Sunday 4 December 2016

China needs to think bigger than gold when it opens $3 trillion treasure chest

Nick Trevethan

Published 05/05/2011 | 05:00

The US prints dollars and the Chinese collect them through the massive trade inbalance between the global powers
The US prints dollars and the Chinese collect them through the massive trade inbalance between the global powers

You know the feeling, you have $3 trillion (€2.02tn) in foreign currency burning a hole in your pocket and you are itching to spend. But on what? A mountain of gold, a sea of oil or a pile of paper?

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So far China has chosen paper, especially in the form of US treasury bills.

But comments this week by China's central bank chief that the country's foreign exchange reserves exceed reasonable requirements, and local media reports that Beijing was considering setting up investment funds in energy and precious metals, again raise the question about what the country can do with its money.

The size of the issue is staggering -- in the first three months of the year China's reserves grew by $197bn to $3.05 trillion.

At first glance, investing in gold, which is at record highs, or oil, which has rallied for each of the past eight months, makes sense.

Gold has thousands of years of history as a store of value, but no nation has ever looked at oil as a way to diversify foreign exchange holdings, only as a strategic resource in case of war or disaster.

There is a very good reason for that -- unlike gold which can sit in a vault indefinitely, oil degrades once it has been pumped out of the ground and a tank of crude would be essentially worthless after 20 years.

Diverting even 10pc of the nation's mostly dollar-denominated treasure chest into commodities would cause huge ripples, and risk fuelling Beijing's current bugbear -- inflation.

"These are very big numbers, but how can China get into these markets without driving them to incredible levels? Any sniff that they are actually doing this would send prices through the roof," said Jonathan Barratt, managing director of Commodity Broking Services in Sydney.

One-tenth, or $300bn, could buy 200 million ounces of gold or 6,400 tonnes -- more than twice the amount mined globally every year. In terms of oil, they could buy 2.68 billion barrels, enough to power the world for a month.

Beijing might be more willing to risk disrupting the bullion market than one which would have a greater direct impact on the lives of ordinary Chinese people.

"Inflation is perceived as a real threat to social stability in China and anything that risks higher prices, especially of basic staples like food and energy, will not be tolerated," Mr Barratt said.

"Gold falls well outside the basic need criteria and the authorities would probably turn a blind eye to a super bubbly bullion market."

The most recent data from the World Gold Council showed that China held about 1,054 tonnes of gold -- less than 1.6pc of its foreign currency reserves.

The US, the world's top gold hoarder, has more than 8,100 tonnes of the metal, equivalent to 75pc of its foreign currency reserves.

The bullion market, like most other commodities, is highly sensitive to China's intentions. In February last year, a report on a Russian website, 'Rough & Polished', that China would buy nearly 200 tonnes of gold from the International Monetary Fund sent prices jumping, despite the most flimsy sourcing.

Ecstasy

The report proved to be unfounded, but any official comment on how China might expand its gold holding would send gold bugs into paroxysms of ecstasy.

"Diversification of foreign reserves is certainly a worthy idea," said Lu Feng, professor of economics at the China Centre for Economic Research at Beijing University.

"However, the experience in the past few years shows that the endeavour could be very difficult; the scale of the foreign reserve is so humongous that the prices of anything that the state showed an interest in purchasing with the reserve would go up."

He said those price rises, even if the purchase was successful, meant the state might end up losing even more money than if it was to hold on to the currency.

China will need to think bigger than energy and precious metals if they want to succeed in diversifying.

In February, the country's top money manager warned of the risks of pushing too much money into commodities.

"Some have argued that we should buy oil, buy gold, buy iron ore, or even buy into companies and land. But it is much easier said than done," Yi Gang, head of the State Administration of Foreign Exchange, said.

China has already been an aggressive player chasing investment opportunities in resource firms.

Recently, Minmetals Resources, a unit of China's biggest metals trading company, bid unsuccessfully for Africa-focussed copper miner Equinox; while Chinalco bought 9pc of global miner Rio Tinto and has also been active in oil and coal.

"The question is whether to buy materials or invest in resources. If the government went to buy materials, it would hike the prices, which would be counter-productive," said Shi Heqing, an analyst at Antaike, a state-backed consultancy based in Beijing.

"The more sensible way is probably equity investment in resources companies, but not necessarily to seek a majority shareholding."

But with state champions and privately owned firms on the acquisition path and its existing sovereign wealth fund worth $300bn hungry for ways to secure supply and hedge against rising commodity prices, more investment vehicles risk competition against each other for the same assets.

"From the point of view of investment structure, should funds be set up to invest in energy and precious metals in the next 30 to 50 years? Absolutely," said Dong Tao, chief regional economist at Credit Suisse.

"With $3 trillion, China should invest in every possible asset. It can probably put $200bn to $300bn in each. Whatever they buy, it's better than buying US Treasuries."

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