The Hindu Business Line : Are Chinese purchases moving gold market?

SCALING newer heights in recent weeks, gold is having a dream run. Breaking out of the $550-an-ounce psychological level, the yellow metal moved up to a multi-year high of $562/oz on Monday.

Global liquidity, geo-political concerns, dollar weakness and buying interest by some Asian central banks have been cited as reasons for the bull run. There are also unconfirmed reports of China actively buying the metal as part of its asset diversification; but the magnitude is unclear.

Liquidity, no doubt, remains the most important driver of gold prices. While the entire metals sector has benefited from a general commodity bull run following huge flow of speculative funds, in the case of gold, there are other contributory factors too.

Geo-political uncertainty has increased in the past week, with the rhetoric over Iran's nuclear programme heating up. An armed conflict resolution cannot be ruled out, according to some observers.

Over the past week, strongly influenced by continued expectation of a lower US-Eurozone interest rate differential, the dollar has weakened.

As gold prices increased, open interest rose to 1,068 tonnes from 1,012 tonnes. Meanwhile, net non-commercial long positions have fallen to 453.5 tonnes from 469.6 tonnes. Latest data reflect that non-speculative market participants, who usually have longer-term investment horizons, have boosted their long positions.

Amidst all these, there are reports of China buying gold as part of reserve diversification. China's foreign exchange reserves are now well in excess of $760 billion, up from about $200 billion in 2001.

As a very significant part of China's dollar assets are in the form of US Treasures, there are currency risks and interest rate risks; and to address the issue, the country is expected to make changes in the currency composition of its reserves; as well as undertake diversification of portfolio by broadening the asset allocation.

While changes in currency composition would not impact gold, change in asset allocation would surely impact the yellow metal market, especially since the currency reserves are massive and diversification into gold would translate into huge tonnage.

A quick calculation done by Macquarie Research Commodities shows that if one per cent of reserves is held in gold, it would translate to 498 tonnes of gold representing 12 per cent of total consumption, while 5 per cent of the reserves going into gold would constitute 2,488 tonnes or 60 per cent of total consumption. At 10 per cent, the volume would double and represent 120 per cent of global consumption. (The calculation is based on total reserves of $800 billion, gold price of $500/oz and annual consumption of 4,145 tonnes).

Any meaningful diversification would mean huge funds going into gold and huge volumes being acquired, representing a significant part of global gold holdings. This is hugely positive for gold prices.

"However, this implies that the country's gold reserves would not be very liquid. Liquidity and availability of funds is a basic criterion of reserve management," observed an analyst with Macquarie Research.