Why China Could Spur a Gold Price Rally

gold prices

Each year, the editors here at Port Phillip Publishing compile a special subscriber-only report about what we think will be our best trade idea for 2017.

It will come as no surprise to you to discover that I thought gold would be the best investment for 2017.

Back in December last year, as the gold price was sitting at US$1,160 (AU$1,472), I suggested that the price of gold in 2017 would, in hindsight, look a lot like the price of gold in 2007.

You see, a decade ago, the spot price of gold traded between US$635–825 (AU$806–1,047). The price soared towards the end of 2007 as the financial crisis reared its ugly head.

Spot gold price in US dollars


Source: Goldprice.org
[Click to enlarge]

The spot price a decade ago now looks like chump change compared to today’s price of US$1,286 (AU$1,632). I’ve heard many investors complain about not buying physical gold back then. After all, even at the higher price of $800, it’s still drastically cheaper than what you would pay today.

While the yellow metal is yet to reach the dizzying highs in 2011 of US$1,900 (AU$2,412) an ounce, the end of this year could see gold push back above US$1,300 (AU$1,650) and remain there indefinitely.

Here’s why.

This year has seen the rise of geopolitical shocks that have supported the gold price. The threat of war between the US and North Korea has caused gold to dance around in terms of price.

These events are driving short-term price movements. However, there are much bigger forces at work here. What will push the gold price much higher over the next decade isn’t day-to-day events. Rather, it is likelier to be the introduction of gold back into the monetary system.

Last month, the Nikkei Asian Review reported that China was in the process of establishing a yuan-denominated oil futures contract. This is a significant move for both China and gold. Partly because it signals an end to the ‘petrodollar’ — the price of oil has been priced in US dollars since the 1970s. But China offering oil contracts in local currencies enables countries to bypass the US dollar.

What’s more noteworthy is that Middle Kingdom is willing to back these contracts with gold. Instead of being lumped with yet another fiat currency, oil contracts can be settled with gold.

This is an incredibly bullish signal for gold. In one fell swoop, China not only defies the US-dollar dominance, but brings gold back into the monetary system. 

Driving the gold price in the long term, though, is likely to be a little-known race between Russia and China.

Russia has made no secret of its gold accumulation over the past few years. Over the past four years, Russia has increased its gold reserve from 1,000 tonnes to 1,746 tonnes. Each month, the Central Bank of Russia declares its gold holdings to the global market.

China, on the other hand, doesn’t. Authorities keep actual gold holdings a closely-guarded secret, and sporadically announce any increases to the market.

Reuters reported in September that the People’s Bank of China announced that its gold reserves were steady for the month, showing no increase. Of course, China kept its official reserves on hold for the month, but the country has a solid track record of reporting gold reserves when it suits it.

Check this out…


Source: BullionStar
[Click to enlarge]

Here we have China’s history of reporting increases in gold reserves. When it updates its gold report, there is generally a significant jump in the gold it’s willing to declare to the market.

As it stands, Chinese authorities are allowing markets to believe the Middle Kingdom is only holding 1,845 tonnes of gold. Chances are that the real figure is much higher. A report from the Vice President of the China Gold Association showed the country should be buying 500 tonnes of gold per year, enabling it to accumulate 5,787–6,750 tonnes by 2020.

Furthermore, in 2014, President of the China Gold Association Song Xin wrote that 4,000 tonnes of gold should be the immediate target for the People’s Bank of China, saying:

That is why, in order for gold to fulfil its destined mission, we must raise our [official] gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.

Over the next few months, there is likely to be a very bullish signal for the price of gold. And it will come from the People’s Bank of China when it updates its ‘official’ gold holdings.

What would drive it to announce to the market that it has more gold than we thought? Simply put: China doesn’t want to lose its spot in the gold reserve rankings.

You see, China currently has the fifth largest store of reserves in the world, with Russia behind them in sixth.

Given the rapid rate at which Russia has been accumulating gold, there’s only a 103-tonne gap between Russia and China. In other words, if Russia buys 100 tonnes of gold over the next three months — which is entirely possibly given that they have been buying more than that on a quarterly basis — Russia will overtake China.

But if Russia does decide to beef up physical purchases of gold before the end of the year, that means China could potentially slip behind them. There’s no way Chinese officials want to slip to sixth place behind Russia.

Make no mistake: China holds more gold than we know about. But China is unlikely to want to give up its ranking to Russia, no matter how friendly relations between the two nations appear to be at present.

Keep your eyes peeled for a large jump in Chinese gold holdings in the next couple of months. Then get ready for gold to potentially rally.

Kind regards,

Shae Russell,

Editor, Markets & Money

Shae Russell

Shae Russell

Drawing on her extensive experience, Shae is the lead editor of Markets & Money. Each day, Shae looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

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