Gold breaks $1,100: Does It Matter?
Last week, gold prices briefly touched $1,100/oz before settling just under that number. Apparently the Indian government decided to sell US dollars and make a 200 ton gold purchase from the IMF, which created the spike in gold prices. Right now, the spot price for the yellow metal is $1,106.
The IMF still has another 203 tons of gold to sell and the hot favorite to make the purchase has been China. However, according to a report by Reuters, its a lot cheaper for China to buy domestically mined gold than purchase bullion from the IMF at the current spot price. According to Li Yang, a former adviser to the People’s Bank, “China’s gold is much cheaper than that.”
You may not realize it, but China is the world’s No. 1 gold producer, and its mine costs are much less than $1,100 per ounce. And given China’s propensity to put national well-being over any private individual or firm, they’re likely to just pay for the gold being mined at cost, which would be a lot lower than the spot price.
According to another Chinese Central Bank official,
China is the world’s biggest gold producer, so there’s no urgency for us, as there is for India, to snap up big volumes whenever they come onto the global market. It’s cheaper for us to buy gold from the Chinese market, but it doesn’t help diversify our huge foreign exchange reserves.
To diversify our portfolio, we should spend dollars on things like gold. But the catch is that even if China bought half the world’s annual gold supply, it would only cost a few tens of billions of dollars, which is tiny compared to China’s huge reserves.
China has 2.27 trillion dollars in reserves. Spending 25 Billion a year buying gold is chump change. The question that’s relevant is whether they will, because that will put upward pressure on gold prices.
While no one knows whether China will or will not buying gold on the open market, the one thing we do know is that the monetary base of the US Dollar is growing exponentially making each existing dollar less valuable. Check out this graph from the St. Louis Fed:
While its not obvious from the graph, the monetary base has in the past year. Its true that this money hasn’t worked its way in to the economy, but if and when it does we should expect higher inflation and a spike in prices of real assets like gold, silver and real estate.
If I had a few trillion dollars, I’d be buying a few hundred tons of gold every year!
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November 14th, 2009 at 6:18 pm
I appreciate the posts especially the ones on gold and the dollar. I too believe gold is a good investment for the long-term. I was having a debate with someone about how inflation affects it. They say that for the past 30 years inflation adjusted with CPI i believe that gold has not kept up with inflation. and I looked at a chart and gold had a bad couple decades or so over the past 50 years. How can we be sure gold will continue to keep up with inflation given this history?
best
Mark P
November 14th, 2009 at 11:53 pm
Rather than a hedge against inflation, gold is more of a hedge against poor fiscal or monetary policy. In times of good monetary policy, gold does poorly, but in times of poor monetary policy it does exceedingly well. In fact, its the best asset to own over the past 10 years!