Sat Post #3: Wikileaks on China and Gold

In case you missed it earlier this week, news came out that Wikileaks published their entire US State Department cable database.

As people pour through the massive data dump, the first nuggets (excuse the pun) of information are starting to surface.

And a gem of information has been uncovered in this US Embassy cable. Here is what the US Embassy in China had to say:

• 3. CHINA'S GOLD RESERVES
  
  "China increases its gold reserves in order to kill two birds with one stone"
  
  "The China Radio International sponsored newspaper World News Journal (Shijie Xinwenbao)(04/28): "According to China's National Foreign Exchanges Administration China 's gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the U.S. and European countries. The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold's function as an international reserve currency. They don't want to see other countries turning to gold reserves instead of the U.S. dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar's role as the international reserve currency. China's increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB."

China is ecstatic that the price of Gold is being suppressed by the Americans.  They fully intend to take advantage of it.  As they note, "suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar's role as the international reserve currency."

China has every intent to grow their reserves at these fire sale prices. And if things play out in the direction they are currently heading, $1900/oz will be considered cheap.

Zero Hedge commented on this today as well and they make the connection that anyone with any foresight can see for themselves. To wit: "What happens when "mutual and pension funds finally comprehend they are massively underinvested in the one asset which China is without a trace of doubt massively accumulating behind the scenes?"

The result will be nothing short of a worldwide scramble, not so much for paper, but every last ounce of physical gold.

As we have said before, we do not believe a return to the Gold Standard will be a good thing or that it will happen with full gold backed currency.

What WILL  happen is a worldwide rush into Gold and Silver, which will catapult prices parabolically upward.

Casey Research did an excellent paper back in March 2011 titled, "The Driver for Gold You're Not Watching".

It's well worth you time to check it out.

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Email: village_whisperer@live.ca
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Why the emphasis on Silver (and Gold)?

If you didn't get a chance to check out yesterdays post, The Debt Days of Summer, please take a moment to read it. In many ways today's post rounds out Thurday's post on local real estate, Friday's post on Silver, and yesterday's on Sovereign Debt.

There are three central themes on this blog: Sovereign Debt, Real Estate, Silver (and Gold).

The connection, we like to believe, is simple. 

Sovereign Debt will force interest rates up as the cost of borrowing money becomes critical.  High interest rates will crash the local Real Estate bubble, and the mad dash to print more money to rescue the economy/salvage Sovereign debt will drive the value of Silver and Gold parabolic.

Others in the blogosphere disagree with the last component.

This blog has tried to demonstrate why we believe Silver and Gold will increase. 

It's important to understand, it is our belief that a return to a Gold Standard is not the solution to the world's woes (more on that another time).  However, we do believe there will be a mad dash into Silver and Gold, thus pushing those precious metals exponentially higher.

Further evidence of that trend came out this week from the Bank of International Settlements recent annual report.

According to the Financial Times, the central banks of the world have pulled 635 tonnes of Gold from the Bank for International Settlements in the past year - the largest withdrawal in more than a decade.

This marks a sharp reversal from the previous year when central banks added to deposits of gold at the so-called “bank for central banks” rather than lending it directly to the private sector amid growing concerns over counterparty risk.

The central banks of the world are loading up on Gold.

Why?

As the website Seeking Alpha observes, If you’re a central banker and you actually believe in the value of paper money and your ability to create wealth by printing it... why would you be loading up on Gold?

The central banks of the world are in a competition to devalue their respective currencies against each other. They will work together to suppress a particular currency if a carry-trade gets too out of control (see Japan earlier this year), but in general the ECB wants a cheap Euro, the Fed wants a cheap Dollar and so on and so forth.

These guys know that the financial system is broken. They’ve known it for over a decade (Greenspan even admitted that derivatives could “implode” the market in 1999). But they’re going to kick the paper money can down the road as long as they can… primarily because the entire financial system is banking on their ability to “fix” things.

(And this is why many blogs written by economists or other financial planners/experts eschew Gold and Silver.  Everything they have been taught, everything they know about finance, is wrapped up in their "faith" that the central bankers can "fix" things.)

The 2008 crisis was the first taste of systemic risk. The central banks threw everything including the kitchen sink at the problem in an attempt to hold things up. And it’s worked temporarily in the sense that the financial world still believes central banks can handle the situation.

However, the fact remains that the central banks actually didn’t fix anything. You can only fix a debt problem by paying the debt off or defaulting. Moving it around and issuing more debt to meet current payments does nothing to solve the problem.

In this sense, the world’s central banks literally “bet the farm” on themselves and the view that sovereign balance sheets can stomach this toxic waste. As we’re now discovering in Europe, the laws of the markets (oversaturation of debt, default and the like) apply to countries as well as private banks.

The central banks know this and are now acting accordingly. It is not coincidence that they became net buyers of Gold within two years of the 2008 crisis.

Nor is it coincidence that they are now loading up on Gold at the fastest pace in over a decade.

They know (not think) that systemic risk is still on the table in a big way and that they will be powerless to address the next crisis when it explodes.

You can already see this in their public statements.

Bernanke himself even admitted the Fed has no idea why the economy isn’t recovering.

If you extend the implications of this statement it becomes clear Bernanke and pals are realizing that printing money is not going to patch up the financial system.

Hence the Gold purchases.

In plain terms, the real crisis, the crisis that was put off temporarily during the last two years, is coming.

It will not be a crisis of stocks or bonds. It will be a crisis of the financial system itself. A crisis in which entire countries default. And it will make 2008 look like a picnic.

The central banks are suppressing the price of Gold and Silver right now to support the value of the world's reserve currency - the US Dollar.

A by-product is that it is making the acquisition of Gold and Silver a steal in terms of value when compared to what is coming. And the central banks of the world are snapping it up at these bargain basement prices at the fastest rate of central bank acquisition in over a decade.

Do you think they are doing this because Gold/Silver are in a bubble and vastly overvalued?

That's why, along with the Real Estate bubble and the issue of looming rising interest rates, this blog focuses on Silver (and Gold).

Can it be made any plainer for you to see?

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Standard Chartered: "Three Factors Will Drive Gold To $5,000"

I trust faithful readers will forgive the recent indulgence in posts about hockey, the Stanley Cup and the Vancouver Canucks. As with real estate, the topic of hockey has consumed the Village on the Edge of the Rainforest lately.

But that doesn't mean our attention is completely diverted away from real estate, the global economy and the interest in Gold/Silver as a result of sovereign debt.

And today our attention is caught by a report released by Standard Chartered Bank.

Standard Chartered provides personal and business banking services in Asia, Africa, the Middle East, UK, Europe and the Americas and their recent report, "In Gold We Trust",  looks at actual gold breakeven prices, production bottlenecks, central bank interest, and Chinese and Indian buying, and comes to the conclusion that $5,000 gold may just be a matter of time.

• "The limited supply comes at a time when central banks have completely changed their tune on selling down their gold stocks and now appear likely to accelerate their net buying programmes. China is way behind the curve. Currently, only 1.8% of China’s foreign exchange reserves is in gold; if the country were to bring this proportion in line with the global average of 11%, it would have to buy 6,000 more tonnes of gold, equivalent to more than 2 years of gold production. We believe that these factors – limited gold production, buying by central banks and increasing demand from India and China – can potentially drive the gold price to US$5,000/oz."

Standard Chartered joins the growing list that believes the significant move to Gold/Silver is only a matter of time.

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Where is the price of Gold going?

Interesting article in the Vancouver Sun newspaper this week.

In a mid-year review of the world economy, the UN warned of a possible crisis of confidence in, and even a “collapse” of, the U.S. dollar if its value against other currencies continued to decline.

The report, an update of the UN “World Economic Situation and Prospects 2011” report first issued in December, noted that the dollar exchange rate against a basket of other key currencies had reached its lowest level since the 1970s.

This trend, it said, had recently been driven in part by interest rate differentials between the United States and other major economies and growing concern about the sustainability of the U.S. public debt, half of which is held by foreigners.

At another point the report referred to the “still looming risk of a collapse of the United States dollar.”

As this blog has stated on numerous occasions, the next decade is going to be all about debt. Specifically 'soverign debt'.

And it is the looming spectre of massive sovereign debt that drives our iron-clad belief that Gold and Silver will be going up significantly in value in the coming years.

And one of the clearest signs that this belief is not misplaced is that Central banks (who were net sellers of gold a decade ago) are now buying vast amounts of the precious metal to reduce their reliance on the dollar as a reserve currency.

In April the Gold price reached a record level 15 times different times month on demand from investors seeking an alternative to the US dollar.

China's Central Bank is one of the largest buyers of Gold.  China has already stated they are out to have more gold than America. China wants to show its currency has more backing than the U.S.

Russia is aspiring to the same, having purchased more than 8 tons in the first quarter of 2010.

India is also well known as having a voracious appetite for Gold.

In fact in 2010 central banks added 87 metric tons in official-sector purchases by countries including Bolivia, Sri Lanka and Mauritius, according to World Gold Council data.

And, as Zero Hedge notes today, the middle east is ramping up it's purchases of Gold too.

Jim Sinclair, perhaps the most successful commodities trader of all time and a frequent CNN and CNBC commentator, was one of the few who recognized what Gold was going to do in the 1980's.

Based on a simple formula, he predicted early in the the 70's (when Gold was at $35/ounce) that Gold would probably go to about $900 (the high was actually $873).

He has been predicting another Gold resurgence for the past 15 years.  The metal has already sourced from about $220/ounce in 2001 to over $1,500 an ounce today.

Where does Sinclair see Gold going this time around?

• Because gold is held by many central banks, once as a reserve currency but now as an inventory currency, it functions as a swing asset to balance the International Balance sheet of the US.
• Central banks are sellers of dollars but still hold, by default, large dollar inventories.
• China has hedged its dollar position 50% through commitments to long term dollar commercial agreements, pay in, mineral, and energy deals internationally. That is an act of pure genius.
• We can assume other central banks still hold 90% of their reported dollar positions, on average unhedged by commercial obligation positions.
• In crisis times, the US dollar price of gold ALWAYS seeks to balance the International Balance Sheet of the USA.
• Therefore: Take 90% of international US dollar debt less China and then add 50% of the US debt owned by China. Then divide that number by the ounces supposed to be owned by the US Treasury. The result is where gold wants to go.
• In 1974 this gave me $900 gold.

So what do we get if you believe Jim Sinclair is, once again, correct about Gold?

From the most current TIC report:

Total Foreign Holdings of Treasury Securities: $4,479.2 Billion

-Less : China – Mainland (1,144.9)

-Plus: 50% of China – Mainland 572.5

Adjusted Foreign Holdings of Treasury Securities $3,906.8 Billion

Number of Fine Troy Ounces held in Custody by the US Mint for the US Treasury:

Note to Financial Statements 6, "Custodial Gold and Silver Bullion Reserves", page 59

Statutory value @ $42.2222 per FTO $10,574,053,000

Number of FTO 250,438,229

Valuation of Gold required to equal Adjusted Foreign Holdings of Treasury Securities

Adj Fgn Holdings $3,906,800,000,000

Number of FTO Gold at US Mint 250,438,229

Therefore Sinclair's formulat gives us a Gold price Valuation of: $15,600 per ounce

This is the level at which Sinclair believes Gold wants to go. And if Gold goes to that level, what about Silver? If Silver remains at it's approximate 37:1 ratio to Gold, we would then have a Silver price of $421/ounce.

If Silver goes back to it's historic average ratio of 16:1 to Gold, we would have a Silver price of $970/ounce.

If Silver overshoots to a ratio of 10:1 to Gold (as many predict), we would have a Silver price of $1,560/ounce.

In 1974 everyone thought Jim Sinclair was absolutely bonkers for predicting a $900/ounce price for Gold. By 1980 he was hailed as a genius. I am pretty confident even more people will dismiss his current prediction of a Gold price of over  $15,000/ounce.

It's all about Sovereign Debt. It's going to be an interesting decade.

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