A Chinese gold standard?

Gold and silver settle higher as consumer prices rise in the U.S. and rumors circulate that China may be beefing up its gold stores to back its currency.

By TheStreet Staff Feb 17, 2011 12:04PM

Gold © Comstock Images/JupiterimagesthestreetBy Alix Steel, TheStreet

 

Updated at 3:34 p.m. ET

 

Higher consumer prices in the U.S. and unconfirmed reports that China is seeking to beef up its currency, the yuan, by backing it with gold bullion helped move gold prices higher Thursday.

 

Gold for April delivery gained $10 to settle at $1385.10 an ounce at the Comex Division of the New York Mercantile Exchange. The spot gold price was adding $8.50, according to Kitco's gold index.

 

Silver prices closed up 94 cents to $31.51, settling above the $31.50 resistance area -- the metal's highest level in 25 years -- which could be a green light for bullish silver traders headed into Friday.

 

Leading today's charge was news that year-over-year domestic inflation grew to 1.6%. Excluding food and energy prices, the Consumer Price Index was still up 1% on the year. Although still below the Federal Reserve's 2% inflation target rate, the surge was enough to prompt traders to buy gold and silver as an inflation hedge.

Jon Nadler, senior analyst at Kitco.com, says it's entirely possible gold prices could hit $1,400, but not on inflation data alone. "I think the spread of the societal unrest in the Middle East and North Africa might contribute more to gold bids."

 

Turmoil kept spreading throughout the region on Thursday as protester deaths mounted in Bahrain and Iran tried to get two warships passed through the Suez Canal.

 

Meanwhile, China's grab for gold is accelerating at a rapid pace, and it's raising questions about the country's ultimate intentions. China consumed 175.2 tons of gold in the fourth-quarter of 2010, bringing its grand total for the year to 579.5 tons, or 18.5 million ounces, according to the World Gold Council.

 

That's a lot of gold. The U.S., in comparison, consumed 233.3 tons in 2010.

 

It's unknown how much of that gold was consumed by citizens or its central bank, but the question still remains: What will China do with all that gold?

 

There is a controversial theory percolating in the gold community that China wants the yuan to become the world's reserve currency and is buying gold and silver in order to make it happen.

 

A Chinese gold standard?

 

The idea is staggering, not to mention fraught with difficulties. China's central bank currently holds 1,054 tons of gold, about 1.8% of its total reserves. China holds $2.85 trillion in foreign reserves, which means the country would need to buy roughly 66,000 tons of gold to fully back its currency. Even if the country upped the ante to just 3%, the country would need to buy 1,000 tons.

 

Technically, a full gold standard isn't an option. Under the IMF's first amendment to Article IV of Agreement, ratified in 1978, participating countries are not allowed to peg their currency to gold.

 

But that doesn't mean that China won't try to legitimize its currency by ramping up its gold holdings. The U.S., which sports the current world reserve currency, holds more than 8,000 tons of gold, more than 8 times the size of the SPDR Gold Shares (GLD) ETF.

 

Not only has China been furiously buying gold, but local gold producers have been looking outside the country to find more of the metal. State-controlled China National Gold Corp bought half of Coeur d'Alene Mines' (CDE) gold concentrates from its Kensington gold mine in Alaska.

 

China has also been telling its citizens to buy gold, promoting different gold funds, giving investors access to overseas products and launching a global gold contract based in yuan by Chinese Gold & Silver Exchange. The ICBC and World Gold Council recently teamed up for the creation of the Only Gold Gift Bar in China, where a customer can buy gold as a gift, complete with engraving, and can sell it back to the ICBC for cash.

 

"Private citizens have bought more gold in the last 30 months than the People's Bank of China owns altogether," says Adrian Ash, head of research for BullionVault.com. And because there are no individual property rights in China, all that gold citizens own technically belongs to China; whether the country would confiscate it is a different story.

 

China has also been trying to beef up the yuan to make it a more viable global currency.

 

The People's Bank of China says on its website that it is trying to allow banks and businesses in countries like Russia and the U.S. to be able to make direct investments in the yuan, which essentially brings the once-isolated currency onto the world stage. The website says this move "better support(s) Chinese enterprises to go abroad and facilitate trades and investments."

 

The country announced Thursday that yuan Forex options will be available in China by April, according to a report in the Wall Street Journal. The option to exchange the yuan into another currency and vice versa will help traders and businesses hedge their bets as the yuan appreciates, not to mention make it a more tradable asset.

 

There are now retail bank branches in the U.S. where you can trade in your dollars for yuan. The country is also negotiating currency swap agreements with trading partners where the U.S. dollar is taken out of the transaction and goods are traded in yuan.

Despite grumblings over letting its currency appreciate versus the dollar, from 2005 to 2008, before the financial crisis hit, the yuan rose 30%.

 

China is also a country that plans for the long term. Once the largest holder of U.S. debt, China has stopped loaning money as aggressively. According to the U.S. Treasury department website, in November 2010, China loaned the U.S. $895.6 billion, which was down 3.6% from the same period a year earlier.

 

"China has shortened all their maturities to less than 5 years and now they are not as strong in the auctions," argues Chuck Butler, president of EverBank, who believes China wants the yuan to be the world's reserve currency. Speculation is bubbling that the country is shying away from the dollar to make more room for another asset.

 

Some experts say that asset could be gold.

 

"The world needs to get off the dollar standard," says Peter Schiff, CEO of Euro Pacific Capital. "If China were to back its currency by gold, its currency could be the world's reserve currency."

 

Yan Xiaomei, deputy director at the People's Bank of China, says "if China holds more gold and silver, it would make RMB more confident in people."

 

Xiaomei believes that China would buy more gold and silver at the "proper time, but not as a critical policy, the quantity would also be not too big."

 

According to a report supposedly published by the Economic Information Daily, which is sponsored by the state run Xinhua News Agency, and a statement by a central bank advisor, Xia Bin, China is actively trying to buy gold and silver on price dips with the specific goal of globalizing the yuan.

 

There are some glaring holes with the article, but it circulated in the gold community nonetheless. First, no one could find the report. Second, if China is actively buying gold, it would be unlikely to announce it for fear of moving the price. China usually makes a formal announcement only after it is done with its purchase.

 

"Once again, we have seen 'news' that is but at the embryonic and certainly not fact-supported stage at this point," says Jon Nadler of Kitco.com.

 

Nadler also argues that China loves growth too much to switch to a gold standard, "forget about 8% growth." If China supports its currency with gold then it will be forced to limit the amount of money in circulation, which could hurt the economy. “(This is) a far-fetched dream by the gold bugs," says Nadler.

 

Ash warns, "Never say never ... But throwing over the world's 40-year experiment with un-backed money? That really would be a historic move by any power."

 

If China does increase the size of its gold reserves with the express purpose of backing the yuan, the result would be explosive for gold prices.

 

Butler says that the consensus would be "$4,000 to $5,000 gold within the decade."

 

Jim Rogers, legendary investor who is bullish on China, says a gold standard "would be good for gold if it happened, but it is a long way away."

 

GFMS executive chairman Philip Klapwijk was unable to comment on how much gold China bought in 2010 or will buy in 2011 due to the sensitivity of the information. But he did say that even if China were to raise its reserves by 1,000 tons to 2,000 tons with yearly purchases of 200 tons, it would be good for gold prices.

 

"Not only because of its impact on the global supply/demand balance but also due to its positive effect on investor sentiment and, to some extent, the negative signal it would send about the U.S. dollar."

 

With gold prices stalling out so far in 2011, down 3.4%, and large gold stocks like Barrick Gold (ABX) and Newmont Mining (NEM) down 6% and 5%, respectively, year to date, the gold world is looking for any kind of catalyst to shake it out of the doldrums.

 

Gold stocks were mixed Thursday. Barrick Gold was gaining 2.1% to $50.75 and Newmont Mining was up 1.7% to $58.96, but Agnico-Eagle (AEM) was tumbling 4.9% to $72.69 after disappointing investors with its fourth-quarter earnings.

 

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1Comment
Feb 17, 2011 2:11PM
avatar
very interesting development.  sounds like no matter what, the chinese are working to a plan. 
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