China's Gold Reserves: Watch What They Do, Not What They Say
Yi Gang, Vice Governor of the People's Bank of China (PBOC), recently made the headlines with his comments on Chinese gold reserves. On Wednesday, Mr. Yi stated that China's gold reserves remain static at 1,054 tonnes, and suggested that a sizeable increase in those reserves would be unlikely in the future. "We need to take into account both the stability of the market and gold prices," Mr. Yi stated, adding that as the world's largest gold producer and importer, China produces about 400 tonnes of gold annually, and imports an additional 500 to 600 tonnes of gold every year. "Compared with China's 3.3-trillion-U.S.-dollar foreign exchange reserves, the size of the gold market is too small," Yi said, rejecting speculation that China would further diversify its foreign reserve investments into the precious metal. "If the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers ... We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small," Yi stated.
If Yi's comments are to be believed, he is implying that the Chinese government has not added a single gold bar to its reserves since 2009 - which was the year the Chinese government officially announced its gold reserve increase to 1,054 tonnes. Given the production and import numbers stated above, we find that extremely hard to believe.
Mr. Yi's comments stand in stark contrast to earlier comments made by Chinese government officials regarding the need to increase China's gold reserves to ensure economic and financial safety, promote yuan globalization and act as a hedge against foreign-reserve depreciation. In 2009, a State Council advisor known as "Ji" said that a team of experts from Shanghai and Beijing had set up a task force to consider expanding China's gold reserves. Ji was quoted as saying "we suggested that China's gold reserves should reach 6,000 tons in the next 3-5 years and perhaps 10,000 tons in 8-10 years".
More recently, Gao Wei, an official from the Department of International Economic Affairs wrote a commentary in the China Securities Journal in November 2012 stating: "While gold prices are currently near record highs, China can build its reserves by buying low and selling high amid the short-term volatility." Gao also described China's gold reserves as being "too small", according to articles on the subject released by Bloomberg.
According to a recent World Gold Council (WGC) report, central banks have consistently bought gold over the past eight consecutive quarters, representing the highest level of central bank gold demand since 1964. The WGC stated that on average, gold constituted 13% of total central bank reserve holdings between 2000 and 2012. The WGC also suggested that in an optimized scenario, gold should represent 9% of foreign exchange reserves when factoring in all alternative currencies. China would need to grow its reserves from 1,054 to 5,541 tonnes if they were to follow this advice. We believe this figure is much closer to what China is targeting than its current reserves.
We also believe China's current gold reserves are significantly more than the stated 1,054 tonnes. Given that the entirety of China's domestic gold production remains held in-country, the escalating level of gold imports through Hong Kong (which have totaled a cumulative 1,051 tonnes since 2010), and the sheer size of China's US dollar reserves, it seems highly probable that a large portion of that gold is making its way to the PBOC. The fact that Chinese officials seek to deny this should not be surprising, as any suggestion to the contrary has the strong potential of moving the gold price higher. Investors will remember that China's 2009 gold reserve announcement propelled gold above US$1,000 shortly thereafter, which it has traded above ever since.
Given the way their announcement affected the price for gold, we doubt China will reveal how much gold it has accumulated until it is satisfied it has accumulated enough. The question now is how many tonnes "enough" will represent.
When it comes to China's gold reserves, watch what they do - and don't believe everything they say.
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