There was sense of optimism amongst gold bugs in the west that the advent of the Shanghai Yuan denominated gold price fix, launched in April 2016, would quickly lead to true price discovery in the gold markets. Four months later and despite seeing Gold rise 23% in the first 8 months of 2016, the anticipated movement in the price has not been seen and has left many people scratching their heads. However, China always has a plan, it is just that more often than not we are not aware of it.
What we can say is that the movement of gold from west to east has been prolific. For several years as much as 1 ton per month headed east, via London and Switzerland, were it was recast into kilo bars before shipment. Whilst official figures for Chinese gold reserves currently stand at 1800 tons the reality is that they hold in excess of 30k tons. It is no secret that China and Russia have been draining the west of gold for many years, but there has been a sharp acceleration in demand since 2012. It is a little known fact that Russia has even higher gold reserves than China.
In March 2016, China planned on launching the gold backed Yuan which would have been the precursor to the Yuan denominated gold price fix. Washington, unsurprisingly, took great exception to this idea saying that should China proceed with this course of action they would see it as tantamount to a declaration of war. China wisely decided to back away from this course of action, allowing the west to implode under the weight of its own incompetence in handling its own financial system.
When the gold price fix was launched in Shanghai it was anticipated that they would arbitrage the price between London and Shanghai, causing a rapid drain of what Gold was left to purchase from the west. However China decided that whilst it was able to acquire gold at a cheaper price from the west there was no need to resort to arbitrage so the gold price fix in London and Shanghai has more or less remained on parity. Afterall, whilst there are western donors willingly to feed China’s demand for gold they will be happy to accumulate at current prices and leave the arbitrage opportunity on the sidelines.
However there will come a point in time when the supply from the west will dry up in entirety. Once China deems that point in time has arrived it will then raise the price in Shanghai to create an arbitrage between itself and London. If managed correctly this would then create the supply again enabling China to drain the west of further gold, who would take advantage of this price differential between London and Shanghai, placing an intolerable stress upon the Comex and LBMA. This course of action would also enable Shanghai to then find true price discovery that gold enthusiasts, such as this author, having been demanding for years.
The obvious question is when will this happen. We are seeing evidence of a run on gold now, not least in the following story which has been unfolding with regards to Deutsche Bank and Xetra-Gold.
What is also clear is that foreign holders of US Dollars have been dumping them and acquiring Gold. There will come a point soon when the demand supply curve will become so skewed that China will have to take the course of action to arbitrage the gold price, unleashing probable and irreparable damage to London and New York gold markets. This alone could cause a seismic tremor in the western financial system leading to a systemic crash. Perhaps then would be the time for China to announce their plans to launch a gold backed Yuan. As ever China always has a plan, even if they have to reverse some key decisions and delay their implementation by six months or so.
A final point to mention is the special drawing rights (SDR) basket of currencies which currently includes the US Dollar, Euro, the Japanese Yen, and the UK Pound sterling. On October 1st China is due to be added to this basket and much has been made as to the significance of this event. From this author’s perspective why would adding the Yuan to a basket of basket case currencies be seen as a precursor to a new financial system and the much vaunted “reset”? China is likely to only join for two reasons, to pacify Washington short-term and to utilise the SDR mechanism for another purpose going forward, perhaps by the inclusion of Gold in a 5+1 arrangement. You can rest assured that they are not joining the SDR merely to play second fiddle, in a basket of FIAT currencies, to the US dollar which, in any case, is now in terminal decline.