Wednesday, November 19, 2008

China's Greatest Trade...EVER - Part II

On October 29th, 2008 I wrote "China's Greatest Trade EVER!" in which I suggested that if China were to diversify its foreign exchange reserves into gold they would overwhelm the market. Since they hold so many dollars and gold is priced in dollars, buying gold is a way for China to diversify without selling the dollar.

Lo and behold, The Economic Times reported today (11/19/08) that China is considering increasing gold reserves from 600 tons to 4,000 tons, as a way to diversify their foreign exchange holdings (Economic Times, "China to Increase Gold Reserves to Diversify Risks"). As per usual the People's Bank of China declined to comment on the report. As well, there was a discussion on about what to do if the dollar crashes; curiously, that link has now been deleted, which should keep the conspiracy theorists busy all day.

On Wednesday 11/18/08 the World Gold Council (WGC) released its quarterly report "Gold Demand Trends." According to the WGC, gold demand in tonnage increased 18%, while in US dollar terms demand increased 51%, a record jump. Total supply fell by 10%, primarily due to lower central bank sales.

In 2007 total demand in tonnage was 3,518 tons and 2008 year to date demand is 2,599 tons. Total supply in 2007 was 3,497 tons and 2008 year to date supply is 2,492. It is clear to see that if China were to enter the market for an additional 3,400 tons they would need to purchase all the gold supplied in a given year. The gold market is already under supplied, any additional demand could have a major impact on price.

Disclosure: I am long DGP and GLD call options.

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