GLDI - Why China Is Buying Gold Hand-Over-Fist And So Are We

2023-07-10 09:00:30 ET

Summary

• China's central bank has been buying gold very aggressively recently.
• We explore the possible reasons why they are doing this.
• We also look at the implications of this phenomenon and why we are buying aggressively ourselves.

China has been buying gold ( GLD ) ( IAU ) hand-over-fist lately, with its gold stockpile increasing for eight straight months. In this article, we will look at why China is doing this and why we are buying it aggressively as well.

Why China Is Buying Gold Aggressively

The so-called People's Bank of China - China's central bank - bought 23 tons of gold in June alone, bringing its total hoard of the yellow metal to 2,330 tons. This continues a run of aggressive gold buying by the communist nation. In fact, some analysts estimate that China has increased its gold holding by as much as 20% over the past few years alone. Why are they placing such an aggressive bet on gold? While it is impossible to know for sure, here are at least several likely reasons:

First and foremost, China is the number one gold producer and consumer, so by purchasing gold, China's government is not only serving its own international geopolitical and economic agendas (more on that later), but it is also stimulating its own economy.

Another major reason is that China has seen how the U.S. and its allies have attempted to punish Russia economically in the wake of its war in Ukraine. Back on February 26th, 2022, the G7 and EU coordinated to freeze Russia's Central Bank's U.S. Dollar and Euro reserves. This clearly got China's attention given that it also has a massive foreign reserve position of its own (particularly in U.S. Dollars), so it is likely now moving aggressively to diversify its reserves away from currencies that can be manipulated and frozen by foreign governments and instead hold a time-tested store of value that is universally accepted across the globe yet is not currently recognized as a currency. Russia also adopted this approach in response to these sanctions, with the Russian Duma energy committee chairman Pavel Zavalny stating about what it accepts in exchange for its exports:

Let them pay either in hard currency, and this is gold for us, or pay as it is convenient for us, this is the national currency.

Other countries are following suit, with 2022 seeing central bank demand for gold skyrocket and Q1 of 2023 seeing demand soar by 176% year-over-year, and numerous surveys indicate that central bankers expect their holdings of gold to rise in the coming years while they expect their U.S. Dollar holdings to decline.

Another related reason is that China is diligently working to usurp the U.S. Dollar's status as the global reserve currency. By building up a massive gold hoard, China is laying the foundation for potentially creating a rival global reserve currency that would be backed at least in part by gold. In an age of runaway government deficit spending and high inflation, such a currency could have immense appeal across the globe.

A final reason is simply that a strong case can be made for holding gold as a financial investment right now. These reasons include:

1. Growing levels of geopolitical instability make it an attractive hedge against a worst-case scenario playing out. China's dictator Xi has made it clear on many recent occasions that he wants his country to prepare for tumultuous times, including encouraging its citizens to buy gold . Therefore, it shouldn't be surprising that it views gold as a good investment for its central bank as well.
2. Elevated inflation that appears likely to stick around for a while longer makes gold a potentially attractive hedge.
3. Gold prices - while fairly close to their all-time highs - are actually pretty attractive at the moment relative to S&P 500 ( SPY ) valuations:

Why We Are Bullish On Gold

What does this mean for gold, and why does it make us bullish enough on the yellow metal to be buying it aggressively ourselves?

At a minimum, it is an extremely bullish indicator, as China - the world's largest gold consumer - is further increasing its appetite for the precious metal. This means that global demand is increasing by extension, driving prices higher.

Moreover, as China increasingly leans on gold rather than the Dollar and Euro as a store of wealth, many other countries around the world - who, foolishly or not, are increasingly receptive to China's influence and increasingly cooling to perceived U.S. hegemony - are also following suit. This will further boost demand for gold, likely driving its price higher.

Third, as central bankers and governments increase their allocations to gold and reduce their proportionate holdings of U.S. Dollars, more of those Dollars will likely be pushed back into the U.S. eventually, driving inflation higher and reducing the value of the Dollar relative to gold. This will serve as an additional tailwind for gold prices.

Fourth, if China eventually succeeds in upending the U.S. Dollar's status as the world's reserve currency, this would have a dramatic impact on the value of the U.S. Dollar and the health of the U.S. and the world economy as a whole, making gold a great place to be invested in such a circumstance. Moreover, if China's replacement reserve currency does indeed have gold backing, it would make gold even more valuable.

Finally, if China does indeed follow through on its threats to seize Taiwan by force, or some other major geopolitical disaster erupts, gold will also likely be a great place to be invested given that it functions as a safe haven asset.

Investor Takeaway

China's central bank has become a gold-guzzling institution in recent years and is showing no signs of slowing down. Moreover, its one billion plus person population is also being encouraged to partake in increased gold buying, which could only further accelerate demand for the metal. Given China's influence around the globe and surveys taken of other central banks, it appears that gold will only continue to grow in popularity compared to the U.S. Dollar as a store of wealth in the years to come.

As a result, we believe that gold ETFs like GLD and IAU and even some leading gold miners ( GDX ) such as Barrick Gold ( GOLD ) - that currently trades at a discount to NAV - are very attractive investments right now, particularly as portfolio diversification tools. China is buying gold hand-over-fist, so are we, and perhaps you may want to consider doing so too.

For further details see: