As South Korea Sets Off To Formally Expand Its Gold Holdings, Is China Far Behind?

Tyler Durden's picture

Today's most important piece of news for holders of precious metals comes from the far East, where Kim Choong-soo, governor of South Korea’s central bank, told a parliamentary committee on Monday, that the country: "needs to give careful consideration to the matter of increasing gold volumes in the foreign reserves.” In other words, as the FT summarizes, "South Korea, holder of the world’s fifth-biggest foreign exchange reserves, is considering expanding its small holdings of gold to diversify its dollar-heavy portfolio." Last week, a mere unsubstantiated whisper that China was doing the same sent gold $10 higher. So with the regional game theory framework changing, as more countries rush into the yellow metal, will China finally be forced to come out of its shell of gold shyness and officially start accumulating, sending gold soaring?

More from the FT:

Such a move would have a powerfully bullish effect on the gold market. With just 14 tonnes of gold – or 0.2 per cent of $290bn reserves – Seoul is one of the smallest holders of gold among large economies. The world average is about 10 per cent, according to the World Gold Council, while countries such as the US, Germany and France hold well over 50 per cent of their reserves in gold.

That trend is one of the most important changes in the gold market in recent history, and has helped drive the metal’s rally to a series of fresh highs. On Thursday it touched $1,387.10 a troy ounce, an all-time nominal record.

South Korea’s central bank stressed any moves would have to be “cautious” and “prudent” because of the high gold price . One person familiar with the Bank of Korea’s stance on the metal said it was “receptive to the idea” of buying gold, but stressed that there remained “differences of views” within the central bank.

It appears that South Korea's traditional repository of FX reserves have been UST Bills, which however, as we demonstrated a few weeks ago, have lost value in FX adjusted terms even when taking into account the price appreciation. Furthermore, with the 2 Year trading at 0.3%-ish, there is little room for capital upside, and little yield to be extracted in the future.

“The bank is likely to remain hesitant, waiting for gold prices to come down, which is unlikely,” he said. “Although gold prices have risen sharply in recent months, the upward trend is likely to continue for now as the dollar is likely to remain weak, with Ben Bernanke talking about additional easing measures and central banks worldwide likely to keep buying gold amid ultra-low interest rates.”

Another issue for central banks looking to diversify into gold is the size of the market. Relative to the size of foreign exchange reserves, the gold market is tiny, meaning any large purchases could drive up the price. An increase in Seoul’s gold holdings of just a few percentage points would translate into 100-200 tonnes of purchases – a significant additional source of demand compared to annual production from mines of just 2,500 tonnes.

Not only that, but the ratio of short paper bets hedging long physical exposure as done by such market manipulating luminaries as JPM, means that should the price take off in a parabolic blow off like that seen in Apple recently, then the short covering capitulation, once set off post margin call thresholds, will shoot the price of gold into the stratosphere. Of course, with JPM being the FRBNY's banker of choice, one wonder how far Bill Dudley will go to give Jamie Dimon preferential terms on overnight liquidity before the bank is forced to cover its billions in paper shorts. Which of course may be the easiest way to pull a Soros, and take the US central bank on. After all, even the Fed has a breaking point.

h/t Papa Swamp