India, China Central Banks Rather Have Gold Than Dollars

Let’s review the big picture for gold. What’s going on? And what are people saying?

For much of 2009, gold traded in the range of low-mid $900 per ounce. There was a dip over the summer, with a strong upswing starting in September. Gold is now trading well over $1,000 per ounce, in fact just under $1,100.

Turns out that the government of India was buying gold in mid-October. Over a two-week span, the central bank of India bought 200 tonnes (metric tons) of gold from the International Monetary Fund (IMF) at an average price of $1,045. The IMF — over which the U.S. holds veto power for most actions — got approval to sell the gold from — where else? — the U.S. Congress, last spring.

Previously, the government of India held 350 tonnes of gold reserves. This 200-tonne purchase is a 57% increase in India’s reserves. There’s joy in India, I’ll bet. (It makes me wonder what the Pakistanis think, now that their large neighbor has both nuclear weapons AND a growing gold hoard.)

Collapsing Economy?

Here’s what the Financial Times had to say. “Gold prices on Tuesday surged to an all-time high after India’s central bank bought 200 tonnes of the precious metal, swapping dollars for bullion as the country’s finance minister warned the economies of the U.S. and Europe had ‘collapsed.’ India’s decision to exchange $6.7 billion for gold equivalent to 8% of world annual mine production sent the strongest signal yet that Asian countries were moving away from the U.S. currency.” (Emphasis added.)

Have the economies of the U.S. and Europe really “collapsed”? As I sit here at my desk in Pittsburgh, I would not exactly say that the U.S. economy has collapsed around me. OK, so the economy isn’t booming, either.

Just yesterday, I saw that consumer powerhouse Johnson & Johnson foresees a long, continuing economic slump. J&J anticipates a slow recovery at best, contrary to the optimism of its namesake “No More Tears” brand. J&J management evidently believes that things will stay tough out there. And as if to add to the predicament, J&J is laying off about 8,000 employees.

Economic collapse or no, the point is that Indian gold purchases from the IMF are supporting the gold price. And the IMF has another 203.5 tonnes of gold yet to sell.

Who will buy the IMF gold? I’ve previously speculated that the Chinese are waiting in the wings. But now that the IMF has set a precedent for selling to a non-Chinese buyer, there are surely other players out there polishing their shoes and practicing their speech to the IMF bankers. We might see Arab countries buying. Or Russia. Maybe Brazil, with all its newfound energy wealth offshore.

China’s Golden Ambitions

Reuters news service has an interesting take on the matter. Reuters noted that it’s cheaper for China to buy domestically mined gold than to purchase bullion from the IMF at $1,045 per ounce. According to Li Yang, a former adviser to the People’s Bank, “China’s gold is much cheaper than that.”

In other words, China is the world’s No. 1 gold producer, and its mine costs are much les than $1,045 per ounce. So — China being governed by the Communist Party — why not just buy gold at “cost” from the mouth of the mine, right? Take the accounting hit and get the gold. In the long run, will it matter? (And we all know how the Chinese are able to think in terms of the long run.)

According to another Chinese Central Bank official — although with no direct authority over gold buying, “China is the world’s biggest gold producer, so there’s no urgency for us, as there is for India, to snap up big volumes whenever they come onto the global market. It’s cheaper for us to buy gold from the Chinese market, but it doesn’t help diversify our huge foreign exchange reserves.”

This Chinese official added, “To diversify our portfolio, we should spend dollars on things like gold. But the catch is that even if China bought half the world’s annual gold supply, it would only cost a few tens of billions of dollars, which is tiny compared to China’s huge reserves.”

And then the Chinese official offered this comment. “Having said that, I think China still should buy some IMF gold this time, and it might indeed do so, but it’s unlikely to take all the 200 tonnes that are left, as the price is, obviously, not particularly appealing. It would be a symbolic purchase, but better than nothing.”

Finally, Xia Bin, head of China’s Financial Department of the Development and Research Center also said China should buy IMF gold. “Why not? Even if it’s sold at a market price, we should still buy,” he said, according to Reuters, which was clearly a personal view from Xia Bin and not state policy. “India’s OK with it, why shouldn’t we be? What’s the use for so many dollars, whose purchasing power is weakening anyway? With so many foreign reserves in hand, I think China should buy, without doubt.”

What do you think it will mean for the dollar with the central banks of both India and China dumping dollars for gold?

On that happy note, I bid you adieu.

Until we meet again,
Byron King

November 9, 2009