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Why China is Still Buying Gold

China's Expanding Gold Presence

Written by Geoffrey Pike
Posted January 15, 2016

goldchgoldIt is no secret in the financial community that China is trying to gain a stronger presence in the global financial community. It was just recently that the IMF admitted the Chinese yuan into its reserve basket of currencies.

It is also no surprise that China and its banking system are trying to gain a stronger presence in places such as London, which is a huge financial center.

China has a presence in the London Bullion Market Association (LBMA), which sets the benchmark price for gold. China is also attempting to gain a presence with the London Precious Metal Clearing Limited (LPMCL), which settles paper trades in gold and silver.

The Industrial and Commercial Bank of China (ICBC) has applied to become a clearing member of the London group. ICBC is actually the largest bank in the world in terms of assets. ICBC is a state-owned Chinese bank, so this expansion is as much a political move as anything by the Chinese government.

To go along with this is news that the ICBC is buying a lease on a London vault that is owned by Deutsche Bank. This obviously fits in with the Chinese bank’s plans to be a major player in the gold market in London and around the world.

It is always hard to know the intentions of political figures. The Chinese involvement in the gold market is almost a story of contradiction. On the one hand, it is encouraging to see this communist country (mostly in name only) looking to be involved in the financial market system, especially as it relates to gold. Gold is really symbolic as a bet against big government and manipulated currencies.

On the other hand, this is a state-owned bank and perhaps the government is just trying to make sure it is involved in central decision making, regardless of what it involves.

The Chinese central bank has been accumulating gold for several years now, and it was just this past summer that it updated its reported holdings of gold reserves. The large increase was mostly expected, but still interesting to see.

Again though, one has to wonder what the political calculations are that go with this. Does the accumulation of gold also play into getting the yuan accepted as a reserve currency by the IMF?

Chinese Gold and a Backup Plan

If there was any question about the Chinese economy a few weeks ago, those questions were mostly answered in the first week of trading for 2016. Chinese stocks tumbled hard and all indications are pointing to some kind of deep recession for the Chinese economy.

While the move towards freer markets has been great over the last several decades, the Chinese officials still show their authoritarian colors from time to time. This comes out particularly in times of turmoil.

Chinese stock markets were halted during the sell-off, and rules against short selling and large shareholder selling were extended from the previous downturn in stocks. At this point, the markets in China are completely rigged. Stocks are not going to give you a good picture of what is happening when so many people are forbidden from selling and the Chinese government/ central bank is pumping in tens of billions of dollars worth of stimulus money to buy stocks.

But why the heavy interest in gold these last several years? It is true that Chinese gold reserves are a small percentage of overall reserves, but maybe this is why that small percentage is increasing.

Just as individuals buy gold for diversification and as a hedge against uncertainty, Chinese officials are likely doing the same thing. Gold is something of a backup plan.

It has to make Chinese officials at least a little bit nervous that it owns massive amounts of foreign debt – especially U.S. dollars and euros. The latest figures show China still holds over $1.25 trillion in U.S. debt.

With the Chinese economy now imploding, Chinese officials are going to be looking for anything to give it some stability. This will, of course, include major interventionist policies (economically speaking) by the Chinese government. But they may also look towards gold for some stability.

I don’t expect Chinese officials to sell off any of this gold any time soon, even in a desperate financial situation. Even though they are mercantilists and Keynesians, it is more likely that we see some selling of their foreign government debt than gold.

Despite the economic woes, the Chinese banks are pushing ahead for more involvement in global financial markets, especially when it comes to gold. This includes the buying of gold by the Chinese central bank.

This helps put a floor under the gold price, as China buys on the dips. The Chinese politicians and central bankers may not be that great when it comes to economics, but at least they understand that gold has a role to play in providing more diversification and stability. Some individual investors could learn this lesson.

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