China Goes After Gold and Oil

Let’s say, for the sake of argument, you’re sitting on about $2.4 trillion in assets. And let’s say that to pay the bills, you need only about a quarter of that – $600 billion – in ready cash.

What do you do with the rest?

As you might guess, this is not a hypothetical question. $2.4 trillion is what China holds in foreign exchange reserves. And it needs only about a quarter of that to handle three months of imports and short-term external debt.

While we were in China last week, we got an official answer to that question.

The Caixin news agency reported that China’s State Administration of Foreign Exchange has begun using some of that money for loans to foreign governments. And when China makes those deals, it’s usually for something tangible in return.

Right now, that something tangible is oil.

In the last 18 months, China has signed loan-for-oil agreements worth more than $60 billion with Russia, Kazakhstan, Turkmenistan, Brazil and Venezuela, among other countries. The deals represent more than 500 million barrels of crude every year.

In just one of those deals, China agreed in February to provide $25 billion in long-term loans to Russia in exchange for 100 million barrels a year between 2011-30.

The deals haven’t been a secret. But the Caixin report confirms something that’s only been rumored to this point: China is drawing on its forex reserves to make these deals happen. That is, China is using its paper reserves to buy real assets in the ground.

Nearly half of China’s forex reserves are in US dollars.

This quest for real wealth extends to everyday Chinese. Hence, the bustling Cai Bai gold market Chris Mayer, Joel Bowman, Bill Bonner and I visited last week.

There was a noisy crowd of people buying gold in all its forms from jewelry to bars.

“Housing speculators from Wenzhou City in southeastern China,” reports China’s state-owned CCTV on the same beat, “are switching their money from property into gold, following government restrictions on the real estate market.”

“We often heard on our trip,” commented Chris Mayer, editor of Mayer’s Special Situations, “that the Chinese buy empty apartments and just sit on them, treating the investment as a store of value. The other favorite place to park cash is gold.

“As gold investors, there is an interesting dynamic at work here. It also gives us another big catalyst for a higher gold price – a buying surge from the Chinese.”

The sale of gold bars in China has doubled from a year ago.

As if we didn’t have enough catalysts already. “Speculators are buying gold faster than the world’s biggest producers can mine it,” reports Bloomberg News, “as analysts forecast a 27% rally that may extend the longest run of annual gains since at least 1920.”

Mine supply has fallen in five of the last eight years, according to GFMS, the London-based consultancy. That’s why mines in South Africa are digging 2.4 miles deep into the earth – not unlike the quest for oil in deep water.

ETFs and similar gold-backed products now sit on a record 1,938 tons of metal. Only four of the world’s central banks hold more. The buying has accelerated all this month, a pace not seen since the first quarter of 2009.

Investment demand now exceeds jewelry demand for the first time since those heady days of early 1980, when gold touched $850.

Even central banks want gold again. Last year, they switched from being net sellers of gold to net buyers. The last time that happened was 1988. And the amount they accumulated was the most since 1964.

Addison Wiggin
for The Daily Reckoning