China Issued Covert Insurance on Gold and Silver

Back in August, China started publicly endorsing gold and silver as an investment on state sponsored television. Western financial media, but in particular a lot usually made fun of, the gold bugs, were quick to pick up the story and flood every precious metals section on every financial news website with the news from China. I don’t consider myself a gold bug, but having taken a look at the fundamentals of gold and silver, I am as convinced as any gold bug that there is huge upside potential for gold and silver. Factor in the frantic money printing all over the world and global economic and social instability, a combination which has historically been positive for the price of gold, and you’ve got yourself a front page news story. But this is not the end of the story.

When I first wrote about the Chinese disclosing their gold purchases back in April, I was pretty sure that any upside potential these purchases might have were long gone. But then, stories about Chinese government officials openly decrying the US dollar started to surface. Officials from other countries followed suit and German Head of State Angel Merkel dismissed Obama’s cries to print more money. But the US didn’t care, it kept on monetizing debt and buying up toxic assets from insolvent companies. All of this was followed by the TV commercial story.

The TV commercial story, on its surface, is groundbreaking enough to put a smile on every gold bug’s face. But beneath the obvious is something much more powerful. From Lawrence Williams: “Chinese state endorsement of gold and silver as good investments means the country can no longer afford to let precious metals prices drop by any significant amount.”

If this doesn’t make you want to run to gold, consider the fact that the Chinese government has to manage it’s way around 1,338,000,000 people, according to the latest estimates for 2009. Civil unrest has been a problem for years with tens of thousands of protests each year occurring all over China, but it is only going to get worse as factories are being closed for various reasons and environmental degradation takes a toll on the health of citizens; unless the government acts in ways to mitigate those problems. One has to realize that the only objective of the Communist Party is to stay in power and the only way to do that is to keep the probability of a revolution, peaceful or not, as close to zero as possible. That government cannot afford to lose the trust of its citizens and it has to, and will, do everything in its power to keep that from happening. Keeping its promises and standing by its words (endorsing gold and silver as an investment) is a part of that.

One also has to consider cultural implications. “‘Losing face’ is an important aspect of Chinese psychology and if millions of investors lose out because state-promoted investment in precious metals is not borne out this would be a massive government loss of face and one which is certainly not beyond its capabilities of not allowing to happen.”

The Chinese have no problems with keeping a floor under the price of gold and silver, especially considering the huge currency reserves that they have accumulated over the years and their diversification plans which involve the central bank of China and an undisclosed number of Chinese sovereign wealth funds buying up domestic as well as international gold. In effect, the Chinese have issued a massive insurance policy on the price of gold and silver. So there you have it. Considering that China started promoting gold and silver as an investment back in August, one can assume that the current floor is around the price seen in August: 950 in US dollars, 650 in euros, 1130 in Aussie dollars, 1030 in Canadian dollars, 570 in pound sterling, 890,000 in Japanese yen. The price of silver was around $14 in August, which means that one ounce of gold bought you 67.85 ounces of silver (use that to calculate the price of silver in other currencies for the month of August). Over time, I would expect to see the floor price rise as more and more Chinese accumulate gold and silver at higher price levels.

http://www.kristjanvelbri.com/2009/10/china-issued-covert-insurance-on-gold-and-silver