It was a perfect sunny autumnal day in Melbourne yesterday.
Conditions were perfect for a barbie. So in honour of my sister visiting from England, we laid on a spread at Cowie HQ yesterday afternoon.
There was a mix of poms, pommie ex-pats, and true-blue Aussies in my backyard, and the talk quickly turned to sport. Someone might have said something about a certain urn being back at a certain cricket ground. The Aussie reply was that ‘well we got our own back by sending Warnie in to sort out Liz Hurley, mate’. Fair point.
Then we got onto just how expensive it is for Brits to come over here now.
Ten years ago, a pound sterling bought about $3s. Now it buys just $1.50. The Aussie has doubled in that time. Not just that but the higher cost of living makes it more unaffordable for visitors. So, if you see a hungry looking backpacker walking around Melbourne today, it might be my sister, so please offer to buy her some lunch!
How China is Using Gold to Internationalise
Around the time we were chatting about the exorbitant Aussie dollar, China announced it would increase the trading range on its currency, the renminbi, from 0.5% to 1.0%. This means the currency has more scope to rise and fall in response to economic forces.
It has been a long five year wait since China last relaxed the trading band. The reason this is such a big deal is this is a big step towards the renminbi (RMB) becoming a floating currency like the Aussie, euro or yen. This is an essential step if China wants to ‘internationalise’ its currency.
China has been building the foundations for the RMB’s use internationally over the last few years. The latest milestone has the China Development Bank planning to offer loans in renminbi to the other BRIC countries, Brazil, Russia, India – as well as South Africa.
Having an international currency promotes trade, cutting the US dollar out of the equation. The ultimate goal may be to pitch the renminbi as a reserve currency to compete with – or displace – the US dollar.
To really sell the RMB as an international currency, it helps if it is backed with a significant amount of gold. China would never openly admit this, but a snippet from an embassy in China, via a wikileaks story, as good as confirmed it last month:
“The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold’s function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. dollar or Euro.
Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.“
China has long been the world’s biggest gold producer, with all of this gold staying within its borders. China is now adding to this with huge gold purchases on the international market. Every time the price dips, as it is now, China buys dozens of tonnes of gold. Chinese buying started in earnest halfway through last year. At the current rate, China will overtake India as the world’s biggest gold consumer.
With China buying on the dips in a big way, it will be hard for the gold price to fall far. So why isn’t it soaring? India is the other big gold importer, and a few factors have slowed gold buying down there.
Last year India imported 969 tonnes of gold (roughly 20% of total gold imports in 2011).
But Indian gold imports slowed down towards the end of last year.
The main reason for this slowdown is that the value of the Indian currency, the rupee, fell 17%. This effectively added 17% to the price of gold for Indian buyers. And because the gold price was rising at the time, it meant Indian buyers had to pay as much as 35% more for gold in the second half of last year. Imports fell as Indians waited for the price to come back to a more affordable level.
Click here to enlarge
Looking at this chart, you can see that after falling for the last four months of 2011, the gold price in rupees has now come back to its long-term trend. This is partly thanks to the rupee rising by 6% this year. This should help more Indian gold buyers come back into the market, and increase imports again.
Keep An Eye on Gold Buying by India
There is another reason Indian gold imports should increase from here. Indian jewellers have just finished a three-week-long strike in protest of a new 4% tax on most gold jewellery. So for nearly three weeks, they all shut up shop until the government agreed to back down. For most of March, the world’s biggest army of gold buyers had nowhere to buy gold. Imports into the country all but stopped. Now they have re-opened, there is three-weeks-worth of buying to catch up on.
With this latent buying hitting the market, and the Indian gold price falling back to trend, we should see Indian gold imports rise. And with the world’s biggest consumer back in the game, the gold price should start to recover.
I heard over the weekend that India has already come back into the physical market in size. Even if Indian demand doesn’t recover straight away, this is an opportunity for China to pick up what India can’t afford.
In the Market for Gold Mines?
I think what China will need to do to step up its gold purchases, and secure future supply at a good price, is buy gold mines around the world.
This has started happening.
Late last year, China Gold International Resources Corporation, one of China’s largest gold producers, acquired a mine in Central Asia, and now might pick up more in Canada and Mongolia.
A Shanghai-based group has since picked up a controlling interest in an Eritrean gold project, Zara Mining.
And just last week, Zijin Mining Group made a bid for an Aussie gold stock, Norton Goldfields (ASX:NGF). This is a 150,000-ounce-a-year producer with plans to increase production to 220,000 ounces over the next four years. You can expect to see a lot more of this, if China wants to seriously ramp up its gold reserves.
A serious move by China to increase gold reserves by acquiring projects is great for gold investors. Firstly, speculation over takeovers can often give share prices a nudge.
More importantly, because these mines have a long mine life, it tells investors China’s plans to buy gold take a long-term view.
China Builds its Gold Reserves
China has been busy, but its official gold reserves are only worth US$55 billion. The core Euro countries of Germany, Italy and France have around US$430 billion of gold, and the US claims to have US$424 billion of gold.
But it’s been three long years since the People’s Bank of China last updated us on its gold holdings in 2009, when the count was 1054 tonnes. This was almost double the gold it had when it reported before that in 2003. We can safely assume China has been adding to its official reserves in the last three years. It’s anyone’s guess how much by.
If the amount of gold the Euro nations and the US government have on their books is any guide, you can see that China needs eight times more gold than it last reported to confidently back its currency for internationalisation. That would take the world’s entire annual mine output for at least three years.
This makes Chinese gold demand the most important of all the gold price drivers, and a very good reason to be bullish on gold long term.
That’s why I read yesterday’s news – that China has made another important step towards internationalising its currency – as being a very bullish result for the long-term gold price outlook.
China’s gold demand should support higher gold prices, but it’s not all good news for gold bugs. China’s growth also means a growing military power. And this may pose a threat to some of the gold producing countries close to its borders that Aussie gold producers are operating in.
Over the next four years, China’s military budget will grow to almost half that of America’s. There is growing geopolitical chess game playing out between the two. With the arrival of US marines in Darwin, it is a game that Australia is firmly part of.
What this means for investors is a story for tomorrow.
Dr. Alex Cowie
Editor, Diggers & Drillers