By MoneyMorning.com.au
The Chinese are as gold hungry as ever.
If you saw the news this week, you’ll know that’s true despite the current small dip in the price. ‘Gold has soared past coal as Australia’s second most valuable physical export to China, with sales up a whopping 900 per cent for the first eight months of the year,’ reported The Australian on Thursday.
What’s remarkable about this is that China is already the world’s biggest gold producer, and all of it stays in China. But China needs all the gold it can get. Big time. Preferably on the cheap. News like this confirms the thesis of our colleague Greg Canavan, who explains why here.
But it also ties in with some other news. Despite being responsible for the biggest debt load in history, can you believe the US Treasury actually got lucky this year? That was the conclusion of a Sober Look article this week when it summed up the biggest buyers of US Treasuries so far in 2012.
The fact that there is still a healthy demand right now for US Treasuries is what puzzles everybody. You get hardly any return, with a pretty big risk of inflation wiping you out and, mmm, possible default in one way or another. But that’s been known for a long time.
Money Morning chief Kris Sayce told us about going to a conference in the States when almost every speaker said US Treasuries were an obvious sell. That was back in 2010. In the meantime, US bonds have kept going up. Why?
USA Benefiting from the Currency War
Maybe Sober Look has the answer. Right now, it says demand for US debt is due to the shenanigans in the currency markets. It turns out the biggest buyer is Japan.
The land of the rising sun has now brought its holdings of US government paper to just behind China. At first glance there is nothing remarkable about this. For a long time, Japan has run a trade surplus with the United States and recycled those earnings into US bonds.
But Japan has a problem.
It has one of the strongest currencies in the world. The yen is almost at an all-time high against the US dollar. This obviously hinders rather than helps its exports. To help stop the yen going higher, Japan is buying US dollar assets and intervening in the currency markets.
But why is the yen so strong anyway? After all, Japan has a debt to GDP of over 200% and low growth under 1% at home.
The yen is rising because of the eurozone crisis. Global capital has been panicked out of the euro and into the yen. Japan, like Australia, has seen capital flow in as a ‘safe haven’ country.
Here’s the twist in the tale. The second biggest increase in US Treasuries came from Switzerland. You probably recall Switzerland stunned everybody in September last year when it effectively devalued the Swiss franc.
The Swiss National Bank declared it would peg its currency to the euro by allowing it to go no higher than €0.83. One way it would do this was by buying euros and selling francs.
But that left the Swiss building up an enormous liability to the value of the euro. Take a look at the chart below…
Swiss Foreign Currency Reserves
Source: Sober Look, Bloomberg
As of 29 June 2012, 60% of the current Swiss foreign exchange reserves were euros. The solution? Diversify into the US dollar (and to other currencies, to a lesser extent).
This inadvertently helps the US finance its trillion dollar deficits and keep the 30 year bull market in US Treasuries going. At one time, the euro seemed like a credible alternative to the US dollar. Not anymore.
So is there a credible alternative?
This brings us back to China’s lust for the yellow metal.
Why China Wants a Higher Gold Price Later, Not Sooner
It reminded us of something former banker Satyajit Das told attendees at the Port Phillip Publishing conference After America in March of this year. It was a cracker of a speech. China, he said, via its trillions in foreign exchange reserves, had stepped on a ‘bounding mine’.
Now China’s foreign exchange reserves are normally described as a healthy asset. Das, who used to trade currencies, described a different picture. We looked up the transcript of his speech to show you why:
‘It’s a vast sum of money, except it’s worth nothing because you cannot monetise it because it’s invested in US dollars, US Treasuries, euro, eurozone bonds, yen, Japanese government bonds. You only have two choices if you’re Chinese. As the Chinese government, you’re either going to have to write that off at some stage or you’re going to sit there pretending these are assets of real value, see them diminish in value as all of those countries devalue their currency to nothing against the renminbi. And that is a massive wealth loss for the Chinese.’
A bounding mine, he said, doesn’t explode when you step on it. It explodes when you step off it. ‘China has stepped on the world’s largest bounding mine. It’s called a US dollar, it’s called the euro, it’s called the yen.’
In other words, China has bought dollars, euros and yen, and now it’s stuck with them. If China tries to sell out of these currencies quickly, the whole currency market could explode.
That’s not good news for China. It knows it’s stepped on the mine. But, as Greg has detailed, gold gives it a way out. If China can accumulate gold, at some point the rerating in the gold price will help offset its foreign exchange losses.
But first it needs the gold. As the Australian article we mentioned at the top points out, ‘China’s foreign currency reserves of gold are low and its move to build them up will provide an important base demand for gold, analysts said.’
Like any buyer, China wants a cheaper price now. It’s banking on a higher price later. The dips in gold are a signal to buy.
Callum Newman
Co-Editor, Scoops Lane
The Most Important Story This Week
The Aussie stock market has been trending higher lately. This gives you the general impression that its lacklustre performance so far this year might be about to improve. Perhaps you’ve even thought it might time to buy ‘the market’ and shift more of your wealth into shares. Before you do, see what value investor Greg Canavan says in Debt and Government Spending Means You Should Be Wary of this Stock Market
Highlights in Money Morning This Week…
Kris Sayce on Money Printing Funds Drug Deals — Don’t Blame Bernanke: ‘When Bernanke, King and Draghi print money, it’s crucial for the survival of the world economy. When the Aussie government gives away ‘free’ money, it’s a stimulus to get people spending and support the economy. Yet when Mr Fry takes economic stimulus into his own hands to stimulate the economy, he’s a crook. Think about it.’
Murray Dawes on The Stock Market is Up, What’s Next?: ‘The stock market is continuing its upward march. I almost feel like the boy who cried wolf after watching US equity markets jump over 2% in the last two trading days. But I remain firm in my view that a weekly close under 1422 in the S+P 500 will be the catalyst for much further downside. Let me explain why…’
Callum Newman on The Territorial Spat Between Japan and China Putting Australia at Risk: ‘Japan’s top three car makers recorded a ‘steep’ drop in sales in the Chinese market last month. This is entirely due to the recent ‘territorial spat’ between Japan and China over islands in the East China Sea… But here’s the thing: China is Japan’s largest trading partner. So the stakes are high.’
Nick Hubble on The Secret Investment to Buy When GDP Falls: ‘The world is slowing down. China’s GDP growth is not what it used to be. And if you’re sceptical about Chinese statistics, you probably know it never was what it used to be. The Americans still haven’t found their feet, despite epic stimulus efforts. Europe is a basket case and probably in recession. In short, it’s time to invest in shares.’
Why China Wants a Higher Gold Price Later, Not Sooner
Tradervox.com () – The market is expecting a report to be released today to show that the cost of living in US rose in September for the second month as energy expenses lead other small gains in goods and services. The consumer price index is expected to increase by 0.5 percent last month after climbing by 0.6 percent in the previous month. The core consumer price index is expected to have advanced by 0.2 percent. Another report on manufacturing is expected to show stabilization in the sector.
