China's new ASX-listed gold rush

PORTFOLIO POINT: China wants more gold, but rather than buying bullion it’s looking at gold stocks. There could be some golden opportunities for Australian investors.

Anomalies in a market come no bigger than the official gold holding of China.

By any measure it is tiny at just 1.7% of the country’s financial reserves – a situation that not only should be corrected, but is, albeit in a suitably inscrutable manner that contains a valuable lesson for Australian investors.

Rather than simply buy more gold to bolster its 1054.1 tonnes, a level which puts China behind France, Italy and Germany, and a country mile behind the US with its 8133.5 tonnes (which represents 75.4% of official US reserves), China has unleashed its corporate sector on a global treasure hunt for gold assets.

China is not the only one, of course. The rush to gold, the ultimate safe haven currency, has been evident for some time – with central banks moving to bolster their physical bullion reserves to offset the effects of currency debasement in Europe and the US.

Investment funds and investors have followed suit – buying a combination of bullion, gold exchange tradeable securities, and interests in listed gold companies, and this demand has triggered a near-term revival in the spot gold price.

Over the past few months, Chinese companies have executed at least six gold deals, either by investing in gold exploration and production companies, or through the outright acquisition of gold in the ground.

Given that no Chinese company invests outside the country’s borders without government approval, it is impossible to imagine that what’s just happened is anything other than part of a national plan. That plan is to re-direct some of the country’s savings into non-financial assets, with a particular eye on lowering exposure to the steadily weakening value of the US dollar and Europe’s common currency, the euro.

Deals done, so far, include:

• The purchase of the soon-to-be-developed Zara gold deposit in the North African country of Eritrea from ASX-listed Chalice Gold for $US114 million by China SFECO, a Shanghai-based company normally involved in civil, industrial and agricultural engineering.
• An investment of $227.5 million to acquire a 51% stake in WA-based goldminer, Focus Minerals, by Shandong Mining.
• An investment of $85 million to acquire a 42% stake in ASX-listed Noble Mineral Resources, which owns the Bibiani goldmine in the West African country of Ghana, by Zhongrun Resources Investment.
• The planned acquisition of London-listed African Barrick Gold for US$3.9 billion by China National Gold Group Corporation.
• An investment of $2.5 million to buy an 8.95% stake in ASX-listed Norseman Gold by Zhaojin Mining Industry.
• The takeover of ASX-listed Norton Gold Fields at a cost of $229 million by Zijin Mining.

On their own, each deal could not be regarded as anything unusual. Chinese companies have been stalking mining assets around the world for some time.

But, there are three significant factors in what’s listed above compared with earlier Chinese mining investments.

Firstly, and most obviously, they all involve investment in gold companies and gold in the ground, whereas much of China’s earlier mining-focused investment was in basic industrial commodities such as iron ore and coal used to feed industrial output.

Secondly, the deals occurred in a burst of buying that appears to indicate the work of an invisible government hand somewhere in the approvals process.

Thirdly, they have all occurred at a time when the western world’s leading economies have accelerated their paper-money printing process.

That final point is critical to what appears to be happening because China is in the firing line to be the biggest victim of the global currency devaluation process underway, with anyone having a high exposure to the US dollar and the euro likely to incur heavy losses as they fall under the pressure of huge debts.

In the case of China, the (paper) foreign currency exposure is massive. Holdings of US dollars alone (mainly in Treasury bonds) is estimated to be around US$1.7 trillion.

Reducing such a high level of exposure to a weakening currency has been a priority for China’s central bankers since the outbreak of the global financial crisis in 2008, with some success.

Recent estimates put the US dollar position at 54% of China’s total reserve holdings, down from 65% in 2010, and 75% in 2002.

But one of the steps that China took in lowering its exposure to the US dollar was to buy euros, a currency with an even worse track record over the past few years, and any holdings in Australian dollars now seems to be headed in the same direction – south.

Gold, as ever, is now playing its traditional role of the world’s ultimate safe house for storing wealth – only in China’s case it has a found itself playing a game of catch-up from a long way behind.

That’s why the 1.7% of China’s reserves being held in gold is such an important number for all investors, because it is an irregularity in the country’s financial structure and it looks like a correction process has started.

Wading into the bullion market and buying 1400 tonnes of gold, which would lift China to an equal footing with France (2435.4 tonnes, or 71.7% of official French reserves according to data from the World Gold Council) is not an option. It would send the gold price through the ceiling.

As for catching up with Germany (3395.5 tonnes, or 72.3% of official reserves) or the US and its 8133.5 tonnes, that is even less likely.

Stealth is how China is building its gold exposure. Rather than disturb the global bullion trade, it is buying gold in the ground, using the companies that are all ultimately controlled by its government to scour the world for gold investment opportunities. That’s because, what’s good for a Chinese company is for good for China.

Australian investors not exposed to gold should not ignore the latest piece of evidence about who’s buying gold, what that means to the price, and what currency changes really mean to investment portfolios.

More than three years ago (The Bullish Bullionaire) Australia’s “Mr Gold”, Mark Creasy, explained why central bank activity in the gold market is critical to the price of gold.

When central banks are buying, the gold price rises. When they sell, it falls.

His most instructive answer was in this exchange – in May 2009:

Eureka Report: “And recently we’ve seen the Chinese central bank buying gold?”

Mark Creasy: “Correct. The best way to look at gold is not on the peripheral, say the scrap market or even mine supply; it’s to ask what are the big shareholders doing. In the past we’ve seen big holders such as the Bank of England and the Swiss National Bank selling, and people think we’re out of this. When they see a big new buyer, people want in.”

As a final point, it’s worth looking at what’s happened to gold since early August (and on several prior occasions) that it was time to sell iron ore stocks and go for gold.

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Back on August 1 gold was trading at US$1622 an ounce and the Australian dollar was valued at $US1.05, producing an Australian dollar gold price of A$1544/oz.

Today, the gold price is around US$1779/oz (a rise of US$157/oz, or 9.7%, in just over two months) while the Australian dollar gold price has risen to A$1774/oz, an increase of A$230/oz, or 14.9%. It’s a fair bet that not many investments can match that performance since August 1.

Impressive as the performance of gold has been, the central message remains that investors should not treat gold as an item for speculation.

Gold must be treated as a currency with commodity uses that should occupy a key place in all investment portfolios.

China’s latest burst of gold market activity is just the last clue in what looks like being a long game as major western economies try to inflate their way out of the debt traps into which they have fallen.

A few more numbers to consider. If, as seems possible, the Australian dollar slides back to an exchange rate of US90 cents, the Australian gold price rises to A$1976/oz, using today’s US$1779/oz price as a marker. At an exchange rate of US88c, the Australian gold price would be comfortably above A$2000/oz (A$2012/oz to be precise).