China Buying Gold At Discount

gold_mine

Source: Kitco Commentary – China Buying Gold At Discount

Notable excerpts:

China has been trying to diversify her foreign exchange reserves for some time… Chinese reserves contain only 2% gold, compared to nearly 10% for India and Russia, and figures in the 70th percentile for developed nations such as the USA and Germany.”

China is getting out of paper and into gold as fast as she can, because she simply doesn’t have enough of old yella’. Any effort to internationalise the RMB will not work until it is a trusted enough currency. One of the key ways to achieve trust is larger gold reserves.

However the physical gold market is not a deep and liquid market like the U.S. Treasury market. Therefore China is not able to rebalance her portfolio out of sovereign debt quickly without causing the gold price to “gap up” whilst sending ripples through the gold market.

China knows that she must tread carefully in the physical gold market, for fear of her bidding power sending the price upwards before she has been able to accumulate enough gold in the PBOC’s coffers. China does not want to be chasing the gold price.

Nonetheless China is accumulating physical gold, often via her Sovereign Wealth Funds, and other proxies, so that her bids are not open for all to see. Large above ground inventories of physical bullion are difficult to find outside of central bank vaults

Where can China turn to firstly get her hands on more gold, but secondly without sending the gold price soaring? The answer is increasingly being found in gold mining.

By buying gold mines, and thus accumulating the produced gold before it hits the international market, China is able to purchase gold below the spot gold price.

Average extraction costs to mine gold have been rising, but not as fast as the gold price, making owning gold miners an increasingly efficient way to stock up your central bank’s vaults. If Chinese controlled gold mines were producing at an average cost of $657 in 2011 alone her gold accumulated via this strategy for that year was sourced at a discount of $915/ounce, or 58%. China is accumulating gold at a discount through her gold mines.

China herself is the world’s largest producer of gold, but none leaves the country.

If China intends to acquire more gold via this mining strategy she is thus forced to reach beyond her borders and buy foreign gold mines.

The fact is that to effectively rebalance her reserves China needs to buy thousands of tonnes of gold. Given a small physical gold market that will have to be carefully navigated, and that not much more than 4,000 tonnes of gold are mined each year, a limited quantity of quality global mining assets will likely have to be pursued by Beijing.

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