Dear stockbrokers, dear stockbrokers,

most assets have had poor records over the past year. Gold is one of the few assets that has posted gains.

Since the end of October, the price of gold has risen from under $1,630 to almost $1,950. It’s a big move. What’s going on there?

One could argue that it has to do with inflation. The problem with this argument is that (official) inflation has been declining in recent months. In contrast, gold prices appeared to have underperformed during the sharp inflation early last year.

So again, why are we witnessing a surge in gold prices now?

The most likely answer lies with central banks and geopolitics.

The central banks as a whole, especially Russia and China, bought 399 tons of gold in the third quarter of 2022. (Data for the fourth quarter is not yet available.)

That’s the largest amount of gold ever bought by central banks in a single quarter. That’s more than 1% of all gold held by all central banks.

If this pace continues or accelerates, it would mean a rise in central bank gold reserves of over 4% per year.

China’s official gold

Let’s take a look at China. China’s State Administration of Foreign Exchange (SAFE) announced Jan. 7 that China added 30 tons to its official gold reserves in December 2022. This announcement comes on top of an earlier announcement that China added 32 tons in November. That is an increase of 62 tons in just a few months.

This announcement is significant not only because of the magnitude of these increases, but also because this is the first time China has announced an increase in its official gold reserves since September 2019 – more than three years. Why now?

The first thing to understand is that China hasn’t simply bought so much gold in the market over the last two months and then reported it in a timely manner. China had the gold all along. They just didn’t officially keep it on the books of SAFE.

This announcement was simply a political decision to make some accounting entries so that the gold would appear on the books and not disappear from the books. There is no doubt that China is keeping at least 1,000 tons of gold off the books in this way, possibly many more.

So the question for investors to ask is not where China got the gold from, but why China decided to report increasing its holdings at this time?

As with everything in China, the real reasons remain hidden and the public pronouncements are mostly lies. Still, we can draw conclusions to find out what the Chinese are up to.

The dollar: victim of its own success

This gold announcement comes at a time when the dollar is becoming increasingly scarce in China and around the world. Perhaps the Chinese just want to boost confidence in their reserve position.

And then there’s the geopolitical side. There is a growing movement to divest from dollar reserves as the US has abused financial sanctions to freeze assets, including the central bank reserves of Russia, Syria, Iran, North Korea, Venezuela and others.

They work to deplete dollar holdings and develop new forms of currency for international payments.

That’s why countries like China, Brazil and India are pulling away from the dollar over fears of being next on the sanctions list.

In this regard, Bloomberg recently reported on a meeting of Southeast Asian officials and experts hosted by a think tank in Singapore. The report revealed that participants, like major countries, fear the US has gone too far in arming the dollar as a bargaining chip in geopolitical disputes.

George Yeo, Singapore’s former foreign minister, even went so far as to say that  „the dollar bewitches us all“.  He continued,  „If you weaponize the international financial system, alternatives will grow to replace it.“

Former Indonesian Trade Minister Thomas Lembong praised Southeast Asian central banks for developing digital payment systems using local currencies. He also urged government officials to find new ways not to over-rely on the dollar.

„I have long believed that reserve currency diversification is absolutely crucial,“  Lembong said.

Even America’s „friends“ are fed up with it

What is amazing about this report is that criticism of US dollar policy comes from trusted allies and countries that have traditionally favored the dollar. After the global currency crisis of 1997-98, enormous dollar reserves were built up across Southeast Asia.

This policy of building up precautionary reserves should prevent another run on local banks and provide a nest egg for essential imports such as food and oil.

Now the asset appears more of a potential drag as the US uses the dollar to threaten countries that do not support warmongering or other actions by the Biden administration.

When friendly countries like Southeast Asia join serious rivals like Russia and China to reduce their dependence on the dollar, it can only mean a weaker dollar and possibly more inflation.

It will also mean a much higher gold price because gold is the only alternative to the dollar or other currencies like the euro that can be weaponized against them.

That’s because stockpiling gold is a defensive measure that helps insulate them against sanctions. Physical gold in safe custody cannot be frozen, confiscated or digitally banned.

It’s just gold – and it’s good money in the hands of the owner.

Russia and China are building ground below gold prices

China’s release on its gold purchases came just weeks after Russia announced it would double the gold limit on its sovereign wealth fund’s allowable holdings from 20% to 40%. This will possibly lead to an additional demand of about 100 tons in the coming year.

If China continues to add about 30 tons to its reserves while Russia buys 100 tons at the same time, it will effectively put a floor under the gold price while encouraging further gains in gold prices, as we have seen in the recent months‘ rise.

Russia and China could act together to send the message to the world that the dollar is old news and gold is the new basic reserve asset (as it was for centuries before 1971).

We could be witnessing a crucial turning point in the international monetary system. Russia and China, as well as the other nations I mentioned, are using gold as another “weapon” in the ongoing financial war surrounding the military conflict in Ukraine.

Since Russia and China are among the top five gold producers in the world, they can buy gold from their own mines with their own currency.

This tactic minimizes their need for dollars since they pay with money they print themselves. At the same time, the value of their own gold in hard currency increases as they withhold significant production from world markets.

Great news for gold investors

While demand for gold is increasing, total world production of gold has remained constant over the past six years. This combination of stagnant production and rising demand will put upward pressure on prices and create a de facto floor for gold prices.

Central banks are prone to opportunistic buying and will definitely buy on dips in gold prices.

This is all very good news for gold investors. Therefore, it is not too late for investors to buy gold if they are not fully invested.

Best regards

Jim Rickards

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