The Golden Chinese Dilemma

“Some Chinese economists are urging Beijing to quadruple its gold reserves to 2,500 tonnes from the current 600 tonnes because the country foreign exchange reserves had become the world’s largest. Gold reserves have remained unchanged since December 2002″.

China claims to have a dilemma in buying due to rising prices. If this was so in late 2005 how much more so is it relevant today.

But China has a far greater problem that tends to argue not only with the price of metal but rather with the basics laws of supply and demand. Global production has an annual mining output of only 2,500 tonnes.

Even if China were to add 7% to their reserves allocated to gold ($84 billion, and the figure may be higher) at a current price of $675 an ounce, this would swallow the 2,500 tonnes of the entire global production this year!

This of course does not factor in buying from other gold hungry nations (Russia, India) and industry demand (jewelry) and would spur excess speculation from investors the world over. We read “Barclays Capital did a survey of their institutional clients and 70% of them said they would have 5% of their assets in gold in three years time.” Do you have any idea of what a mere 3% is in regard to the current money supply? (Read recent posts Meaningless Money, China Restless, Financial Manipulation and 1900 Dinner Menu).

Investor’s Corner

This brings us to hedging in the markets of gold – and undeniably silver. Spreads, for instance, generate profits not based on a bet on the price of gold, but on the relative change between the months bought and sold. (Do not be hard-pressed if you as well can’t imagine a legitimate economic purpose for these trades).

Similarly, many a hedge fund may go short gold and long stocks for instance, a method that would have been fairly profitable for almost 20 years between 1980 and 2000. The huge short position of over 240 million ounces in silver may be a result of many trades that have ultimately been more profitable than the mere $3 billion bill they’ve racked up. But one thing is for certain and that is that these positions will either be paid off in full (not much of a problem in todays multi-trillion dollar economy) or face serious defaults. (Both scenarios in which would have cataclysmic effects on the overall market.

As Mark Twain said “It’s not the size of the dog in the fight, it’s the size of the fight in the dog.

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