Gold: Even more good news
Summary
Readers know of our long-held belief in gold, one that goes beyond the popular "gold is a hedge against inflation" argument. So, on 20th April we issued a "Macro Trade" advising that you buy gold. in it, we looked at a new pattern that has emerged since last October: how gold has performed when the market goes up or down. Since then, the instrument that we suggested has risen by 3.2%. Finally, we have linked China to US government bond yields for some time; now we square the circle by linking China's purchases of gold to US bond yields. Today we look at another bit of good news that should boost sentiment on gold...and give you two ways to make money off this.
Topics Covered
- Gold purchases and US bond yields
- How much more gold China needs to buy
- Influence on bond yields
- How to make money off this
Background
1. Gold purchases and US bond yields
According to our local rag, the South China Morning Post (SCMP) , China now holds 1,054 tons of gold. That represents a 76% gain in the weight of her gold holdings since 2003, according to the person revealing this news, Hu Xiaolian, a deputy governor of the Peoples' Bank of China.
How come this odd news, linking today's holdings with those of 2003, was announced yesterday?
The importance of this news cannot be under-estimated: China is getting worried about her large holdings of US Treasury bonds, and thus is seeking to diversify out of these. Indeed, we have warned that China just needs to hint that she may not be buying so many US bonds, and up go their yields. This happened on Friday: US long bond yields rose, with 30-year yields standing at 3.9%, their highest since 20th November 2008. So China's announcements on gold exert some influence on US bond yields; of course, other factors play a role, too (see part 3 below).
2. How much more gold China needs to buy
In said SCMP, China's 1,054 tons of gold, when valued at Friday's closing price of $906.60/ounce, are worth $30.72 billion. That equates to 1.58% of China's total foreign exchange ("forex") reserves of $1.94 trillion.
In the same SCMP, on page B6, we read that "the norm" is that countries have two percent of their foreign reserves in gold. According to Michael Lewis, head of commodities research at Deutsche Bank, China's current holdings equate to "under one percent" of her forex reserves.
In order to reach that two percent "norm", China thus must buy an additional
- 264 tons, if her current holdings already equate to 1.58% of her forex reserves, or
- 1,054 tons, if her current holdings equate to just one percent of her forex reserves, or
- 659 tons, this being the average of the last two figures.
The IMF is proposing to sell 403.3 tons. So China could buy these up. Some people feel that if China buys these 403.3 tons, the price of gold won't go up. We disagree. Why should the IMF sell gold below its current market value? Besides, if traders suspect that China is about to buy more gold, they will climb in ahead of this.
The bottom line is that China's appetite will drive gold prices up on account of speculative and subsequent actual demand.
3. Influence on bond yields
We are not going to quantify this, as it would be imprecise. Suffice it to say that if China buys more gold and less bonds, the gold price goes up and the bond price goes down... This is what happened on Friday: gold prices rose to $912/ounce while Treasury 10 year note yields touched 3%, according to Bloomberg. Of course, it was not only China's "gold announcement" that drove Treasury yields higher: the more muscular driver was that the Treasury wants to sell $101 billion more notes next week, increasing the supply of paper available.
Nevertheless, prices are made at the margin. This means that by buying more gold and less bonds, China will drive up gold prices and thus bond yields.
4. How to Save/Make Money Off This Idea
- Always consult your financial adviser first.
- Buy gold. One popular ETF is GLD:US .
- Short US Treasury bonds. We have advised buying such an ETF, TBT:US for some time.
