Rickards: China Using Gold to Offset Inflation

Release Date: 
Friday, May 30, 2014

Gold and Silver Prices

Gold and silver prices moved lower this week on positive U.S. economic data and the recent easing of tensions in Ukraine. “Gold’s recent decline ‘can largely be explained by a reduction in safe-haven demand, as concerns over the wider fallout from the crisis in Ukraine have eased and global equities have rallied,’ wrote Julian Jessop, head of commodities research at Capital Economics. But potential catalysts for renewed gains for gold over the rest of the year include easing of monetary policy in the euro zone and Japan, said Jessop. ‘While the impact on the dollar price of gold of these moves may partly be diluted by renewed weakness in the euro and the yen, further monetary stimulus by two of the world’s major central banks should provide some support.’” (“Gold futures heads for monthly, weekly declines,” MarketWatch, 5/30/14.)

Gold finished the week down $41.60, closing at $1,252.30. Silver prices closed at $18.91, down $0.67.

Rickards: China Using Gold to Offset Inflation

Financial author and portfolio manager Jim Rickards shared his thoughts with CNBC regarding some of the developments at the recent economic forum in Russia.

“If there was one takeaway from Russia's annual economic shindig in St Petersburg last week, it was that the country is continually looking to its neighbor China for trade and investment. While the United States can't claim that it might be losing a friend with Russia's pivot east, it might be a different story for the dollar, with the alliance having the potential to undercut the domination of the U.S. currency.

“‘Taken alone, these actions do not mean the end of the dollar as the leading global reserve currency. But, taken in the context of many other actions around the world including Saudi Arabia's frustration with U.S. foreign policy toward Iran, and China's voracious appetite for gold, these actions are meaningful steps away from the dollar,’ Jim Rickards, portfolio manager at West Shore Group and partner at Tangent Capital Partners, told CNBC via email.”

“According to Rickards, who has written extensively about the subject, the problem is that in complex systems - such as global financial markets - small trends can rapidly develop into catastrophic collapses. ‘The larger problem is that the U.S. is taking the reserve currency role of the dollar for granted and risks jeopardizing confidence in it through (Federal Reserve) monetary policy and the Treasury's cheap dollar policy. Confidence in the dollar can persist for now and then be lost as quickly as happened in the late 1970s.’”

“China has become the largest holder of U.S. debt. Its authorities hold around $3.8 trillion of reserves, the majority of which is denominated in U.S. dollars. However, they have expressed a desire to diversify away from the greenback, and have already pared back their U.S. Treasury holdings. Analysts believe the strength of the euro has been due to China buying the single currency and with the country rivaling India to be the biggest global buyer of gold, it appears this diversification could be well underway. As China can't easily dump its Treasury holdings due to the market panic that it could cause, Rickards believes that it is creating a hedged position to preserve Chinese wealth. ‘As the U.S. devalues the dollar through inflation, China will lose wealth on the dollar position but will profit on the euros and gold and those profits will offset the losses. So, basically, China is constructing a massive hedge using gold,’ he said. If the dollar's role as the leading reserve currency is lost, he believes the replacement would come from among euros, gold or special drawing rights (SDRs) - a supplementary asset maintained by the International Monetary Fund.” (“What Russia-China relations mean for the dollar,” CNBC, 527/14.)

China Looks for More Influence in Gold Fixing

With the London gold fix under siege, China is searching for ways to have more influence in the process via the Shanghai Gold Exchange.

“China has approached foreign banks and gold producers to participate in a global gold exchange in Shanghai, people familiar with the matter said, as the world's top producer and importer of the metal seeks greater influence over pricing. The Shanghai Gold Exchange (SGE) got the go ahead from the central bank last week to launch a global trading platform in the city's pilot free trade zone, a move that could challenge the dominance of New York and London in gold trade and pricing.”

“State-backed SGE has asked bullion banks such as HSBC, Australia and New Zealand Banking Group, Standard Bank, Standard Chartered and Bank of Nova Scotia to take part in the global trading platform, two people approached by the exchange said. SGE, the world's biggest physical gold exchange, where domestic banks, miners and retailers buy and sell gold, could also open up the international platform to foreign brokerages and gold producers, they said. ‘China wants to have more voice in gold prices,’ said Jiang Shu, an analyst with Industrial Bank, one of 12 banks allowed to import gold into China. ‘The international exchange is the first step towards gaining a say in gold pricing. If you don't allow foreign players to participate in your market actively, or do not push Chinese financial institutions to participate in the international market, then China's strong gold demand is only a number, not a power,’ he said…Currently, the London gold ‘fix’ is the benchmark for spot prices, while New York's COMEX contract sets the futures' benchmark. SGE prices are tracked to gauge Chinese demand as reflected in premiums or discounts to spot rates.” (“With London 'fix' under fire, China seeks bigger sway in gold trade,” Reuters, 5/27/14.)

Pomboy on Quantitative Easing, Gold

Stephanie Pomboy, founder of economic research firm MacroMavens, discussed her thoughts on the Federal Reserve’s monetary policy in a recent interview with Barron’s.

“‘The No. 1 thing is that investors generally have underestimated the impact that QE [quantitative easing] has had on the economy and the degree to which it has supported growth. As a consequence, they have underestimated the cost the tapering [of monthly Treasury bond purchases by the Fed] would have, and that is starting to come into focus. People will realize that the economy really has not achieved any self-sustaining momentum and that it requires continued stimulus. I liken it to a car on a flat road that has no momentum. When you take your foot off the gas, the car just stops moving. That's essentially what the Fed is doing. Eventually, people will start to connect the dots and say, ‘Hey, wait a second. We had five years of unprecedented monetary and fiscal policy, and the Fed did succeed in reinflating asset prices. Household net worth increased $25 trillion from the lows of the financial crisis, and yet we haven't generated a sustainable wealth effect.’ Maybe this is a dark place to go, but where would we be if the Fed hadn't succeeded in inflating household balance sheets to that degree? It is scary to imagine, because if you look at a chart of nominal consumer spending, which is 70% of GDP [gross domestic product], it has continued to decelerate, even in this period of unprecedented monetary accommodation and rampant financial-asset inflation.’”

“‘The easiest way to play the idea that the dollar is going to take a hit in terms of global psychology is being long gold.’” (“Stephanie Pomboy: The Fed Will Have to Reverse Course,” Barron’s, 5/24/14.)

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†This material has been prepared for private use. Although the information in this commentary has been obtained from sources believed to be reliable, Goldline does not guarantee its accuracy and such information may be incomplete or condensed. The opinions expressed are subject to change without notice.

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