Where are gold prices heading next? Just know this; China increased its gold reserves by 57%.
According to China’s central bank—the People’s Bank of China—gold reserves at the end of June 2015 were at 53.3 million ounces, or 1,658 tons. That was a 57% increase in gold reserves! (Source: People’s Bank of China, last accessed July 20, 2015.)
It has been more than six years since China updated its gold reserves in April of 2009. After the 604 tons being added to the country’s vaults, China has surpassed Russia to become the country with the fifth-largest amount of gold reserves.
There is a good reason for China to show its gold this time around; to internationalize its currency, the yuan.
Buying Gold to Push Yuan into IMF Reserve Basket
China has been pushing for full convertibility of the yuan for some time now. In particular, its central bank has been asking the International Monetary Fund (IMF) to include the yuan in the Special Drawing Rights (SDR) basket. However, the currency did not qualify in 2010 because it was not considered “freely usable” in trade and finance.
Recent events did not help. With China’s stock market losing more than thirty percent of its value in a few weeks, there are many questions surrounding China’s financial system.
The past year has been nothing less than a roller coaster ride for investors in the Chinese stock market. Fueled by margin lending, the Shanghai Composite Index had climbed by as much as 140% in just 12 months. Some say that the crash was partly due to tighter rules on margin lending. When the crash continued, margin lending rules were relaxed again.
A substantial amount of uncertainty remains in China’s equity markets. At the peak of the crash, more than half of all publicly-listed companies in China filed for trading suspension to prevent their shares from further tumbles.
The IMF is due to review the composition of its reserve basket later this year. The recent turn of events does no good in pushing the yuan as one of the IMF’s reserve currencies, as the world questions whether the Chinese regulators can maintain the stability and integrity of capital markets.
What did the country do? It showed how much gold it has.
Although the world is not under the gold standard anymore, having gold reserves still gives a country’s central bank (and its currency) credibility. Just look at what some central banks have been doing these days.
Russia increased its gold reserves by more than 83.0% in less than five years. Turkey’s increase in gold reserves during the past five years was an even higher 341.9%. (Source: World Gold Council, last accessed July 20, 2015.)
Around the world, central banks bought a total of 119.4 tons of gold in the first quarter of 2015. The key statistic to know is that this was the 17th consecutive quarter where central banks were net buyers of gold.
More Gold for China?
Now let’s go back to China’s numbers. The thing is, even after the massive hoarding efforts, China’s gold reserve was still worth less than 1.7% of its foreign exchange reserves by the end of June.
According to Christine Lagarde, Managing Director of the IMF, the ideal gold reserves should be at least five percent of foreign exchange reserves.
If China were to further increase its gold reserve to the IMF’s suggested five percent target, it would have more than 3,200 tons (or 74 million ounces) of gold to buy!
And if that kind of demand does not push up gold prices, I don’t know what could.