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Monday, March 16, 2015

China Sells Treasury's, Yields Collapse...China Buy's Gold, Prices Collapse..."Markets" at Work?!?

Funny thing about markets, they typically look to find a balance between a willing seller and willing buyer...both ultimately with a profit motive driving the exchange.  However, when nation states or their agents (central banks) are allowed unlimited access to a nation states fiat, things like profits or losses are quaint notions.  Unlimited new currency can be conjured to avoid these nations ever sustaining a "loss".   When these nations become involved in markets, price discovery and profit motive can be discarded for ulterior motives.  This is what I believe we are currently viewing in the US Treasury market, and very likely in conjunction, the gold market.

For instance, from July ’11 to December of ’14, China decreased its holdings of US Treasury debt by $71 Billion (according to the most recent TIC data )…while China continued to run record trade surplus' with the US.  During this period, China took in excess of a trillion new dollars and simultaneously was a net seller of US Treasury debt…so, China had to find a home for nearly $1.1 trillion new dollars.  The chart below highlights China's annual trade surplus with the US, annual Treasury purchases, and total Treasury holdings.
Source, US Census, Trade, Source, Treasury, TIC report
From ’00 to ’11, China had (on average) recycled about 50% of its trade surplus dollar reserves into Treasury’s.  However, as noted above, China has been a net seller since July ’11…why is this date important?  It was the month of the US debt ceiling fiasco…and the date when China’s purported gold purchase binge began.  It’s also August ’11 that gold hit its peak price and has fallen since.  I don’t think these happenings were a coincidence.

As shown in my previous post, on China's July '11 reversal in Treasury buying (then holding in excess of 10% of all public debt), Treasury yields collapse on new buying from untraceable, off-shore, financial centers.

Since we know China didn’t recycle the dollar surplus into Treasurys over this period, perhaps we should speculate what those new dollars would do if focused on gold purchases?!?  If China rotated the 50% of surplus dollars it had been utilizing to buy Treasurys and instead bought Gold…at an average of say $1500 an ounce since August ’11…that would buy China 10,000 tons of gold by year end 2014.  Hmmm…Implications abound.

According to the World Gold Council (WGC), China’s gold demand rose from 300 metric tons up to 1300 metric tons in 2013 and about 1200/mt as of 2014.  This is important as WGC reporting nets all newly produced global mine supply, global recycled scrap, and (based on the above WGC data on Chinese demand) denotes that the gold market is in balance between global supply and global demand.  However, based on the data from the Shanghai Gold Exchange (SGE), the central clearing house for all Chinese gold purchasing, China’s demand is far greater (the chart below highlights the discrepancy).  But if the data from SGE is correct, then where did all the additional gold come from and why did the price collapse on record demand?  The answer is almost certainly, the gold was imported from someone else’s inventories willing to part with something of great value at low prices.  But according to the SGE data, the Chinese demand was about 2,700 metric tons greater than global available WGC supply since July 2011 (3.5 years) or about 771 tons annually.  In the prior 3.5 years, the WGC and SGE had only diverged by about 600 metric tons or a 171 ton differential annually.  To reiterate, China had massive dollar reserves not utilized to buy Treasurys and someone sold a lot of gold to China and in the process drew down their own inventories as the demand was far greater than available mining and recycling supply!

Who would have this massive amount of gold in inventory (and willingly part with it at significantly lower prices) and why would the price of gold collapse on this clear imbalance in demand over supply?  Most sources of potential inventory are audited on a regular basis and this drawdown would be quite noticeable.  Of course, the greatest source of gold holdings are collectively held by the Federal Reserve and the US Federal government…and this is not openly audited.

Some questions spring to mind!  

From ’08-'09 through July '11, could China and the US have agreed to temporarily perform the thousands of years old activity of recycling excess currency; China officially purchasing US Treasurys but quietly and in secret being compensated in some sort of gold arrangement?  This certainly would have served both parties nicely allowing US deficit spending in an economic downturn without spiking interest rates.  China for it's part would continue its export driven economic miracle while single-handedly creating in excess of 1/3 of all global credit in an attempt to restart global demand and growth.

  • From '00 'til July '11, China increased its holdings of US Treasury debt from $65 billion to $1,315 billion…and in particular, from ’08 to July ’11, China increased its Treasury holdings by $588 billion while the US ran massive budget deficits flooding the Treasury market with new supply…and China’s trade surplus with the US ebbed on lower US consumer demand during the ’08 through ’11 economic slowdown (said more plainly, China bought more when they had less with which to make those purchases).

Since July ’11 China has net sold $71 billion in US Treasury debt on record dollar trade surplus in excess of a trillion dollars. 

    • China as of July ’11 suddenly changed course with their dollar surplus even as their trade surplus with the US reached new annual records over ’12-’14?  Did China suddenly decide gold was valuable and begin buying in the open market?  My guess is China believed gold was of value all along but once the gold was no longer available (perhaps the US ran out or simply determined, like Nixon in '71, who watched almost 60% of US gold depart in the prior decade, that closing the gold arrangement was essential to save whatever gold reserves the US had left). 

Put it all together…China, the largest buyer of US Treasurys ceases buying Treasurys…and US Treasury yields collapse?!?  The Chinese (and others) buy record amounts of gold and create an imbalance of demand over available supply…and prices collapse?!?  These are clearly not the actions of a market attempting to find a balance between price, supply, and demand.

Of course I can’t prove that China did purchase any amount of gold.  I can't prove the US and China had any arrangements.  The Chinese authorities haven’t made any updates since 2009 when they last made public a 600 ton increase (to their then official holdings of 454 tons) to the current official Chinese gold reserve of 1054.1 tons.  What I can say is Russia, which likewise has (had?) a large dollar trade surplus and likewise to China has consistently reduced its Treasury exposure since August of 2011…has consistently been openly adding to its gold reserves, now up to 1153.3 tons.  Then again, I can’t prove the US truly has 8133.5 tons (of course if the US government and/or Fed were willing to allow an audit, this open question could be put to rest).  Nor can I prove the Germans truly hold 3384.2 tons or Italians 2451.8 tons.  Still waiting on those open and transparent audits.

All I can say is the above math regarding China’s dollar hoard would nicely support what is visible in the chart below and also support those that claim Chinese gold buying and gold reserves are far larger than advertised. 


  1. Thanks for the article. The only thing I am not getting is the apparent greater demand and a falling price. This seems to go against the grain of normal economics, that and the fact that most investors seem very, very bearish on gold. The negativity is quite surprising. I have seen some great cycle based work across a whole range of assets, and all seem to be fairly accurate, aside from that for gold. The models suggest much higher prices, but we are seeing the opposite. I'm confused!!

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