another discussion on gold

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    Pick this up on the Certified Mint Inc site;

    Asian Central Banks are Stuck with Dollars . . .
    May 22, 2003
    . . . so says CPM Group.
    In its Gold Survey 2003, CPM Group notes that China had, as of October 2002, the second largest stash of cash, $265.5 billion, of all the world’s central banks. Japan was number one with $443.6 billion. Although the survey did not report on it, China is adding dollars to its reserves faster than Japan, or any other country. Because of the massive transfer of manufacturing capability to China, nothing can stop China from becoming an economic giant in this decade.

    The survey also pointed out that six Asian nations--China, Hong Kong, Taiwan, Japan, South Korea, and Singapore--combined own 51% of the $2.3 trillion held in government reserves worldwide. Note, these are paper assets, primarily dollars, as approximately 85% of all central bank paper assets are denominated in dollars.

    Top 15 Central Banks by Foreign Exchange Holdings
    As of October 2002
    Country Billions $
    Japan 443.6
    China 265.5
    Taiwan 157.0
    Korea 116.4
    Hong Kong 110.6
    Singapore 80.5
    India 61.2
    Mexico 45.5
    Russia 43.0
    Germany 42.7
    Thailand 36.3
    Switzerland 36.3
    Brazil 35.4
    United Kingdom 34.9
    Canada 33.0

    (In case you’re wondering why the United States is not on the list, it is because our central bank, the Federal Reserve, holds only a few billion in paper reserves, mostly euros, yen, and British pounds. For reserves, the US claims to own 262 million ounces of gold.)

    Much has been written about what will happen to the price of gold when China becomes earnest about converting some of its dollar holdings to gold. Richard Russell, of Dow Theory Letters fame, has speculated that China plans to make its currency convertible into gold. Russell believes that the opening of the Shanghai Gold Exchange is evidence of China’s intentions. However, CPM Group thinks otherwise, believing that China is stuck with dollars.

    Much of the speculation about China’s intentions stems from China’s purchases of gold in recent years. According to the survey, at year end China may have boosted gold holdings by 20%, from 16.4 million ounces to 19.6 million ounces. A 20% increase in one year is not small. If China were to increase its reserves 20% annually, in a few years we would see huge quantities of gold taken off the market.

    CPM Groups thinks that the 3.2 million ounces added to reserves was a result of the Bank of China getting out of the domestic gold trading business, where it used to act as the national gold trader for the entities that could legally trade gold, such as jewelers. CPM thinks the 3.2 million ounces were simply transferred from the bank’s trading account to monetary reserves.

    CPM further says [page 86] that “this [the transfer] seems to be in line with public statements from officials in both government and People’s Bank of China, in which they have repeatedly said they do not see gold as a significant alternative to the U.S. dollar and other currencies as a reserve asset, and they do have any intentions of adding to their gold reserves.”

    CPM’s analysis continues:

    “As the second largest holders of dollars in the official community, the Chinese bank would have a lot to lose if it were to publicly or privately start to shift out of dollars. Plus, any significant move out of currencies into gold would push gold prices through the ceiling. For gold to have a significant role in monetary reserves, it would need to be at least 2% of total reserves. In fact, at 16.1 or even 19.3 million ounces, Chinese gold reserves are around that level. To add to these stocks, say to shift 2% of the $265.5 billion in currency reserves to gold, would require purchasing another 16.3 million ounces of gold (at $335 per ounce), which would push gold prices extremely higher, even if it were done with the utmost of discretion and caution. Given this sort of calculation, and other reasons, gold is not seen as a major foreign exchange substitute by most major central banks and monetary authorities.”

    So, according to CPM Group, China is stuck with dollars. If this is true, then the other five Asian nations that hold immense quantities of dollars are equally stuck. In short, the six most prosperous Asian countries have no choice--as CPM Group sees it--but to continue to manufacture goods and ship them to the United States in exchange for dollars, which the Fed can--and has said it will do--print at will. Asians get little pieces of paper (actually, electronic entries), and we get the goods. A good deal (for us) if there ever was one.

    Sounds too good to be true, doesn’t it. It is.

    At some point, one of the Asian big six will break for the exit, i.e., start converting dollars into gold. It is inevitable. Asians are among the most savvy business people in the world. They will not stand by and watch their assets be flushed down the drain by the Federal Reserve’s printing press.

    Here is another reason CMI questions CPM’s position that China’s central bank, nor any other large Asian central bank, will not buy gold because such buying would sink the dollar. The top fifteen central banks (in paper reserves) hold some $2.31 trillion. Yet, the annual new supply of gold, according to CPM, is only 106 million ounces. At $370 gold, annual new supply comes to only $39.2 billion, which is a lot of money but is only 1.7% of the paper dollar holdings of the top 15 central banks (according to paper reserves).

    So, less than 2% of the top fifteen central banks paper reserves would buy the world’s annual gold production. Now, follow this line of reasoning a little further. If only China converted 2% of its paper dollars, which is a “mere” $5.1 billion, it “would push gold prices through the ceiling.” Yet, would the selling of $5.1 billion sink the dollar? Hardly. Five billion dollars in the foreign exchange markets is a drop in the bucket.

    While China, as CPM notes, may not want to make a public statement about switching dollars to gold, its purchases over the last few years suggest that a slow move into gold may be in the works for China. If so, gold prices could rise because of such a move, with little impact on the dollar.

    Changes in China’s--and other Asian central banks’--gold holdings deserve scrutiny this year. Any increases could be a sign of someone headed for the exit, or, at least, someone increasing their gold holdings.

    As an aside, can anyony say why China quotes both Yuan and Renminby as currency?

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