The Dollar And Gold In The New Great Monetary Game

This is an excerpt from the latest Thunder Road Report entitled “The New New Great Game” by Paul Mylchreest. 

Let’s consider recent developments in the monetary element of the NNGG, because they are coming thick and fast now.

A good place to begin is the March 2012 meeting of the BRICS nations, which saw them sign the “Master Agreement on Extending Credit Facility in Local Currency. ” This made it their POLICY to increase trade in local currency. This process is beginning to speed up. China is driving this process and now conducts 17% of its foreign trade in Yuan compared to almost zero in 2010. It has set up 23 (at the last count) currency swap agreements with major trading partners (including
the EU) and 60% of global GDP in all, to facilitate this process.

We also had the recent news that the Yuan is now the second most-used currency in trade finance, supplanting the Euro. According to SWIFT, the Chinese currency had a market share of 8.66% in October 2013 compared with 6.44% for the Euro. This share looks set to grow rapidly. The FT reported on 2 December 2013 that companies can now clear Yuan-denominated transactions in London. “UK-based Standard Chartered and Agricultural Bank of China have signed an agreement to start renminbi clearing services in the UK for the first time, in a deal announced to coincide with the visit of David Cameron, prime minister, to Beijing. London is becoming the main city outside of Asia for trading and transacting in the Chinese currency.”

A major pillar of the dollar’s dominance in world trade is pricing oil. China surpassed the US as the world’s largest oil importer in September this year. So, a potentially significant development was the comment from the Chairman of the Shanghai Futures Exchange that preparatory work for a crude oil futures contract priced in Yuan is being accelerated. This was from a Reuters report on 21 November 2013.

“China is the only country in the world that is a major crude producer, consumer and a big importer. It has all the necessary conditions to establish a successful crude oil futures contract,’ Yang Maijun, SHFE chairman, said at an industry conference.”

And Tyler Durden at Zero Hedge: “In doing so China is effectively lobbing the first shot across the bow of the Petrodollar system, and more importantly, the key support of the USD in the international arena. This would be in keeping with China’s strategy to import about 100 tons of gross gold each and every month, in addition
to however much gold it produces internally, in what many have also seen as a preparation for a gold-backed currency, which however would require a far broader acceptance of the renminbi in the international arena and most importantly, its intermediation in a crude pricing loop. It is precisely the latter that China is starting to focus on.”

Oil and gold again.

Given all of the above, it’s fairly obvious that China is moving ahead with its plan to dismantle the dollar’s dominance in world trade and internationalise the Yuan. However, it would hasten this process if the Chinese make good on recent comments from the PBOC. This was a Bloomberg report on 21 November 2013.

“It’s no longer in China’s favor to accumulate foreign-exchange reserves,’ Yi Gang, a deputy governor at the central bank, said in a speech organized by China Economists 50 Forum at Tsinghua University yesterday. The monetary authority will ‘basically’ end normal intervention in the currency market and broaden the yuan’s daily trading range, Governor Zhou Xiaochuan wrote in an article in a guidebook explaining reforms outlined last week following a Communist Party meeting. Neither Yi nor Zhou gave a timeframe for any changes.”

This would be a MASSIVE development.

Confrontation in the monetary sphere between the US and China has been building for many years Both sides seem to be preparing for just such a scenario. In his book “Currency Wars”, James Rickards recounts participating in the first Pentagon-sponsored “financial war game”, at the Applied Weapons Laboratory, outside Washington in 2009. In an interview with Max Keiser he commented.

“There was a Russia team, a China team, a United States team and then we had Europe, Switzerland, hedge funds…I was on the China team…My object, in order to help the United States, was to attack the United States as hard as we could in order to teach our own intelligence community what the threats were…I actually cooked up a little plot with a friend of mine who was on the Russia team and China and Russia combined forces and combined their gold and announced a new gold-backed currency using UK banks and Swiss depositories. And what they said was, from now on, if you want Chinese exports or Russian natural resources, we will no longer accept dollars, you must pay us in this new gold-backed currency.”

It seems that China is not sitting back either. For example, this was Zheng Gang, the CEO of Keen Risk Solution Co. and consultant member of the Chinese Competitive Intelligence Association.

“Before actual combat over land, sea and air, an enemy nation that possesses offensive capabilities in finance can disrupt China’s economic stability, thereby striking before a physical war, subduing us without a fight. The strategic ‘Game’ to preserve the USD’s global status is now focus of international political and economic activity; the US makes a new kind of non-military offensive against developing and transforming countries derived from her ability to set favorable rules, an ability she possesses through the dollar hegemony.”

One of the ultimate anti-dollar elements of the New New Great Game is China’s accumulation of gold at both state and private level. Whatever way you cut the analysis, it seems that China’s annual gold consumption is running at about 2,000 tonnes, possibly more.

This is a HUGE 70-75% of estimated 2013 world mine production.

The much discussed Chinese net imports through Hong Kong amount to just over 980 tonnes this year through October. This is an increase of 160% versus the first 10 months of 2012. The October figure of 130 tonnes was the second largest ever.

So we should see more than 1,200 tonnes in 2013 as a whole. Then we have to add in domestic mine production, hardly any of which leaves Chinese shores. This will be about 430 tonnes in 2013. It’s no surprise, nor coincidence, that China has ramped up gold supply dramatically.

So Hong Kong imports plus domestic mine production total about 1,600 tonnes. This is just one point of entry for gold into China and note this comment from Koos Jansen from the “In Gold We Trust” website (which has the best analysis of Chinese gold demand).

“There is also gold going into China through other ports that is not reported. I know this from the biggest transport company that ships gold from Switzerland to China.”

Including imports through Shanghai and other points of entry and we are probably getting close to 2000 tonnes. The other way of looking at it is from physical deliveries on the Shanghai Gold Exchange (SGE). The diligent Mr Jansen keeps close tabs on this – and produces great charts comparing SGE deliveries with world mining output ex-China (see below). From his conversations with the SGE, Jansen discovered an unusual aspect of what constitutes “delivery” on this exchange – it is metal that has been withdrawn from the vault and none of these bars are permitted to come back in. As he says.

“mine and import supply in China are required to be sold over the SGE. The result is that the gold that leaves the SGE vaults reflects total supply, and thus demand.”

Through the first 47 weeks of 2013, SGE deliveries amounted to 1,928 tonnes.

Then consider this quote.

“The Western governments needed to keep the price of gold down so it could flow where they needed it to flow. The key to free up gold was simple. The Western public will not hold an asset that is going nowhere, at least in currency terms (if one can only see value in paper currency terms then one cannot see value at all).”

Western investors were completely wrong-footed when the price turned last time.

And finally.

“The battle now is between the CBs [central banks] trying to keep gold in the $300s and the ‘others’ buying it up…Some people know this, that is why they aren’t trading it, they are buying it.”

It’s also clear that the Chinese fully understand the mechanics of the gold market and the determinants of the price.

For example, the following is a translation of an article from Zhang Jie of the China Gold Association (basically an arm of the State Council),

Gold Leasing Is A Tool For The Global Credit Game”, published on 15 April 2013. This will probably shock many investors in the West. With thanks to Koos Jansen for the translation. “Gold leasing is an important innovation in the gold settlement system. Through continuous gold leasing the gold in the market can be circulated and produce derivatives, creating more and more paper gold. This is very significant for the United States. Gold leasing is a major tool for the Federal Reserve and other central banks in the West to secretly control and regulate the gold market, creating gold credit derivatives…The purpose of gold leasing is not just to receive a rent, but it also provides the ability to short-sell gold, which allows central banks to interfere in the currency market…If one wants to control gold, it is a necessity to have the ability to short-sell the same. A central bank that directly suppresses gold would be suspected as a market manipulator. However, gold leasing by the central bank can take place unnoticed…For the Fed, it is crucial that the dollar dominates the world and so the Fed will store gold reserves from countries all over the world to control the gold settlement system. If there were another gold settlement system, it would compete with the dollar’s trust. Natural gold credit would be a nightmare for the continuous printed dollar. The dollar can only be the world currency as a result of the United States controlling global gold settlement. However, if other countries want their gold back from the Fed, the Fed will lose its gold settlement position.

The physical gold market prevailed last time and it will prevail again. Current tightness in physical supply is suggested by market indicators. For example, GOFO (gold forward offered rate), which is the interest rate for borrowing dollars using gold as collateral, has moved back into negative territory…just.

The market will pay gold holders to borrow dollars

GOFO_rates_november_2013

The gold futures market remains in backwardation, i.e. there is a negative gold basis (spot versus near-month future). Traders are turning down a free profit (albeit a small one currently) rather than risk any physical delivery problems in the futures market. See the blue line in negative territory in this chart from Sandeep Jaitly’s excellent “Gold Basis Service.”

Gold_base_november_2013

Gold should, and almost always has traded in contango, the only other exception was a brief period following the collapse of Lehman.

It’s our contention that the demarcation between paper and physical markets is becoming increasingly apparent. As an indication of the strength of physical gold demand, especially coming from China, here is an excerpt from an interview Koos Jansen conducted earlier this month with Alex Stanzyk of Anglo Far-East, a precious metals investment and custodial company. The interview followed Stanczyk’s meeting (along with “Currency Wars” author, Jim Rickards) with the managing director of a major Swiss refiner.

“He (the managing director) indicated the price didn’t make sense because he has got so much fabrication demand. They put on three shifts, they’re working 24 hours a day, and originally he thought that would wind down at some point. Well, they’ve been doing it all year. Every time he thinks it’s going to slow down, he gets more orders, more orders, more orders. They have expanded the plant to where it almost doubles their capacity. 70 % of their kilobar fabrication is going to China, at a pace of 10 tons a week. That’s from one refinery, now remember there are 4 of these big ones (refineries) in Switzerland. …

At this Swiss refinery there have been several times this year on which they were unable to source gold, this shocked me. They’re bringing in good delivery bars, scrap and dore from the mines, basically all they can get their hands on. This gentleman has been in the business for 37 years, he was there during the last bull market in the late seventies. I asked him when was the last time this happened, that he was unable to source gold, he said never. And I clarified it, I asked: let me make sure if I understand what you’re saying to me, in the last 37 years you’ve worked in the gold industry this has never happened? He said: this has never happened.”

The consensus seems to be upbeat on 2014, tapering not withstanding. Indeed, we’ve seen reports about “show time” for growth in developed economies.

Hmmm, we are less upbeat and when it comes to the “New New Great Game”, we may only just be getting started.

Given all of the threats to the US dollar as we head into 2014, you start wondering whether the Fed’s expressed desire to taper is also about trying to shore up the dollar (as well as addressing collateral shortages in the repo market).

us_dollar_index_november_2013

We’re also mindful that when the Fed began to float the idea of tapering back in May 2013, the BRICS currencies (albeit excluding the managed Remnimbi) were hammered.

Read the full report:

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