Alan's Finance Blog

China’s “Mystery” Gold Buyer

Was the People’s Bank of China really buying gold at the rate of 1 ounce in every 8 sold worldwide last quarter…?

SO THOSE MILITANT crazies known to the mainstream media as “gold bugs” – and to the FBI as subversives – got the headline they’ve been longing for, apparently, last week.

“China central bank in gold-buying push,” declared the Financial Times. “It does appear the People’s Bank of China has been a significant buyer,” agreed a Reuters columnist.

At last, rapture is upon us! Beijing is buying gold in the open market! The FT picks up the story…

“China’s imports from Hong Kong, which account for the majority of its overseas buying, soared to 227 tonnes in the last three months of 2011, according to data published by Hong Kong. Mine production in the country, the largest gold producer, stood at about 100 tonnes in the quarter, implying total supply of at least 330 tonnes.

“That compares to demand of 191 tonnes for gold jewellery, bars and coins – which account for the vast majority of Chinese demand – reported by the World Gold Council on Thursday.”

With gold exports banned, you can see the gap right there…all 139 tonnes of it. The FT‘s conclusion? Courtesy of an “inference” and a “could be” from two leading analysts, that excess of supply over demand must have gone to the People’s Bank of China. Must have, right?

Well…

• The data came from 3 different sources, one of which is an official agency, another is the mining industry, and the third is trying to cover end-user sales in the world’s second-heaviest gold market and most populous nation;
• Those demand figures in particular are likely to be revised – upwards – by Thomson Reuters GFMS (who supply the WGC). The best data available, they were certainly revised –  upwards – quarter-on-quarter over recent years. And even on first release, China’s retail jewelry and investment sales show average compound growth of 36% per year since 2001. That’s one hell of a trend to keep count of in real time;
• No, a revision to end-demand of 139 tonnes will not happen. But would a 75% hike be any less likely than the People’s Bank of China growing its stated reserves (officially 1054 tonnes) by more than 13% inside 3 months? And inside 3 months that saw the gold price average $1684 per ounce, its highest level in history outside the $1702 record of July-Oct. last year?

Somehow, we doubt that China’s central bank snapped up 1 ounce in every 8 sold worldwide between October and Christmas. Most especially because, if Beijing’s policymakers were the “mystery” buyer, why would they then go and make importing gold a little bit harder for China’s bullion brokers?

Starting this month, China’s wholesalers now need to seek permission, reports our friend Bruce Ikemizu at Standard Bank in Tokyo, for each inbound shipment of gold from not only the People’s Bank  of China, but also from the bureaucrats of the State Administration of Foreign Exchange (SAFE). “So it takes longer to import gold,” notes Bruce.

Weirdly, SAFE was the agency which hoarded the 600-tonne addition of 2003-2009, officially switched to and reported by the PBoC three years ago in its last public update. So again, why would anyone buying gold – and already paying very nearly the highest prices in history – want to temper supply?

“In the medium term we do know the Chinese central bank and other Asian central banks with large foreign exchange reserves have been increasing their holdings of gold,” as Marcus Grubb of the World Gold Council told the Financial Times. Plugging some of last quarter’s gap “is consistent with that.” But plugging the whole 139 tonnes as the FT‘s headline suggests?

Both the WGC and GFMS’s Phillip Klapwijk – also quoted in the FT‘s report – in fact added that bullion banks and other stock-pilers would be likely candidates, too. And that would make sense after the scramble to secure supplies in early 2011. Because gold imports through Hong Kong – well ahead of last month’s 2012 Lunar New Year holidays – actually peaked in November. They then fell hard in December as the festivities drew closer.

Indeed, as the London gold price dropped late last September, the Hong Kong premium tripled to jump above $3 per ounce. So calling your UK supplier and booking new shipments would have been a natural response. Cheap prices, plus a fat mark-up if the metal arrives in good time? What trader wouldn’t try to book that? October and November then saw record imports of gold through Hong Kong to China. But the premium had fallen quickly however (according to Reuters data), already back down to $1 per ounce in October.

That’s the trouble with a physical market – delivery needs brokers and shipping, and wholesalers need stockpiles to draw on. Not much of a headline though, is it?

Stock-piling is common in base metals and oil. Standard Bank’s commodities team now reckon silver stockpiles in China are equal to 15 months of fabrication demand. And if Beijing were really on the bid for imported metal, then why, immediately after January’s Chinese New Year celebrations – the single biggest event on China’s gold buying calendar – did it set China’s gold importers a new hurdle?

Our guess? No doubt China is buying gold direct from its miners. That metal is then lacking for retail consumption. So to ensure lots of supply for what proved another strong Chinese New Year, importers booked early and often. But following that trebling of gold imports in 2011, the timing of SAFE’s move, immediately after New Year – and only two weeks after India doubled its gold and silver import duties – suggests Beijing is live to the trade-balance risks posed by Chinese households’ soaring demand.

“IMF slashes forecast for China current account surplus,” announced the Wall Street Journal last week.

“China’s current account surplus for 2011 shrank to $201.1 billion ($187.37bn), from $305.4bn in 2010. More important, as a ratio of gross domestic product, the surplus fell to about 2.7%…close to a decade-low.”

Now, “as China’s trade surplus declines dramatically,” reports University of Peking professor Michael Pettis, “more and more people within the country are calling for interventionist steps to halt the decline, including depreciating the [Yuan], or at least halting its appreciation.”

Pettis’ comment should remind us that Beijing is a big bureaucracy, with lots of divergent views and voices. Devaluing the Yuan would look a highly aggressive decision to its would-be friends in Washington, especially those US politicians talking up China’s “violations” of international law. But trying to stem – or rather slow – the pace of import growth wouldn’t look quite so rude.

This new rule is already frustrating those banks importing gold, but it’s likely only to delay, rather than deter, the flow of bullion. Still, it’s a hat-tip to the potential drain on China’s foreign currency holdings which gold has become for India – still the world’s No.1 consumer, and importing twice as much as bullion as China in 2011 because it has no domestic mine output to help feed its consumption, whether central-bank or private.

India’s hunger for a metal it does not produce is plain to see in its trade balance. The only current-account deficit in the region as Morgan Stanley notes, this gold-heavy outflow of cash also weighed on the Rupee’s exchange rate in 2011, down 15% versus the Dollar as the currency markets tried to force an adjustment.

Because even then, and with Rupee gold prices pushed to fresh record highs despite a 20% drop for US investors after September’s top, India’s full-year 2011 gold demand still rose from 2010 in Dollar terms, setting a fresh record of $46 billion on the World Gold Council’s data, and equal to more than three-quarters of the country’s current account deficit.

“[We hope to] discourage imports so that the Rupee steadies against the Dollar,” admitted a senior, unnamed official quoted by India Today after New Delhi raised import duties and handed a tax advantage to the domestic recycling lobby in January. Beijing’s policy wonks are being equally coy about trying to dampen gold bullion imports just ever so slightly. But China’s feint should remind precious-metals bulls that Asia’s massive demand growth can pose a risk to itself.

First, high prices could dissuade new buyers, as shown all too clearly by Western jewelry demand since 2005. A slow-down in GDP growth, worsened by a shrinking trade surplus, would make that risk worse. But for Asia’s ravenous gold buying, state interference is perhaps the present threat, especially in a market averaging 36% compound growth by value each year since China began deregulating gold a decade ago.

China’s gold buyers have needed no help from over-excitable headlines. But they have needed Beijing’s blessing to date.

Adrian Ash

Adrian Ash is head of research at BullionVault – the secure, low-cost gold and silver market for private investors online, where you can buy physical gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2012

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

Default Threat “Will Keep Coming Back” in Despite Greece Bailout Agreement, Gold Trading Volumes Rise in London But Imports by India May Decline

London Gold Market Report

U.S. DOLLAR gold bullion prices spiked to $1747 an ounce Tuesday lunchtime in London – a 1.3% gain on last week’s close – as US Markets re-opened to the news that European finance leaders have agreed to bail out Greece.

Silver bullion also spiked, hitting $33.97 per ounce – 1.9% up on the start of the week.

European stock markets by contrast drifted lower in Tuesday morning trading, while the Euro gave back most of the gains it made against the Dollar immediately after the Greek deal was announced. Commodities edged higher, while US Treasuries fell.

“Market reaction [to the Greek deal] has been remarkably muted so far,” one London gold bullion dealer noted this morning, before US markets opened.

Greece’s €130 billion second bailout was finally approved in the early hours of Tuesday morning, following a day of discussions among Eurozone finance ministers in Brussels.

The European Central Bank will pass on profits from its Greek debt holdings – bought below face value as part of its Securities Markets Programme aimed at supporting troubled sovereign debt markets – to the Greek government as a means of alleviating Greece’s debt burden.

Private sector creditors meantime will be asked to take bigger losses on their Greek debt holdings than previously agreed.

“From my point of view, this is a solid deal for investors, a fair deal for all parties involved,” said Charles Dallara, managing director of the Institute of International Finance, which negotiated with the Greek government on behalf of private bondholders.

“We’ve been able to avoid a disorderly default.”

Private sector losses will be equivalent to “more than 70%” of the net present value of the bonds, according to Jean Lemiere of BNP Paribas, who was involved in the negotiations.

The bailout means Greece should now be able to pay €14.5 billion of bonds that mature on March 20.

“Does this alleviate the risk of imminent default?” asks Callum Henderson, Singapore-based global head of foreign-exchange research at Standard Chartered.

“Yes, but not further out. Further out, the concerns of a default will keep coming back.”

“The risk,” adds a Hong Kong gold bullion dealer, “that we are going to have a sovereign default which leads to the collapse of the Euro still exists, but for that to happen in March, that risk is gone.”

The official statement released last night by Eurozone finance ministers calls for “further major efforts by the Greek society…to return the economy to a sustainable growth path”, as part of an effort to reduce the country’s debt-to-GDP ratio to 120.5% by 2020.

The statement also invites the European Commission “to significantly strengthen its Task Force for Greece…in order to bolster its capacity to provide and coordinate technical assistance”.

“Greece will find it difficult to shoulder even the reduced debt in the long-run if it does not implement far- reaching reforms,” says Commerzbank chief economist Joerg Kraemer.

“The probability will rise in the second half of the year that a frustrated EU stops payments to Greece.”

Gold imports to India meantime could fall in 2012 for the first time in three years, according to analysts polled by newswire Bloomberg.

India imported 969 tonnes of gold bullion in 2011, according to World Gold Council data, in a year that saw gold ETF demand double. The median estimate in Bloomberg’s poll was for 900 tonnes to be imported this year.

Silver bullion imports however could breach 5000 tonnes – up from 4800 tonnes last year – according to Bombay Bullion Association president Prithviraj Kothari.

“Silver demand is expected to rise on firm industrial and investment demand,”  Kothari told reporters at a conference on Tuesday.

Here in London, the daily average volume of gold bullion transferred between parties by clearing members of the London Bullion Market Association was 690.5 tonnes in January – a 1.0% gain on the previous month, and a 15.3% year-on-year gain – LBMA clearing statistics published Monday show.

By contrast, the daily average volume of silver bullion transferred fell last month, dropping to 4641 tonnes – the lowest level since March last year. The daily average silver volume fell 24.3% from December – though year-on-year it posted a gain of 24.6%.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

“Quiet Session” Sees Gold and Silver Flat, ECB Could Create “Dangerous” Two Tier Debt Market

London Gold Market Report

SPOT MARKET prices for buying gold held just above $1730 an ounce during flat trading this morning in London, as speculation continued over whether a Greek bailout will be agreed next week.

Prices for buying silver were also very flat – hovering above $33.50 an ounce – as were those for commodities and stocks ahead of President’s Day in the US on Monday.

“A quiet session,” said one Hong Kong gold dealer this morning.

Heading into the weekend, the price of buying gold was up less than half of one percent on the week by Friday lunchtime, with silver also showing very little movement from last Friday’s close.

German finance minister Wolfgang Schaeuble has reportedly called for Greece to be allowed to default. Chancellor Angela Merkel is firmly against such a development, according to press reports.

“Schaeuble doesn’t think the Greeks can deliver any more [austerity measures],” an official from Merkel’s CDU party tells the Financial Times. Schaeuble has also this week suggested Greece should postpone general elections scheduled for April and install a technocrat government.

Eurozone finance ministers are due to meet Monday to discuss Greece’s second bailout, with Germany, the Netherlands, Luxembourg and Finland – all rated AAA by ratings agencies – calling for increased permanent supervision of Greece’s fiscal affairs.

“The one thing we should take away from Lehman Brothers,” former US Treasury secretary Henry Paulson said this week, “is you don’t want a big systemic institution to fail in a messy way, and you clearly don’t want that to happen with a [Euro] member state.”

“We expect [gold's sideways] trend to continue into the weekend, as participants remain wary of taking on new positions ahead of Monday’s Eurozone meeting,” says today’s note from Standard Bank commodities strategist Marc Ground.

The German parliament is expected to vote on any bailout deal on February 27. If enough members of Merkel’s coalition government oppose the measure, she may need to rely on opposition Social Democrat and Green votes.

Elsewhere in Germany, Merkel’s personal choice for the ceremonial role of German president resigned today amid allegations he misled parliament over a €500,000 loan to buy a house.

The European Central Bank meantime is expected to swap its existing Greek bonds for new ones that would not tie it to any collective action clauses to which private investors would be subject.

This means the ECB would be protected from taking losses on its holdings – an event that ECB president Mario Draghi has said would amount to monetization of government debt.

“In Europe, all bond holders are equal, but the ECB is more equal than others, apparently,” says Thomas Costerg, London-based economist at Standard Chartered bank.

“This could set a dangerous precedent, and, by creating a de-facto two-tier market, this could discourage investment in other peripheral debt markets.”

If private sector Greek bond losses are deemed to be involuntary, this could also trigger payments on credit default swaps, which act as a form of debt insurance.

“The probability of triggering CDS has increased because the ECB has protected itself,” says Padhraic Garvey, head of developed-market debt at Amsterdam-based ING Groep.

The United States meantime has no plans to give additional money to the International Monetary Fund, US Treasury undersecretary for international affairs Lael Brainard told the Senate banking Committee Thursday.

US consumer price inflation dropped to an annual rate of 2.9% last month, according to figures published Friday – down from 3.0% in December.

China’s central bank may have been buying gold in the fourth quarter of last year, according to a report in Friday’s FT.

Elsewhere in China, a huge stockpile of silver bullion has built up in the country, according to investment bank analysis this week.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

How to Profit as Global Debt Soars

by JR Crooks

It’s no secret that the world’s central bankers and governments are cranking out money at lightning speed to stave off a global depression.

Let’s assume for a moment, that they’re right.

I of course would say much of the stimulus was simply to save the old order, i.e. the welfare state in Europe, which Mr. Obama seems desperate to emulate on this side of the pond. After all, this isn’t the first time we’ve seen massive buildups of debt to save Europe.

Here is an excerpt from the magazine Sphere of July, 1935, summarizing public statements by Adolph Miller, a member of the Reserve Board at that time:

“Mr. Miller, of the Federal Reserve Board, states that the easy credit policy of 1927, which was father and mother to the subsequent 1929 collapse, was originated by Governor Strong, of the New York Federal Reserve Bank, and that it did not represent a policy either developed or imposed by the Board on the Reserve Banks against their will.

“The policy was the result of a visit to this country of the Governors of foreign central banks, who unequivocally stated in New York that unless the United States did adopt it there would be an economic collapse in Europe. It was a European policy, adopted by the United States.”

And even someone who supports this stimulus must be worried when they look at the numbers. If they aren’t afraid, they should be.

I’m not predicting a depression. I do believe, though, that all the elements are in place for one to develop if policy makers don’t act to reduce global debt and institute growth policies.

Since 2008, global GDP has grown 4.7 percent or $2.9 trillion. Yet global debt has grown 14 percent or $25.7 trillion!

And look what David Rosenberg, of Gluskin Sheff, said recently in a research note:

“Maybe the economy seems to be doing better because we have all adjusted our expectations so radically after being disappointed for so long — I mean — take 2011 as an example. A year that would normally see 5 percent real GDP growth for this stage of the cycle came in at a woeful 1.7 percent.

“This, despite a $3 trillion Fed balance sheet (triple its normal size), zero percent policy rates now for three years and now going on year number four of $1 trillion-plus fiscal deficits. Based on all this stimulus, if this were a normal post-recession recovery, GDP growth would be 8 percent right now, not sub-2!!”

Based on the chart below, on a global basis, $0.89 cents for every $1 of “stimulus” is disappearing down the rabbit hole instead of going into the economy.

A few more numbers to view in sheer horror showing Industrialized Countries Debt/GDP adding private indebtedness to the equation:

• United States — 350 percent
• Japan — 490 percent
• Euro-currency countries — 443 percent
• United Kingdom — 459 percent

And in case you missed Monday’s front page of the Financial Times, it said China is being forced to extend out the time for repayment on debts to local governments, in the $1.7 trillion range, because they can’t be repaid now.

Many mistakenly believe, I think, that China’s Debt/GDP is perfectly manageable, and believe the official numbers suggesting it is in the 30 percent range. But more savvy estimates peg the debt closer to 90 percent.

No problem you say when compared with the industrialized countries. Maybe you should rethink that.

Why? Because emerging economies have a much lower threshold for debt. According to Rogoff and Reinheart, economists extraordinaire and authors of This Time is Different: Eight Centuries of Financial Folly:

“[For emerging economies] When total external debt reaches 60 percent of GDP, annual growth declines about 2 percent; for higher levels, growth rates are roughly cut in half. [IMF recently warned a euro crisis would likely cut China's growth rate in half.]“

Not many investors seem worried now, though. The chart below shows how faith in central banks and governments springs eternal despite the lessons of history.

Dow Jones Industrial Average versus the Fear Index (VIX)

To sum it up:

Debt above the 90 percent threshold for the industrialized world means slow growth …

Debt above the 60 percent threshold for the emerging market world means slow growth …

Thus those currencies geared to growth, such as the Australian dollar, could get hit the hardest. And of course, the debt crisis is bound to sink the euro.

There are several ways you can play this, including ETFs and options. Sorry, I can’t give you the specifics. That wouldn’t be fair to my World Currency Trader members.

But I can tell you this … the simple truth is that right now things seem to be shaping up for a break in risk appetite. The public’s perception of this global debt crisis will spark sustained risk aversion once it makes it into the spotlight. And the approaching Greek default could be the catalyst as it would offer a much-needed dose of reality.

Best wishes,

JR

Keynesians Jump the Gun on Inflation

Advocates of government stimulus are running victory laps on recent developments that appear to vindicate their strategy. In particular, Paul Krugman compares the sluggish growth in Europe to the somewhat-less-sluggish growth in the US to prove that stimulus was more effective than austerity. Other economists are using government inflation measures to defend Fed Chairman Bernanke’s easy-money policy. The only problem is, they’re calling the race before the finish line is even in sight.

As usual, Paul Krugman overlooks basic economics (which, despite his Nobel Prize, is a science about which Mr. Krugman really knows very little). The reason stimulus is so politically popular is that it appears to work in the short-term. However, appearances can often be deceiving, as they are right now in the US. Stimulus merely numbs the pain of economic contraction, as the underlying trauma gets worse. Austerity might slow an economy down, but at least the wounds are able to heal. America has chosen the former and Europe the latter, albeit not quite as large a dose as needed. The fact that in the short-run Europe is suffering more than the US does not vindicate Washington’s approach. On the contrary, this is exactly what is to be expected.

What we’re seeing is like a race where each runner has a broken ankle. One has a coach who tells him to pace himself and not worry so much about winning this one, while the other coach gives his runner a shot of painkillers and tells him to give it all he’s got. Of course, early in the race, the doped-up runner is going to be flying down the track like nothing’s wrong, while the other runner might be limping at half his normal speed. However, when the drugs wear off, the sprinter is liable to collapse from pain, leaving the better-coached runner to limp across the finish line.

The true test is not the immediate effects of stimulus or austerity, but the long-term results. For that reason, Krugman’s conclusions are meaningless. The apparent success of stimulus simply results from spending more borrowed money on government programs and consumption. But don’t we all agree now that this is exactly what caused the financial crisis in the first place?

As far as inflation is concerned, a vindication of Federal Reserve Chairman Ben Bernanke is equally premature. First of all, it’s not that Quantitative Easing will lead to inflation; it’s that QE is inflation. Secondly, there is a lag between QE and rising consumer prices, so the jury is still out as to how high consumer prices will ultimately rise as a result of current and past Fed policy mistakes.

But even more fundamentally, it is absurd to look solely at government price measures, which are built to understate inflation, and conclude that QE has not already produced an elevated cost-of-living. For example, the 2.4% rise in the Personal Consumption Expenditure (PCE) Index in 2011 is more of an indictment of the accuracy of the index than a vindication of Bernanke. In fact, of all the ways the government purports to measure inflation, the PCE is perhaps the most meaningless, as it relies on built-in mechanisms like goods substitution to hide a lower standard of living. As an example of how this works, imagine you are used to eating farm-fresh butter but have to switch to cheaper but also less-healthy margarine from a factory; the PCE would say you are no worse off. That’s exactly why the Fed chooses to use this uncommon metric.

Mark Gertler, an economics professor at New York University, argues that even the Consumer Price Index, which rose at a more vigorous 3.2% in 2011, proves Bernanke’s critics wrong. According to Gertler, the CPI has risen at an average annual rate of 2.4% thus far under Bernanke’s tenure, significantly less than the 3.1% average under Alan Greenspan, and the 6.3% under Paul Volcker.  However, Gertler overlooks two key points. First, the methodology used to calculate the CPI was much different during the Volcker era. If we still calculated the CPI the way we did then, the numbers would be much higher for both Greenspan and Bernanke. Second, given the huge economic contraction that has taken place under Bernanke, consumer prices should have fallen – significantly. The fact that they rose anyway indicates tremendous inflation.

Of course, the Fed’s ability to stimulate the economy with inflation only works as long as bondholders remain ignorant of its plan. For now, the seemingly hopeful news reports are giving the Fed cover to keep stimulating. As long as the market remains convinced there is no inflation, the Fed can continue to create it. However, once the effects are so pronounced that even the PCE can no longer hide them, the Fed will be in a real bind.

Think of our two runners again. Even after the race is over, the fellow who chose to dope up likely injured himself even further. He might have even ended his career. So, the early dash and the cheer of the crowd in that one race was clearly not worth the many years of misery he would incur in the future.

Regardless of what the triumphant Keynesians would have you believe, my analysis continues to be that the current combination of monetary and fiscal stimulus is driving us toward disaster. Instead of a real recovery, the US will experience an inflationary depression. Europe, on the other hand, will suffer much less, precisely because it was not seduced by the short-term appeal of stimulus.

What Does the Bank of England Think It’s Doing?

Quantitative easing has not worked as advertised so far. Why push ahead with more…?

“YOU’VE lost control – Bank of England takes over,” says the Bank of England’s cute little game for school-kids if you let the hot-air balloon you control crash into the ground, rather than happily floating it around the 2.0% annual inflation target.

But if the Bank loses control in the real world? Are there grown-ups ready to take over? And what if the Bank purposefully drives its balloon up into the clouds, so far above its 2.0% inflation target – its primary mandate, set by Parliament, and over-riding the secondary aim of “support[ing] the Government’s objectives for growth and employment” – that wage-earners, savers and consumers alike start hurling themselves out of the basket?

We shall never know what would have happened without near-zero interest rates and the first £273.5 billion of quantitative easing. But as the Bank sticks at 0.5% for the 36th month in succession – and starts creating a further £50 billion in new money – we can say what has happened with them:

• For every £1 the Bank of England created from nowhere since March 2009, the total UK money supply grew by only 35p;
• For every £1 million the Bank has created, more than two people have become unemployed;
• Finance-sector salaries outpaced the average wage (rising 8.8% vs. 5.0%), but still lagged the cost of living (up more than 11% on the Consumer Price Index);
• The average house price rose almost 10%, while the FTSE All-Share index rose by nearly two-thirds. Both were beaten by gold (up 70%) and silver (130%).

Was this really the aim? Let’s ask the Old Lady herself.

“The purpose of the purchases [according to the Bank of England's own information] was to inject money directly into the economy in order to boost nominal demand.”

Two ideas there then – injecting money into the economy, and boosting demand. Neither are part of the Bank’s primary mandate, remember, but both ideas have stuck, albeit in the popular imagination more than reality. “Bank injects £50bn into economy,” announced the BBC last week, “to give a further boost to the UK.”

But while the Bank has already created and spent more than £273 billion on buying government bonds in the last three years, the UK money supply (using the broadest measure, known as M4, and covering all the money in banking deposits) has risen by only £97 billion. Gross domestic product has scarcely budged either, rising by only 1.7% (to the end of September) despite the 4.9% actual growth in M4 money.

So for all the good it has done, where did the Bank stick this injection?

Well, “The asset purchase programme is not about giving money to banks,” stresses the Bank in its version of Quantitative Easing Explained. “Rather, the policy is designed to circumvent the banking system.”

Not that the programme does side-step the banks. Instead, as the Bank of England admits elsewhere, it sees the Old Lady “electronically create new money” and then use it to buy UK government bonds directly from the banks, whether held on their own account or on behalf of their clients such as investment funds and insurance companies. Still, handed this new cash in return for the gilts that they sell, “These investors typically do not want to hold on to this money, because it yields a low return,” says the Bank. “So they tend to use it to purchase other assets, such as corporate bonds and shares. That lowers longer-term borrowing costs and encourages the issuance of new equities and bonds.”

Simple, right? The Old Lady wants to cut interest rates and boost the level of capital raised by businesses – private non-financial corporations as the Bank calls them, those companies outside finance and banking which everyone’s so sure had nothing to do with the bubble or bust. Indeed, “the objective of QE is to work around an impaired banking system by stimulating activity in the capital markets,” according to Charlie Bean, the Bank’s deputy governor for monetary policy. And yet PNFCs have shared little in the flood of money issued by the Old Lady’s computer-key strokes.

Since March 2009, total capital issuance by private non-financial firms has totaled £44.5bn – greater than the £34.0bn they raised over the preceding three years, but that was a time of boom, not bust, so the Bank’s stated purpose still begs the question. And the total raised is still nothing compared with the total £275bn “injection”.

Once again, then, where did the Bank’s “injection” go – and was that its aim?

“Money is not growing quickly enough to keep inflation close to the 2% target,” says the Bank of England in an educational briefing for schoolchildren. “The Bank is injecting money into the economy to boost spending to meet the inflation target.”

Okay, so here’s an outcome the Bank should happily claim for its own. But whether boosting inflation is a good thing or not, inflation has in fact been well above the Bank’s official 2.0% target since 2009. So far above, that governor Mervyn King keeps having to write open letters to the government – as he must under the policy framework established when the Bank gained full control of interest rates in 1997 – explaining why he’s repeatedly let inflation breach the upper 3.0% limit for the last 24 months in succession.

The risk of under-shooting inflation looks awfully thin, and the perils of under-shooting might seem academic as well. Because incomes have failed to keep up with inflation – the very opposite of those “second-round effects” so feared by the Bank under Sir Mervyn when it failed to raise interest rates in the face of the banking bubble that started a decade ago. Today, even indebted households have failed to benefit from the drop in what money will buy. Because inflation only eats into debt when a rising income lets you pay it back faster.

Maybe the Old Lady knows what she’s doing. Or maybe she thinks “two” now means “three-point-eight”. Or maybe she’s just losing sight of her 2.0% inflation target, fast becoming a speck in the distance from her hot air balloon. Or maybe – just maybe – now that the Bank holds so many billions of pounds in government debt, it daren’t let the total start falling, for fear of a train-wreck in the gilt market. Once you pop, you just can’t stop, and it did after all switch to buying fewer long-term gilts and more medium-term debt at this month’s £50bn announcement. Which would fit with fretting about a pile-up of maturing debt in the “medium term”, rather than trying to suppress interest rates on 30-year gilts.

Either way, quantitative easing has failed to work as advertised to date. Reviewing the evidence so far, we’re genuinely none-the-wiser about why in the hell the Bank is now pushing ahead with more.

Adrian Ash

Adrian Ash is head of research at BullionVault – the secure, low-cost gold and silver market for private investors online, where you can buy physical gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2012

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

Dollar Weakness “Creating Gold Demand” after Greek Deal, Time for American Austerity “Is Not Now” says White House

London Gold Market Report

SPOT MARKET gold prices touched $1733 per ounce Monday morning – 0.5% up on last week’s close – as stock markets, commodities and the Euro all rallied following Greece’s vote in favor of new austerity measures.

Silver prices meantime hovered around $33.90 per ounce – 0.8% up on the end of last week – while government bond prices dipped and the Dollar fell on the currency markets.

“The weakness in the Dollar…creates a bit of demand for gold,” reckons Bernard Sin, head of currency and metal dealing at Swiss precious metals refiner MKS.

By Monday lunchtime, Euro-denominated gold prices were roughly where they ended last week, at around €42,000 per kilo (€1306 per ounce).

Greek lawmakers last night approved a fresh austerity package, including public sector layoffs, minimum wage reduction and pension cuts. A reported 80,000 people took to the streets in protest, while press reports said up to 30 buildings were firebombed.

Antonis Samaras, leader of the New Democracy party and widely tipped as Greece’s next prime minister, expelled 21 members from his party for voting against the measures. Former prime minister George Papandreou, leader of the socialist Pasok party, also expelled members who did not support the measures.

Eurozone finance ministers are due to meet on Wednesday to review the new agreement, and potentially sign off Greece’s €130 billion second bailout. This in turn should pave the way for a deal with Greece’s private creditors to reduce the country’s debt burden, as well as stave off a default on March 20 when €14.5 billion of 3-Year Greek bonds mature.

“The government may yet find that approving the new measures…proves to be far less of a challenge than implementing them in the months ahead,” reckons one gold bullion dealer here in London.

“We are still looking for more measures out of Europe before we see a sustainable risk rally,” adds Ong Yi Ling at Phillip Futures in Singapore, who expects gold prices to hit resistance at $1760 per ounce.

“That will be the first resistance and the second one is at about the $1800 level. For gold to break the $1800 level, we need more measures, I would say.”

Here in the UK, the latest Bank of England figures relating to Project Merlin – the agreement between the UK government and British banks aimed at promoting lending to business – show that banks lent £214.9 billion overall to business in 2011, against a target of £190 billion.

However, the target for smaller businesses was missed, with £74.9 billion lent versus a target of £76 billion. The final quarter of last year saw a 3% drop in net lending.

“The Merlin targets have failed,” says Andrew Cave, head of external affairs at the Federation of Small Businesses.

“Talking to our members, 30% of them say they missed a growth opportunity because they weren’t able to access finance at the right times, so there is still a problem.”

“The reality,” adds Lee Hopley, chief economist at manufacturers’ federation EEF, “is that small and medium enterprises continue to be frustrated by the cost and terms and conditions around lending, with some opting out of using external finance altogether. This cannot be good for growth.”

China’s government has ordered the country’s banks to begin rolling over its loans to local governments, according to the Financial Times. When the global financial crisis broke in 2007-8, the state launched a massive stimulus program. Local authorities in China now have debts worth an estimated $1.7 trillion the FT says.

US president Barack Obama will today call for higher taxes on millionaires and billions of Dollars’ worth of infrastructure projects to create jobs as part of his 2013 budget proposals, news agency Reuters reports.

“I think there is pretty broad agreement that the time for austerity is not today,” White House chief of staff Jack Lew said Sunday.

Obama is expected to repeat his call made during his State of the Union address for the introduction of the so-called Buffett Rule, which would see millionaires pay a tax rate of at least 30%.

The net difference between bullish and bearish gold futures and options contracts held by traders on New York’s Comex – the so-called speculative net long – went up for the fifth week in a row over the week ended last Tuesday, according to the latest data from the Commodity Futures Trading Commission.

The spec net long and open interest both hit their highest levels since the week ended 15 November.

“It is likely that net spec length may consolidate or even decline in the week to 14 February as futures open interest in the period 8-10 February fell in parallel with the gold price,” reckons Carl Firman at precious metals consultancy VM Group.

“Options open interest in this period also shows a rise in puts relative to calls, suggesting some doubt may be creeping into the sustainability of the price rally.”

The volume of gold bullion held to back shares in world’s largest gold ETF the SPDR Gold Trust (GLD) meantime is at its highest level since 20 December, having risen 0.1% over the course of last week.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

China’s Rebalancing Should Be Good for Gold Demand

The next stage of China’s development could give gold buyers a boost…

THERE IS an old saying: “Nobody rings a bell at the top or bottom of a market.”

Having said that, anyone reading about the stampede for gold during last month’s Chinese New Year celebrations might have heard a faint ringing in their ears.

Here are a few quotations from various press sources:

• “Some customers just walk in and buy a bunch of 100g gold bars all at once…Companies come in too to buy gold bars for presents.” – branch manager, Industrial and Commercial Bank of China.
• “Some companies are giving out gold instead of cash to their employees” –Jia Zhihong, jeweler, Wuhan.
• “With customers crowding and rushing in, we did not even have time to eat and drink.” – gold counter sales clerk.
• “People seem crazy about gold, snatching it up more like a cheap cabbage than such a precious metal…You have to quickly decide whether to make a purchase, or it will be taken away by others.” – Beijing shopper
• “Think of it like investing in the stock market…Gold maintains its value much better than stocks.” – sales clerk, China Gold store.

The classic signs of an investment mania are there. Mass participation, frenzied buying, an established narrative that something is a ‘sure thing’. But though this may look like the-mania-before-the-crash, that doesn’t mean it is.

China’s industrial development is still very much a work in progress. The likely next phase is a rebalancing of wealth away from industry and towards households. Given the demonstrable appetite for gold among Chinese consumers, this should be a major supporting factor for global gold demand.

According to World Gold Council data, Chinese gold consumption totaled 207.4 tonnes in 2003. By 2009 it had more than doubled to 457.7 tonnes. More recently, gold imports from Hong Kong, widely regarded as a proxy for total gold imports, tripled in 2011.

China only began deregulating its gold market a decade ago. Until the Shanghai Gold Exchange opened in late 2002, the government held a monopoly on gold ownership. It is possible that the growth in Chinese gold demand could merely represent catch-up, but this seems unlikely given how rapidly China’s economy grew over the same period. Ordinary Chinese have been growing steadily wealthier, meaning more and more people have had the wherewithal to buy gold.

A working paper by economists Guonan Ma and Wang Yi published last year by the Bank for International Settlements, for example, found that household savings as a percentage of gross domestic product (GDP) rose from 16% in 2001 to 23% by 2008 – a period in which GDP itself regularly grew by 10% or more a year.

The authors also found there was a considerable rise in household’s average propensity to save – that is, the proportion of disposable income that is held as savings. One possible explanation for this could be that economic growth has raised more and more Chinese to just above subsistence level, as agrarian workers urbanize and take higher-paying factory jobs for instance. As incomes grow, an increasing number can for the first time afford to save. Compared to those on higher incomes, though, these new savers must save a greater proportion of their disposable pay in order to attain a given level of savings.

This is not the only factor likely to have driven Chinese savings higher. Ma and Wang also argue that “precautionary savings motives” also explain the rise in personal savings. They cite the period 1995-2005, which saw a 50% fall in employment at state companies:

‘Downsized employees received modest social welfare benefits, while many smaller money-losing state companies were shut down altogether. As a result, the enterprise-based cradle-to-grave social safety net shrank rapidly…The large-scale corporate restructuring and downsizing between 1995 and 2005 increased both income and expenditure uncertainties and weakened the enterprise-based social safety net, thus reinforcing the precautionary motives to save.’

Consider that for a second. Consider how it would have felt from the perspective of a “downsized” Chinese worker. Your socialist government, in power since 1949, has thrown a whole load of people out of work and done very little to help them afterwards.

In this context, it is understandable why people in China started saving more. One only has to think of the long shadow cast by Germany’s hyperinflation in the early 1920s, and the pathological fear Germans to this day have of price instability, to see how economic upheaval can have an enduring impact on financial behavior.

China therefore looks set to have a high savings rate for the foreseeable future. Furthermore, the rapid growth of Chinese gold demand suggests that many of those who can afford it choose to use some of their savings to buy gold (indeed, many have chosen to store some savings as gold).

Of course, this is not to say that the Chinese will continue to buy gold in ever greater quantities indefinitely. Indeed, it is impossible to know how a sharp slowdown in growth would affect Chinese gold demand. There may be some safe haven buying, especially if financial institutions collapse or people fear higher inflation as a result of any central bank response. On the other hand though, slower growth would sap the buying power of would-be gold consumers.

This is not an academic consideration. China faces a number of likely headwinds going forward. Most immediately, its export-led growth model means it is exposed to any deterioration in the global economy, for example the ongoing crisis in Europe, with which China has major trade links. It’s also probable that China has more deep-rooted troubles brewing. Beijing-based economist Michael Pettis argues that China has for years been misallocating capital “on a grand scale”, with state-owned enterprises investing in projects of questionable economic merit.

Elsewhere Pettis draws a parallel with Japan, which he argues underwent a similar phase of overinvestment, making Japan’s subsequent stagnation akin to what China might face (and also qualitatively different from the post-consumption boom crisis the US and Europe currently find themselves in):

‘This is not the problem that that the US or Europe is suffering from.  [The US and Europe] suffer from a typical debt-fueled overconsumption boom, whereas Japan suffered from a typical debt-fueled over-investment boom, and Japan’s period of over-investment was much, much more extreme (centralized investment booms can last much longer and go much further than decentralized consumption booms).  This is why I think the Japanese experience tells us almost nothing about what Europe and the US will go through.

‘On the other hand, it might tell us a lot about what China will go through.  In fact we can make a more general point.  Command economies (Japan, the USSR, Brazil and many others during their “miracle” periods) tend to have much more rapid investment-driven growth during the good times and much more difficult and longer-lasting adjustments.’

So far, so very bearish for China. But Japan’s experience in the years following World War 2 also offers longer term hope. In a working paper published last year,  Bank of Japan economists Tomoyuki Fukumoto and Ichiro Muto argue that the high economic growth rates of today’s China mirror those seen in Japan between 1955 and 1970, which they say were “initiated by vigorous investment”.

After 1970, Japan saw a significant rebalancing of its economy away from investment towards consumption:

Consumption and investment in Japan as percentage of nominal GDP

Fukumoto and Muto find that one key factor behind this rebalancing was the rising share of national income that went to labor, with labor’s share of GDP shooting up ten percentage points between 1970 and 1975.

Pettis argues that ongoing rebalancing towards consumption also explains why Japanese living standards have continued to rise over the last two decades despite the stagnant Japanese economy:

‘It was the state sector that bore most of the brunt of the slower growth, and this shows up as the explosion in government debt.  Households were fine because although the GDP pie was growing at a much slower rate after 1990 than before, their share of the pie was growing after 1990, whereas it shrank before 1990…I think the same might happen, or at least could happen, in China.’

China’s rebalancing has barely begun; consumption as a share of GDP has continued to fall in recent years much as it has for the last three decades:

Consumption and investment in China as percentage of nominal GDP

At the start of last year, the Economist Intelligence Unit rated the results of China’s 11th Five-Year Plan, which ran from 2006 to 2010. One of the categories was ‘Economic rebalancing’, a term which includes China’s external as well as internal imbalances. China scored poorly in this category, being graded a ‘D’ for its efforts to address ‘external imbalances’, another ‘D’ for ‘excessive investment’ (see chart above) and a ‘C’ for ‘innovation- and services-based growth’.

There are, however, signs that an internal rebalancing may be starting to get underway. The EIU scored China a B- on ‘boosting farm incomes’, a B+ on ‘social security expansion’ and an ‘A’ on ‘reducing regional disparities’, commenting that “economic growth has gradually shifted inland”.

This may go some way towards explaining the rise in household savings as a percentage of GDP noted earlier, and in particular the rise in the average propensity to save as prosperity spreads and raises more people above subsistence. (As an aside, it is worth pointing out that expansion of social security provision could in time actually lead to a fall in savings rates if it sufficiently weakens the precautionary motive for saving – i.e. to provide for contingencies such as sickness and unemployment in the absence of a social safety net).

There are other signs of nascent change. Recent disputes at Apple and Microsoft supplier Foxconn are the latest in a series of industrial incidents to hit China recently. Fukumoto and Muto find that China has seen a sharp rise in the number of industrial disputes since the global financial crisis began:

Number of labor disputes in China

Industrial action can and does yield results. As CNN reports, Foxconn twice gave its Shenzhen workers pay rises in 2010 following a spate of suicides at the plant.

That this rise in industrial action has occurred in the wake of the financial crisis is unlikely to be mere coincidence. But the example of Japan – which saw a rise in industrial disputes from the mid-1960s, and a sharp spike following the oil price shock of the early 1970s – suggests that concessions, once given, are difficult to reverse, as Fukumoto and Muto note:

‘…after the mid-1960s, workers’ sense of entitlement to their “fair share” rose…and their bargaining power strengthened. Consequently, it became difficult to restrain the rise in real wages again after the end of the oil crisis, and the rise in the labor share [of national income] became permanent.’

Indeed, China’s government announced this week that the minimum wage should grow by an average of 13% a year between now and 2015. It remains to be seen how this plays out in practice, but it suggests the authorities are aware of a need to raise household incomes.

China is yet to undergo significant internal rebalancing of real incomes away from industry and towards people, such as that experienced by Japan in the postwar era. There is good reason to assume that, sooner or later, such a rebalancing will occur.

And it is people, not industry, who buy gold. So unless China’s development gets completely stuck, its gold consumption should continue to rise over the long run.

Ben Traynor

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

“Desperate Shot in the Dark” of Quantitative Easing “Will Boost Inflation & Gold” Say Analysts

London Gold Market Report

The WHOLESALE MARKET gold price slipped 0.6% to $1730 in London on Thursday morning, regaining most of that dip as the European Central Bank kept its key lending rate on hold and the Bank of England extended its purchases of UK government bonds to £325 billion ($515bn).

When completed, this new Quantitative Easing will see the Bank hold nearly one-third of the UK’s outstanding national debt.

“The growing consensus among central bankers is that their experiment with QE is still working,” wrote Gavyn Davies, now of Fulcrum Asset Management and previously a policy advisor to the UK government, as well as head of global economics at Goldman Sachs until 2001 and chairman of the BBC until 2004, in the Financial Times on Wednesday.

“It was a shot in the dark, and a rather desperate one at that. But up to now it has had the desired effect, which is certainly a far better outcome than the alternative.”

“The Bank of England’s latest round of quantitative easing is likely to increase the risk of higher inflation,” said World Gold Council director Marcus Grubb to Reuters, “and prompt investors to seek assets, such as gold, which can act as a hedge against rising prices.”

The gold price for UK investors today slipped 0.5% to £1093 per ounce as the Pound rallied.

Since the Bank of England began quantitative easing 3 years ago, gold has risen 70% for Sterling investors.

“Continued optimism over Greece is supportive of gold,” said one London dealer this morning, noting the recent link in daily moves between the gold price and the European single currency vs. the Dollar.

“There is agreement on all the issues bar one,” said Greek finance minister Evangelos Venizelos to reporters in Athens today, claiming that only state pensions remain under discussion in budget cuts demanded by Greece’s EU partners and the International Monetary Fund in return for their €130 billion ($172bn) bail-out.

Greek unemployment has risen to 20.9%, the Statistical Authority said today. A large chunk of Greece’s outstanding debt is due for repayment on March 20th.

Holding UK rates today at a record low of 0.5% for the 36th month in succession, the Bank of England announced a shift in its purchases of government debt, targeting more 3-15 year maturities than long-dated gilts.

Twenty and 30-year gilt prices fell on the news, nudging interest rates higher, but shorter-term UK debt rose sharply, knocking the annual yield offered to buyers of 5-year gilts back down towards last month’s record lows beneath 1.0%.

UK inflation over the last 5 years has averaged 3.2% per annum. The Bank’s official target is 2.0% per year.

Back in the gold bullion market, “Everyone is in wait-and-see mode,” Reuters quotes Ronald Leung at Lee Cheong Gold Dealers in Hong Kong.

“We don’t see much scrap [supply] and buying has cooled after prices rebounded. [But] Greece seems to be closer to a concrete deal, which weighs on the Dollar and helps [the gold price].”

Keeping its key lending rate at 1.0% again on Thursday, the ECB will this month repeat its unlimited offer of 3-year loans to Eurozone banks, an offer which drew demand of nearly half-a-trillion Euros in December.

Many analysts expect demand to top €1 trillion on Feb. 29th.

“[Such action] will lead to a lot of interest into gold,” reckons UBS Wealth Management’s head of commodity research, Dominic Schnider.

“Real assets remain something people like to have in their portfolios. $2000 an ounce should be easily achieved. We actually expect prices to go above.”

Adrian Ash

Adrian Ash is head of research at BullionVault, the secure, low-cost gold and silver market for private investors online, where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2012

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

My Forex VPS platform is officially open for business

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The price for an account is still the same $45/month that I promised everyone at the very beginning.

For more info or to sign-up please visit the Forex VPS Nirvana homepage at:

http://www.forexvpsnirvana.com

Cheers,

Alan