China is the world's largest miner and importer of gold. So, it only makes sense that it wants to have more influence over the precious metal's price. In the past, the world's daily gold prices have been set in London, but China recently launched a new yuan-based benchmark for gold bullion.
This makes gold watchers wonder what China is up to -- and why it's so interested in gold. In the past few years, China has been collecting huge amounts of the precious metal. But why would a communist government with a centrally planned economy be interested in gold? Isn't gold the favorite investment for investors who don't trust the government?
Other than the Chinese Communist Party itself, no one knows exactly how much gold China actually has in its reserves. China announced last July that it held 1,658 metric tons. This is 600 tons more than what it reported in 2009, the last time it provided figures.
But people who analyze the world's gold flow and mining data think China has much more gold than that. Some say it has as much as 3,000 tons. While still far behind the U.S.'s 8,000 tons, China's gold reserves are now the sixth largest in the world.
The People's Bank of China, China's central bank, is coy about how much gold China holds. So, conspiracy theorists assume China is "up to something." One of the more popular theories is that China wants to eventually convert the yuan to the gold standard, and overthrow the greenback as the main global currency.
The gold standard means a country's currency is backed by gold. So, if you hold that currency, you can, in theory, exchange it for an equal amount of gold. Most countries moved away from the gold standard during the 20th century, and the U.S. completely abandoned it in 1971.
Since getting rid of the gold standard, most countries in the world use "fiat currency." Fiat currency is money backed by faith in the government. This gives the government flexibility to print money when it needs to -- like during a recession when it wants to stimulate the economy.
Of course, printing too much money -- creating "wealth" out of thin air -- carries a cost. Inflation is one obvious problem. In the bigger picture, excessive reliance on the printing press can lead to a loss of faith in the currency -- and in the government that's abusing its privilege. And without faith in the government, a fiat currency is worthless.
People who want to go back to the gold standard say that central banks are out of control and that the global economy is headed for disaster. They think money should be linked to a tangible asset with real value, like gold.
Some theorize that one day China will announce the yuan is fully backed by gold. Global capital will start switching from the dollar to the new gold-standard yuan. And the price of gold will surge.
But fully backing the yuan with gold may not even be possible. Currently, China backs its yuan with foreign exchange reserves worth more than $3.2 trillion. About $2 trillion of that is believed to be in U.S. currency.
So, let's say China does have 3,000 tons of gold, about twice as much as it is reporting. The current price of gold is about US$1,230 per ounce. So, China has somewhere around $130 billion worth of gold. That's not even close to its $3.2 trillion foreign exchange reserves.
For China to fully switch to the gold standard quickly, it would need to sell a large portion of its foreign exchange reserves to buy thousands of tons of gold. This would cause gold prices to increase and the value of its dollar holdings to decrease. Even the market-manipulating Chinese government must realize this is a very bad idea.
How much gold does China need to fully back its yuan? According to a Bloomberg Intelligence article last year, at current exchange rates, China would need about 525,000 tons of gold. To put that in perspective, about 182,000 tons of gold has been mined in all of history. China would need about three times that amount.
So, sorry conspiracy theorists. There's no way China could ever stockpile that amount of gold any time soon.
China would still need 10,000 tons of gold to back the yuan if gold prices were at $64,000 an ounce. But that's not going to happen, either.
The real reason China is buying gold is pretty boring. It's just trying to diversify its portfolio. China's gold holdings are worth only 1.6% of its total foreign exchange reserves, as noted above. The U.S. holds gold worth 73% of its foreign exchange reserves, Germany 67%, France and Italy 65%. As an aspiring big player in the global economy, China should have a lot more gold.
By increasing its gold reserves, while at the same time owning fewer greenbacks, China is spreading its risk and making its overall "portfolio" less volatile. And like any savvy trader, China does not disclose how much or when it's buying.
What does this mean for your own investments? Every investor should have some gold in his or her portfolio. Gold is one of the best hedges against inflation and currency risks. It also tends to hold its value when stock markets fall.
But don't buy gold because of some big Chinese conspiracy that probably isn't true. Like China, buy it for the boring reason of diversifying your portfolio.
Kim Iskyan is the founder of Truewealth Publishing, an independent investment research company based in Singapore. Click here to sign up to receive the Truewealth Asian Investment Daily in your inbox every day, for free.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.