Gold’s China Syndrome

by Sean Brodrick on January 29, 2010 at 8:30 am

Gold continues to slump lower as the U.S. dollar goes higher — and now we’re hearing talk of a gold “meltdown.” Oh, please! Sure, gold could be in for a deeper correction — I’d love for it to pull back to support around $945, so I could buy more. And as this chart shows, gold could be on its way there in the short-term …

You can see that gold seems to have broken the “neckline” of a head-and-shoulders pattern. This predicts a move down to $945 or so. I think that the end result of such a move down would be a set-up for a tremendous buying opportunity.

But a meltdown? Once this correction is over, I think we should worry more about gold melting up.

I’ve pounded the table on a bunch of forces that should drive gold higher in the longer-term — tight supply, an explosion in government debt, debasement of paper currencies, demand from exchange-traded funds that hold physical gold and more. But today, I want to talk about a force that is becoming more bullish all the time — China.

Now, some people believe China will weigh on gold prices. After all, China is the one major gold-producing country with rising production. The China Gold Association predicted that gold mine output would hit a record 310 metric tonnes in 2009, up from 282 tonnes the previous year.

However, that gold is consumed internally, by the Chinese government or consumers. And it’s still not enough. China is becoming the roaring tiger of gold demand.

China’s Golden Year

You probably know that India is the biggest consumer of gold — a title it’s held for centuries. But according to analysts at the World Gold Council, China may have overtaken India to become the biggest consumer. The China Gold Association estimated demand would exceed 450 tonnes last year, up from 395.6 tonnes in 2008 (the actual figures are not yet available).

“The Chinese have a deep affinity to gold which dates back thousands of years,” Albert Cheng, Far East Manager of the World Gold Council, said in press reports. “No marriage will be ideal if the bride does not receive gold jewelry.”

Meanwhile, India’s private demand ran 45% below 2008 levels during the first 9 months of the year. If India’s purchases are average for the last quarter, that country’s full-year private gold consumption would come in at 336 tonnes, the lowest total since at least 1991.

Looking forward to 2010, physical gold purchases by mainland Chinese households are already running 19% ahead of India’s private demand for the first quarter.

Now, we have the Chinese New Year coming up, and gold demand is hotter-than-hot ahead of the Year of the Tiger. So, down the road, it’s likely that analysts will watch China instead of India, to make their decisions on investments in gold.

All This and Business Investment, Too!

Chinese consumers are on a golden buying spree — snapping up gold ornaments, gold bars, gold coins and gold ETFs. But it’s not just the Chinese consumer that’s buying the yellow metal.

Chinese mining companies, bullion dealers, gold associations, jewelers and traders are also catching gold fever.

One of the companies in my Red-Hot Global Small-Caps portfolio, Jinshan Gold Mines (JIN on the Toronto Stock Exchange, JINFF on the pink sheets in the U.S.), is caught up in this. Jinshan’s major shareholder is China National Gold Group. China National is going to use Jinshan as a vehicle to acquire gold mining projects outside of China, either developed projects or assets that are already in operation.

I think it’s big, bullish news for Jinshan. Do your own due diligence before you buy anything. But it goes to show that the Chinese think gold is cheap at current prices, and they have their sites set much higher.

The Missing Piece of the Puzzle — China’s National Gold Reserves

Looking at a chart of official gold holdings a few things jump out at you.

World Official Gold Holdings as of December 2009
Country	Tonnes	% of reserves
United States	8,133.50	68.7
Germany	3,407.60	64.6
IMF	3,005.30	—
Italy	2,451.80	63.4
France	2,435.40	64.2
SPDR Gold Trust	1,133.62	—
China	1,054.00	1.5
Switzerland	1,040.10	28.8
Japan	764.20	2.4
Netherlands	612.50	51.7
Sources: World Gold Council/SPDR Gold Shares/Reuters

First of all, the SPDR gold trust is huge. It’s #6 in the world, after the U.S., Germany, the IMF, Italy and France.

Second, China’s gold holdings as a percentage of its total reserves is just pathetic. And remember, this comes AFTER Beijing revealed last year that it had been buying gold since 2003, increasing its holdings from 600 to 1,054 tonnes. So far it has bought domestically, but its foreign exchange reserves — the world’s largest, at $2.27 trillion — are largely invested in U.S. government bonds. Given concerns about the U.S. economy, many expect China to buy gold internationally to diversify its assets, as other central banks have done recently.

And now the other shoe is starting to drop. China IS diversifying out of U.S. government bonds … or at least not buying as many bonds.

According to a report in the New York Times, China is buying a lot less U.S. Treasuries:

The United States Treasury estimated this week that during the first 11 months of last year China raised its holdings of Treasury securities by just $62 billion. That was less than 5 percent of the money the Treasury had to raise.

That raised its holdings to $790 billion, leaving it the largest foreign holder of Treasury securities — Japan is second at $757 billion and Britain a distant third at $278 billion. But China’s holdings at the end of November were lower than they were at the end of July.

So if China isn’t buying as many U.S. Treasuries, ask yourself, what are they buying? Foreign currencies, sure. But I think we’ll find out down the road that they’re buying more gold.

Chinese consumers are on a gold buying spree.

And if they’re not buying more gold now, well … look at that table again. China has only 1.5% of its reserves in gold. It’s going to have to put the pedal to the metal sometime.

How to Play This Move

I’m not adding gold to my subscribers’ portfolios now, because I think we’ll get lower prices in the short term. But the time to buy will come soon enough.

One thing I have in common with many Chinese is I believe it’s important to own at least some physical gold and silver for worst-case scenarios. Beyond that, the miners in the Market Vectors Gold Miners ETF (GDX) are nicely leveraged to the underlying price of the yellow metal, and as gold goes high, they should go higher.

Yours for trading profits,

Sean

P.S. If you haven’t checked out my blog recently, remember you can find daily commentary there at http://blogs.uncommonwisdomdaily.com/red-hot-energy-and-gold/. Go see what my latest chart of precious metals is telling me now.

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