, citing two unidentified 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 no indication 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 are no indications they are seeking to buy the gold on offer, even in part, we have another signal that a big gold purchase by China from the IMF at current or near-current prices is a low probability event. Naturally, there is some probability that China will make this purchase. The important question for 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 it does not anticipate such a purchase or assigns it only a low probability, then such a purchase would be a surprise and probably send price higher. It would indicate a greater-than-expected degree of urgency on the part of China to amass a gold reserve. It would indicate that China has a greater-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 actual announcement would probably occasion a short-lived rally followed by a decline with the good news 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 probably not 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 front run the buyer and drive up prices ahead of the buyer’s purchases. If the buyer makes a one-time large 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 consideration alone, it seems to me that it’s rational to make the one-time large purchase if one can find such a seller 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. It might infer that more such purchases are on the way or that more and more central banks will start competing for the limited supply of gold. Or it might infer that investment demand will be more assured once China has taken such a step. And in that case China may be faced with a higher price in the future. That is what their officials keep saying is the reason they do not intend to make a large purchase. On the other hand, if China merely laid back for awhile and if the IMF offered 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 the market again for awhile. In other words, the effect on price of a large purchase a few months after it is made is ambiguous. Furthermore, China could easily dampen expectations by announcing that this was a one-time opportunity and that it did not expect it would be repeated in the immediate future. So if this reason for not buying is not that credible and if China still has not moved 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 the dollar more than it has already let on. This could hurt the value of its portfolio of dollardenominated 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 in tradition, 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. Economists don’t think about gold much. They think about exchange rates and related matters like the effect on 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 Reform Commission and an unidentified central bank official. “China’s labour costs are too low for a revaluation to have a meaningful or lasting effect on inflows of foreign direct investment or the country’s growing trade surplus, the report cited the central bank official as saying. “Repegging the yuan at a level that eliminates China’s labour cost advantage would do too 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 investment returns as it deals with a weakening US dollar, the head of the nation's foreign exchange
regulator said. “The official Xinhua news agency quoted Hu Xiaolian, head of the State Administration of Foreign Exchange, as saying that China also needed to continue to encourage local companies to invest abroad. “The report gave no further indications of how China might expand the investment channels for its foreign exchange. China had reserves of 659 mln usd as of the end of March. “Beijing has also been encouraging companies to invest abroad as part of what it calls its 'go out' policy. It has been particularly keen on offshore investments aimed at securing vital raw materials. “Hu also said China must improve the management, including risk management, of its foreign exchange reserves, according to the Xinhua report.” Gold was not high on the agenda in 2005 and probably still isn’t, and neither were the reserves or their management. Their great size and concentration in dollar securities only recently have made them more of a problem. The main concerns were the exchange rate, exporters, and modernization of the banking system and capital markets. The yuan was to be appreciated only gradually. In September, 2005: “We should first further develop our capital markets and other domestic institutions, to better use our domestic market to finance business," she said. "We have to implement all kinds of control on this hot money. We have to keep our watch on capital inflows. “We've repeated this many times: a stable exchange rate is in China's best interest," Hu said.” My guess is that the gold market does not with high probability expect a big China purchase from the IMF, in which case if it should happen it will be a positive surprise. The market may have pretty much priced in a low probability, if it’s thinking the way I am. It seems to me that Chinese officials have made enough discouraging statements to get across their view, and I don’t think they’re simply trying to get the price down. I think the record suggests they are just not that interested in quickly accumulating gold. But they are clearly interested in accumulating gold steadily and over the long run. For the record, I do not proffer investment advice to anyone. No one should buy, sell, or hold gold based on what this or anything else I write about gold says. The usual disclaimer applies: Get professional investment advice if you need it.
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