Gold Bulls: China Won't Bail You Out

China just announced it bought 19 tons of gold last month, but don't expect that to revive the bull market.

Alex Dumortier
Alex Dumortier, CFA
Aug 14, 2015 at 1:14PM

Stocks are mixed on Friday, with the Dow Jones Industrial Average (DJINDICES:^DJI) and the broader S&P 500 (SNPINDEX:^GSPC) up 0.15% and 0.07%, respectively, at 1 p.m. EDT. The Nasdaq Composite was down 0.14%. 

Source: Zhanyanguange. Re-published under a Creative Commons license.

Goldbugs must be exulting: On the face of it, it would appear that China this week confirmed a number of its foundational beliefs: All fiat money is ultimately worthless, gold is the only legitimate form of money, and finally, governments themselves know this (indeed, they are actively destroying the value of their own currencies). 

On Tuesday, the People's Bank of China (PBoC), China's central bank, devalued the renminbi by lowering its reference rate by 1.9%, triggering the currency's largest decline since China moved to a managed floating exchange rate system in January 1994. 

(The PBoc publishes a daily reference rate for the renminbi against the U.S. dollar, and the exchange rate is allowed to move within a 2% band around that rate.)

Today, the PBoC announced that it had bought 19 tons of gold last month (current value: roughly $680 million), as gold prices fell to a five-year low. This was the second announcement from the central bank regarding gold in as many months. In July, China broke its six-year silence when it released data showing its gold reserves had risen by more than half since April 2009. 

So, China is manipulating its currency while simultaneously taking advantage of weakness in gold prices to increase its reserves of the yellow metal. Surely this supports one of the arguments gold bulls advanced in claiming that the bull run was just beginning as a result of a long-term structural change in the market: the rise of emerging nations with a historical and cultural appreciation for gold's true worth, notably China and India. 


First, in devaluing the renminbi, China is moving toward a more market-driven system in order for it to become accepted as a one of the primary reserve currencies. 

Second, consider that during the same period that China's gold reserves grew by 59%, its foreign exchange reserves rose 81%, so that its allocation to gold has actually decreased. That allocation is currently less than 2%, and there is no chance that figure will increase significantly over the next five, or even 10 years. 

The PBoC itself states on its website: 

Gold has a special risk-return characteristic, and at specific times is not a bad investment. But the capacity of the gold market is small compared with China's foreign exchange reserves; if foreign exchange reserves were used to buy large amounts of gold in a short amount of time, it will easily affect the market. 

There is nothing to argue with there – the PBoC's position is clear and sensible. China understands perfectly well that gold is just another reserve asset with specific risk-return characteristics (highly volatile in the short term, it holds its value in real terms over the very long term) rather than some mystical asset that trumps all others. Gold bulls: Don't count on China to rekindle the bull market, it isn't coming to your rescue.