The Financial Times has recently reported that the most important new factor in the gold market is potentially China. China has more than $2.4 trillion of foreign exchange reserves, but only 1.7 percent of this is invested in gold. The International Monetary Fund (IMF) is projecting that China will run a surplus of $2.6 trillion during the next five years. If it does, its foreign exchange reserves could rise to the $5.0-$6.0 trillion range. Even if it keeps the gold share of its reserves constant, it will have to buy a further 1,000-1,500 tonnes. Odds are high that China will want to expand the gold share of its reserves to lessen its vulnerability to dollar devaluations and strengthen the renminbi's status as a global currency.

Some Chinese officials have publicly called for the central bank to purchase 10,000 tonnes of gold. The central bank has declined to comment on these proposals, but they will become increasingly attractive if the U.S. pursues a policy of dollar devaluation while the renminbi emerges as a global currency.

It may be possible that the massive expansion of China's foreign exchange reserves could create faster monetary growth and increase China's inflation rate. If it does, there could be a sharp rise in Chinese private demand for gold.

China has deregulated its gold market since 2008 and private demand is increasing rapidly. It totalled 143 tonnes during the past 12 months compared with 73 tonnes in 2009 and 17 tonnes in 2008. It could easily rise to several hundred tonnes if investors perceive that China's monetary growth is going to produce higher inflation.

Last week, IMF Managing Director Dominique Strauss-Kahn, spoke with reporters after attending a G20 meeting in Korea. Following discussions with authorities of China, Europe, Japan, and the United States, he suggested they all wanted to do their best to keep the global recovery on track, "They understand that the biggest threat today would be an endless fight over current accounts or confrontation over exchange rates."

The U.S. government has been critical of China's policy of pegging the renminbi to the dollar, but it would abandon this criticism if China pursued a policy of unsterilised currency intervention and allowed inflation to accelerate. The renminbi would then appreciate in real terms, and make Chinese goods less competitive.

There is no way to predict the timing of China's future gold purchases, but many analysts believe there is a strong probability that they will create a demand for gold that will eclipse all other factors during the next quarter-century and guarantee large price gains irrespective of what happens to Federal Reserve policy.

Collateral Support

The current gold price has been a benefactor of the introduction of Exchange Traded Funds (ETFs) five years ago. These funds allow investors to purchase gold bullion as effortlessly as a share of stock. In the second quarter of 2010, investors bought more than 274 tonnes of gold through ETFs. Their holdings now exceed 2,000 tonnes, and are the sixth largest in the world after the official stocks at the IMF and the central banks of the U.S., Germany, France and Italy. At current growth rates, these ETFs could rank third by the end of 2012.

Gold Prices Supported by Long-term Investor Appetites originally posted on goldinvestingnews.com