That brings us to Sun Zhaoxue and China's gold strategy.
Sun is the head of the state-owned China National Gold Corporation. According to the Financial Times, he recently wrote an article in the leading academic journal of the Chinese Communist Party (CCP) that may tell you exactly how China views gold. So then, how exactly does the CCP view gold?
'As gold is a currency in nature,' writes Sun, 'no matter if it's for state economic security or for the acceleration of renminbi internationalisation, increasing the gold reserve should be one of the key strategies of China.' This point will be recognisable if you've read China's Bust, by the DR's own Greg Canavan.
Jim Rickards stated that for China to have a seat at the table when the world's next monetary system is negotiated, it will have to have more gold. China last reported official gold holdings in 2009. At that time, the People's Bank of China revealed it had accumulated 1,054 tonnes — or a 75% increase from when it last reported in 2003 at 600 tonnes.
The 2009 figures leaves China with just 1.6% of its total foreign exchange reserves in gold. That number needs to be closer to 10% to be on par with some European countries. And the US has over 70% of its reserves in gold. Do you see where this is going?
China bought at least 400 tonnes of gold between 2003 and 2009. But it didn't advertise its intentions. You can be pretty sure it bought on weakness, when others were selling. We'd be willing to bet China's done a lot of gold buying in the last 12 months, with gold trending lower off an all-time high.
Sun argues that gold is a 'strategic resource as important as petroleum energy'. And even if he's talking his own book as the head of a gold company, China's gold accumulation is part of a larger story. Central banks around the globe are buying gold too. This has helped put a floor under the gold price.
First off, there is clear over-capacity in the Chinese steel sector. BlueScope steel CEO Peter O'Malley said yesterday that, 'My personal view is that China has already seen peak steel capacity...I think there is significant overproduction of steel in China at the moment. And therefore to the extent that we're at peak steel capacity in China at the moment you will see a slow down.'
It follows that the overcapacity in the Chinese steel sector has led to overcapacity in Australian iron ore and coal production. Because of their ore grades and low production costs, BHP and Rio Tinto can still make a lot of money on iron ore even as prices fall. But higher-cost producers with lower-grade ores will be squeezed out.
Not only that, but producers continue to shelve capacity expansion plans. China-backed Yancoal will move to cut costs and expansion plans, according to an article in yesterday's Australian by Sarah-Jane Tasker. The company sees lower prices and more job cuts ahead in 2012.
What does all this have to do with gold priced in Australian dollars? It is hard to argue that the Aussie dollar can strengthen when you have falling prices for key export commodities like iron ore and coal. Capital flows may determine currency strength more than interest rates. But why would capital continue to flow to Australia if iron ore and coal prices are headed lower? More on that tomorrow...
for The Daily Reckoning Australia
Source: China's Gold Strategy