Investors should understand that a massive transfer of wealth is taking place. Gold has and will continue to be considered an asset as well as the currency of last resort. Over 1 million pounds have left Western vaults this year already. Where is it all going?
It is heading east, most particularly India and China. For India it is mostly consumers buying the gold. There it has traditionally been seen as a way to acquire and pass on wealth. The importation of gold had gotten so extensive that India began to limit it in 2013, as a way to deal with it’s trade deficit. Consumers there switched to silver so the outflow of Indian rupees for precious metals continued. As a result in 2014, India has eased the restrictions on gold imports.
For China it is not only consumers, but the government itself that is acquiring gold in massive quantities. China has accumulated enormous amounts of Western currencies particularly American dollars (USD). China has decided to cash out some of these holdings rather than continue to buy additional amounts of American debt. Their investment of choice to date has been gold.
The investment of gold makes sense, especially if China intends to make the renminbi (yuan) fully convertible and possibly a future world reserve currency.
Although somewhat alarming to Americans and other Western nations, Chinese actions are quite understandable. A number of Western nations particularly the United States believes it can keep running massive trade and budget deficits with no consequences. The appetite for Chinese goods, and the sale of massive amounts of government debt in the United States has allowed China to be in this position.
The same is true elsewhere. The continued purchase of Chinese manufactured products have been a way to keep domestic prices down and offer consumers more choices in many countries. Well, all bills have to be paid eventually and what seemed to make sense at the time, now may seem to be less so.
China has accumulated nearly 2 trillion dollars of USD in it’s foreign reserve holdings. Over 60 % of it’s total foreign holdings are in American dollars. This is more than double the amount that the Chinese hold in Euros, for example.
Another concern for the Chinese is the rapid depreciation of the USD. Thanks to shortsighted monetary policies in the United States, the dollar has been on a rapid downward descent in value. The policies of the Federal Reserve System in the United States namely quantitative easing, has created a great deal of concern among investors in American debt. The rapid expansion in the supply of USD may have arguably helped the American economy in the short run, but it has also made the dollars that investors hold already, far less valuable.
The American dollar has lost 96% of its value in the last hundred years. The most dramatic change has been in the last decade. The virtual “printing of money” in the United States has cost the Chinese 40 billion dollars USD in lost value of the dollars they hold, on a yearly basis.
This is an intolerable position for the Chinese. It is made worse by the Japanese who have also engaged in similar quantitative policies and a massive run up in debt to try to stimulate their own domestic economy. The Europeans in various countries, despite German objections, have made similar moves. It is also clear that the ECB (European Central Bank) is about to lower interest rates even further. It will be in negative territory this time. A first for the Europeans at large. As a result, the close to 1.5 trillion worth in USD numbers that China holds in Euros and Yen are also losing value on a daily basis.
The Chinese have to protect their investment and will of course, look to their own self interest.
The United States became the most powerful nation in the world at the end of the Second World War. The dominance of the USD was codified in 1944 at Bretton Woods and given a new lease on dominance in the 1970’s as the dollar became the world’s new petrodollar.
However, in the 1980’s the United States went from the world’s largest creditor to the world’s largest debtor within a decade. The value of the USD reflected this over time. This happened because the United States refused to reduce spending, and live within its means. The government in fact, continued to spend every greater amounts of money over time. By the 21st century adding to the national debt on a yearly basis became accepted as normal business in many circles. The problem is that the continued financial flagrance of the United States is in reality, being funded by holders of American debt around the world.
The decline in the value of the American dollar will translate eventually, into higher prices in the United States. Inflation there will be the first sign that the world dominance of the USD is coming to an end. There will be a move by investors to put their liquid assets (dollars) into hard assets like real estate, stocks and commodities like gold.
As debt and inflation spiral out of control in the United States it will eventually lead to a default and the collapse of the USD. That would effectively, end the dominance of the dollar and it’s status as the reserve currency of the world
China does not wish to be holding trillions of dollars of USD as this moment of calamity nears. The date of the USD collapse is now only a few years or less away. So the Chinese have to find something to invest these dollars in. They also would rather invest in something that will allow them to keep a lower profile, as to not bring the dollar down too rapidly.
So over time, the Chinese have been gradually and carefully acquiring a huge reserve of gold. They do not wish to create a panic and drive up prices, so the purchases are made with the least amount of fanfare as possible.
The Chinese have continued these purchases of gold regardless of the much higher prices a few years ago. As prices have dropped they have stepped up their acquisitions of gold. Back in 2008, China announced that it had around 1,000 tons of gold in reserve. They have never updated this information since. Many analyst claim, China is now buying over 1,000 tons of gold a year. This is more than 100% above their total domestic annual production.
China must already be the world’s third largest owner of gold. It will soon pass German reserves if it has not already done so. To try to unload the entire $3.4 trillion USD equivalent in foreign reserves would mean, the Chinese would need to purchase 77,000 tons of gold. If they just converted ¾ of their foreign reserves to gold, a more practical number in today’s world, it would still require 58,000 tons. This sum would be about 1/3 of the total amount of gold ever mined in human history. China could not possibly purchase this amount of gold at this time, but their purchases no doubt will increase.
China’s Central Bank has now adopted a policy of more gold and less dollars. Retention of USD is becoming a smaller and smaller share of China’s total foreign exchange holdings.
The ultimate goal will be to end the reign of the dollar, offering the world their own currency (the yuan) as a possible alternative. It will soon be backed by the largest gold reserves in the world. It would also be backed by the Chinese economy which is rapidly closing in on the United States as the number one world economy.
Expect the Chinese to accelerate their purchases of gold in the months and years ahead. Another important thing to remember is that the Chinese take possession of their gold. They will not repeat the mistake of Germany and a number of other nations by leaving a portion of their gold with the United States.
So as the gold leaves the government, banks, and other institutions of the West, it is unlikely to be making a return visit any time soon. It will be kept in China for years to come.
What does all this mean to investors of gold regardless of the vehicle? It will ensure that gold prices do not collapse. It will in fact, ensure that the price of gold will have a floor. It cannot therefore, drop below the cost of production for any length of time. That is about $1,200 USD at present, depending on where the gold is actually mined.
The continued Chinese demand along with that of India, will guarantee that the price of gold will have great potential for future growth. The declining value of the American dollar and other world currencies, just accelerates this process.