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From Jim Rickards’ Blog:
Why most gold bugs are dead wrong
By Jim Rickards, Editor, Jim Rickards’ Strategic Intelligence
One of the most persistent story lines among gold bugs and market participants who foresee the collapse of the dollar goes something like this:
China and many emerging markets, including the other BRICS, are looking for a way out of the global fiat currency system. That system is dominated today by the U.S. dollar. This dollar dominance allows the U.S. to force certain kinds of behavior in foreign policy and energy markets. Countries that don’t comply with U.S. wishes find themselves frozen out of global payment systems and find their banks unable to transact in dollars for needed imports or to get paid for their exports. Russia, Iran, and Syria have all been subjected to this treatment recently. China doesn’t like this system any more than Russia or Iran but is unwilling to confront the U.S. head-on.
Instead, China is quietly accumulating massive amounts of gold and building alternative financial institutions, such as the Asia Infrastructure Investment Bank, AIIB, and the BRICS-sponsored New Development Bank.
When the time is right, China will suddenly announce its actual gold holdings to the world and simultaneously turn its back on the Bretton Woods institutions such as the IMF and World Bank.
China will back its currency with its own gold and use the AIIB, NDB, and other institutions to lead a new global financial order.
Russia and others will be invited to join the Chinese in this new international monetary system. As a result, the dollar will collapse, the price of gold will skyrocket, and China will be the new global financial hegemon. The gold bugs will live happily ever after.
The only problem with this story is that the most important parts of it are wrong. As usual, the truth is much more intriguing than the popular version.
Here’s what’s really going on.
As with most myths, parts of the story are true. China is secretly acquiring thousands of tons of gold. China is creating new multilateral lending institutions. No doubt, China will announce an upward revision in its official gold holdings sometime in the next year or so.
In fact, Bloomberg News reported on April 20, 2015, under the headline “The Mystery of China’s Gold Stash May Soon Be Solved” that “China may be preparing to update its disclosed holdings …”
But the reasons for the acquisition of gold and the updated disclosures – if they happen – are not the ones the blogosphere believes. China isn’t trying to destroy the old boys’ club – it’s trying to join it. China understands that despite the strong growth and huge size of its economy, the yuan is not ready to be a true reserve currency and will not be ready for years to come. It is true that usage of the yuan is increasing in international transactions. But it is still used for fewer than 2 percent of global payments, compared with over 40 percent for the U.S. dollar.
In addition to a bond market, you need the “plumbing” of a bond market. This includes a network of primary dealers; hedging tools such as futures and options; financing tools such as repurchase agreements, derivatives, clearance, and settlement channels; and a good rule of law to settle disputes, secure creditors, and deal with bankruptcies.
China has none of these things on the needed scale or level of maturity. When it comes to true reserve-currency status, the yuan is not ready for prime time. China is also not ready to launch a gold-backed currency. Even if it has 10,000 tons of gold – far more than it currently admits – the market value of that gold is only about $385 billion. China’s M1 money supply as of April 2015 is about $5.4 trillion. In other words, even on assumptions highly favorable to China, its gold is worth only about 7 percent of its money supply.
Historically, countries that want to run a successful gold standard need 20-40 percent of the money supply in gold in order to stand up to bank runs in the market. China could reduce its money supply to get to the 20 percent level, but this would be extremely deflationary and throw the Chinese economy into a depression that would trigger political instability. So that won’t happen.
In short, China can’t have a reserve currency because it doesn’t have a bond market, and it can’t have a gold-backed currency because it has nowhere near enough gold. So what is China’s plan?
Gold is still the safest asset, and every investor should have some in his portfolio. The price of gold will go significantly higher in the years ahead. But contrary to what you read in the blogs, gold won’t go higher because China is confronting the U.S. or launching a gold-backed currency.
It will go higher when all central banks – China’s and the U.S.’s included – confront the next global liquidity crisis, which will be worse than the one in 2008, and individual citizens stampede into gold to preserve wealth in a world that has lost confidence in all central banks.
When that happens, physical gold may not be available at all. The time to build your personal gold reserve is now.
Chinese gold standard would need a rate 50 times bullion’s price
A move to a gold standard in China would require an exchange rate of as much as $64,000 an ounce, 50 times bullion’s price now, according to Bloomberg Intelligence.
A traditional gold standard, in which the precious metal backs the currency, is basically impossible at current prices due to the amount of metal needed and there’s no evidence that the sixth-biggest bullion holder will adopt one, said Bloomberg Intelligence. Any attempt probably would involve new technologies and depend on the ratio of what is backed, it said.
Chinese policy makers are trying to establish the yuan as a reserve currency, and backing it with gold would help attract foreign capital inflows, the Bloomberg research unit wrote. Theoretically, to create an exchange rate of one ounce of gold for every $64,000, the country would need about 10,000 metric tons of the metal, they estimated. That’s nine times the nation’s official holdings and about 6 percent of all the bullion ever mined globally. …
Peak gold seen this year as mining’s ‘weaklings’ bite the dust
The world looks headed for peak gold this year. Record output, spurred by a 12-year bull run that fizzled in 2012, is ready to slide as mine operators that piled in during the good times finally give up hope of a recovery, according to the head of Russia’s second-largest miner of precious metals.
“We are waiting for the weaklings to drop off,” Polymetal International Plc Chief Executive Officer Vitaly Nesis said in an interview. “A lot of CEOs still hope against hope that happiness is just around the corner. This year will see some modest growth. Next year, we will definitely see a decline.”
Investors and some executives lambasted mining companies for producing too much high-cost gold. The industry lacked discipline, hurting prices, Randgold Resources Ltd. chief Mark Bristow said last year. Output rose to a record 3,114 metric tons in 2013 as demand fell 15 percent to a five-year low.
Production rose about 2 percent in the first quarter from a year before, while the market needs at least a 2 percent decline to support higher prices, Nesis said. Difficulty in closing mines, low energy prices and too much hope only delayed things.
“Sooner or later the mines will close down,” Nesis said in London. “We will see more forced closures.”
Weaker output will start in the fourth quarter of 2015 or the first three months of next year, he said. Still, it will take about four straight quarters of declines to improve the market’s mood toward gold prices and mining stocks, Nesis said.
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