What's Going On with China?

Four tidbits of news point to China's growing focus on Gold Investment...

WHAT'S GOING ON with China? asks Doug Hornig, senior editor of Casey's Gold & Resource Report.

That's a question Westerners have been asking for, oh...several millennia now. Or at least since Marco Polo aimed his ponies down the old Silk Road in 1271.

Now as then, China keeps its own counsel. Westerners get to know what they want us to know, plus what we can surmise from rumor and reading between the lines. But lately, we've been able to add presumption to news and come up with something that looks very significant.

Specifically, there's been a flood of tantalizing stories out of the East that, taken together, strongly suggest a growing preoccupation with a form of money that was ancient even in Signor Polo's time – Gold.

We already learned, back in April, that China has been salting away Bullion for the previous six years, out of sight of international gold watchers. To the tune of 14.6 million ounces. Now the evidence suggests that that was merely the prologue.

Let's take these tidbits one at a time:

Dumping Dollars for Gold?
This one is still at the rumor stage, but highly-respected website Mineweb.com reports that the Chinese sovereign wealth fund is selling US Dollars at a rapid clip. Might it be looking to Buy Gold too?

What we know for sure is that the country founded its primary sovereign wealth fund, China Investment Corporation (CIC), two years ago. Its stated aim is rapidly deploying some of its $1.5 trillion forex surpluses – $200 billion initially, with another $100 billion recently added to the kitty – into investment in non-Chinese enterprises. Thus it's been acquiring businesses around the globe, mining companies among them, including Teck Corp., the diversified Canadian mining giant.

We don't know for sure that CIC is Buying Gold, but it seems likely to us here at Casey Research. And, in addition, rumors sneaking off the mainland indicate that within the CIC, a lot of effort is being poured into prospective investment deals in the oil and precious metals sectors. The more it produces, the more it can keep.

The Chinese have made no secret of their disdain for current American economic policy and what they see as the inevitable destruction of the Dollar. That they would be moving to diversify out of the greenback shocks precisely no one, and gold is one logical landing place for all those bucks. We suspect that's exactly what is happening, behind the scenes.

Gold & Silver for the People
As recently as 2002, the private ownership of gold was prohibited in China. You could be jailed if caught with any in your possession. Beginning in 2009, in a stunning about-face, the central government removed all restrictions. In fact, as Mineweb and other sources report now it's actively pushing folks to buy some personal metal, with China's Central Television, the main state-owned television company, running news programs cum infomercials, letting the public know just how easy it is to purchase gold and silver as an investment.

It truly is as simple as can be, because every bank sells gold and silver bullion bars in four different sizes to individuals. (Try to find the same the next time you make the trek down to Wells Fargo.) Mining companies are reportedly encouraging employees to convert some of their wages to gold on payday. Gold is traded in some form 24 hours a day. And paper proxies for the metal are also soaring in popularity.

There are persistent rumors that the export of silver is being banned. Gold could be next. Thus China, which only yesterday was the lowest per-capita consumer of gold in the world, is bidding to become the biggest. Some analysts believe it will pass India – the top dog since forever – as early as 2010. Clearly, the government believes the country is strengthened if everyone who can holds some hard currency.

All this suggests a mania in the making, and only in the formative stage. Imagine if hundreds of millions of new consumers climb on that particular bandwagon...

Hong Kong Opens Storage
In early September, the Hong Kong authorities announced they are moving their two tonnes of physical gold from overseas depositories – most likely London – and transferring them to a newly built, high-security depository at the city's airport.

The aim, it seems, is to launch the promotion of Hong Kong as a Swiss-style, regional trading hub for bullion. Press reports cited government officials as saying that marketing efforts will be launched to convince Asian central banks to transfer their gold reserves to the Hong Kong facility. Outreach will also be made to commodity exchanges, banks, precious metals refiners and ETF providers.

There can be little doubt this signals that the Chinese government fully recognizes the importance of gold in a time of crisis, and decided that the most prudent plan involves keeping its stores close at hand.

China Threatens to "Just Walk Away"
In one of the year's most intriguing developments, commodity and derivative markets were thrown into a tizzy on Monday, August 31, by the worldwide circulation of a story published two days earlier in Caijing magazine (reported by Reuters here...)

According to the Caijing article, a spokesperson for China's state-owned Assets Supervision and Administration Commission – the regulator and nominal shareholder for state-owned enterprises (SOEs) – told six foreign banks that SOEs reserve the right to default on contracts.

Say what?

Maybe the commission has been paying attention to the "just walk away" forfeiture movement that blossomed among American homeowners whose overall debt on their properties far exceeded the assessed value. But small wonder there was panic in trading houses that hold a lot of Chinese paper. They hope any problems will be worked out short of a default. In fact, "It's [only] a handful of companies who are being encouraged by regulators to 're-negotiate'," says one banking source.

"It's outrageous, but it's China, so everyone is treading very carefully." Very carefully.

Nevertheless, in addition to tangible losses, those potentially affected fear the establishment of a dangerous precedent, one that could lead to utter chaos in the enormous, tangled world of derivatives.

And there is one other, albeit highly speculative, possibility. Some major entities – we don't know who, due to the opaque nature of international gold trading – have huge, perhaps quite concentrated short positions in the metal, both on the Comex Gold Futures and dealer-to-dealer OTC market (over the counter). Is one of them China, acting through American intermediary banks?

A short position in precious metals means that the initiator of that position is obligated to deliver physical gold or silver if the buyer (who holds the long end) wants it. Suppose China is one of the big shorts. Suppose it's been playing the market in order to buy at what it sees as bargain prices. Now suppose a gold rally induces it to just walk away from all those obligations to deliver. Who's going to force it to make good? Guess what; no one has a gun large enough.

Granted, it's an outlandish scenario. But impossible? No. Beijing has shown nothing but indifference to what others think of it. And if the Dollar does crap out as the world's reserve currency, there's nothing to say that China won't see its self-interest as lying in a completely new direction.

Conclusion...?
Gold, and the companies that produce it, have enjoyed a brisk runup of late, as the metal mounts yet another assault on the beckoning, symbolic $1,000 level. How much of this can be traced to what China has done, is doing, or may yet do?

We don't know, but we suspect it's not entirely coincidental. All rumor and speculation aside, as China clearly turns more and more bullish on gold, so will everyone else.

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