Gold’s Breakout: It’s Not the Inflation

Most assets have a poor record over the past year. Gold is one of the few assets that posted a gain — not a major gain, but a gain.

Gold has really taken off since late October, from below $1,630 to almost $1,930 today. That’s a major move. What’s going on?

You might want to argue that it has to do with inflation. The trouble with that argument is that (official) inflation has been coming down for the past few months. Meanwhile, gold seemed to massively underperform with respect to the very serious inflation we saw earlier last year.

So again, why are we seeing a gold spike now? The most likely answer lies with central banks and geopolitics.

Central banks as a whole, led by Russia and China, purchased 399 metric tonnes of gold in the third quarter of 2022. (Fourth-quarter data are not yet available.)

That’s the most gold ever purchased by central banks in a single calendar quarter. It represents over 1% of all the gold held by all central banks combined.

If that pace continues or increases, it would amount to an increase of over 4% per year in central bank gold reserves.

Gold in China’s SAFE

Let’s take a look at China. China’s State Administration of Foreign Exchange (SAFE) announced on Jan. 7 that China had added 30 metric tonnes to its official gold reserves in December 2022. This announcement came on top of a prior announcement that China added 32 metric tonnes in November. That’s a 62 metric tonne increase in just the past few months.

This announcement is significant not only because of the size of those increases, but because this is the first time China has announced increases in its official gold reserves since September 2019 — over three years ago. Why now?

The first thing to grasp is that China did not simply buy that much gold in the market over the past two months and then report it in a timely way. China had the gold all along. They just held it off the books inside SAFE.

This announcement was simply a policy decision to make some accounting entries to allow the gold to appear on the books instead of off the books. There is no doubt that China has at least 1,000 metric tonnes of gold held off the books in this manner, perhaps much more.

So the question investors need to ask is not where did China get the gold (they had it all along), but why did China decide to go public with an increase in their holdings at this time? As with everything in China, the real reasons are hidden and the public announcements are mostly lies.

Still, we can use inferential methods to get at what the Chinese are up to.

The Dollar: Victim of Its Own Success

This gold announcement comes at a time when there is a growing dollar shortage in China and around the world. The Chinese may simply want to bolster confidence in their reserve position.

Then there’s the geopolitics of it. There’s a growing movement to move away from dollar reserves because the U.S. has abused financial sanctions to freeze assets including central bank reserves of Russia, Syria, Iran, North Korea, Venezuela and others.

They’re working to reduce dollar reserves and invent new forms of currency for international payments. That’s why countries like China, Brazil and India are moving away from dollars for fear that they will be next on the sanctions list.

In that context, Bloomberg recently reported about a recent meeting of Southeast Asian officials and experts hosted by a think tank in Singapore. The report revealed that participants were just as fearful as the major countries that the U.S. has gone too far in weaponizing the dollar to apply pressure in geopolitical disputes.

George Yeo, the former foreign minister of Singapore, went so far as to say that “the U.S. dollar is a hex on all of us.” He went on to say, “If you weaponize the international financial system, alternatives will grow to replace it.”

The former trade minister of Indonesia, Thomas Lembong, praised Southeast Asia central banks that have developed digital payments systems using local currencies. He also urged government officials to find new ways to avoid relying extensively on the U.S. dollar.

“I have believed for a very long time that reserve currency diversification is absolutely critical,” said Lembong.

Even U.S. “Friends” Have Had Enough

What’s amazing about this report is that the criticism of U.S. dollar policies is coming from reliable allies and countries that have traditionally favored dollars. There was a huge buildup of U.S. dollar reserves throughout Southeast Asia in the aftermath of the global currency crisis of 1997–98.

This policy of building precautionary reserves was designed to prevent another run on local banks and to provide a rainy day fund for essential imports such as food and oil.

Now the asset seems more like a potential liability as the U.S. uses the dollar to threaten countries that don’t support Biden administration warmongering in Ukraine or other U.S. policies such as the Green New Scam.

If friendly countries in places like Southeast Asia join serious rivals such as Russia and China in reducing their reliance on the U.S. dollar, it can only mean a weaker dollar and possibly more inflation ahead.

It will also mean much higher gold prices because gold is the only alternative to dollars or other currencies such as the euro that can be weaponized against them.

That’s because stocking up on gold is a defensive move that helps insulate them against sanctions. Physical gold in secure custody cannot be frozen or seized or digitally banned. It’s just gold — and it’s money good in the hands of the holder.

Russia and China Place Floor Under Gold Price

Returning briefly to China, China’s announcement comes just weeks after Russia announced it had doubled the ceiling on permitted gold holdings of its sovereign wealth fund, from 20% to 40%. This will create demand for perhaps 100 metric tonnes over the coming year.

If China continues to add 30 metric tonnes or so to its reserves at the same time that Russia is out to buy 100 metric tonnes it will put a de facto floor under the gold price, while supporting the 20% rally in gold prices we’ve seen over the past few months.

Russia and China could be acting in concert to send a message to the world that dollars are yesterday’s news, and gold is the new foundational reserve asset (as it was for centuries prior to 1971). We could be witnessing a critical turning point in the international monetary system.

In short, Russia, China and the other nations I’ve mentioned are “weaponizing” gold as another weapon in the ongoing financial war that surrounds the war in Ukraine. Since Russia and China are among the top five gold producers in the world, they can buy gold from their own mines using local currency.

This tactic minimizes their need for dollars since they are paying with money they print themselves. At the same time, it increases the hard currency value of their own gold because they are depriving world markets of substantial output.

Great for Gold Investors

For gold investors, that’s excellent news. Here’s why…

While demand for gold is accelerating, total global production of gold has been flat for the past six years. That combination of flat output and increasing demand will put upward pressure on gold prices and act as a de facto floor under gold. Central banks tend to be opportunistic buyers and will definitely buy if any dips emerge.

That’s a recipe for consistently higher prices. It’s not too late for astute investors to acquire gold if you are not fully allocated already.