The gold bug's new best friend - the Chinese government

After a long wait, the price of gold recently broke through a key barrier. But events in China may mean that $1,000 an ounce is just the start of a new bull run. Dominic Frisby explains why.

There have been a number of extremely exciting developments in the world of gold and silver this week, not least the price. Gold is once again flirting with $1,000 an ounce.

As you might have noticed, I like to look at the markets from a technical point of view. I stare at charts, I note moving averages, momentum indicators, trend lines and goodness knows what else. $1,000 is a key level for gold. A lot of us have been waiting a long time for $1,000 gold.

But what has me really excited at the moment is not in fact the price, as you might expect. It's the news...

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Hong Kong is taking delivery of its gold

The tremors in the gold market began last week when Hong Kong announced it was pulling all its physical gold holdings from depositories in the UK and moving them home to newly-built vaults near the city's airport. We've said it before: wealth is moving east. Yes, Hong Kong has ambitions to be the bullion trading hub of the Orient, but there could be more to it than that.

It's estimated that they own some $63m worth of gold. In the international scheme of things, that isn't much. There might even be a banker somewhere who takes that home this year as his bonus. What is noteworthy is that Hong Kong is taking delivery of its metal.

Many gold followers have argued that if everyone who owned futures, exchange traded funds, warrants, options, CFDs - and any other gold derivative you care to mention - decided to take delivery of the gold against which their contract is written, there wouldn't be enough physical metal to go around, and the price would rocket.

Indeed, it was the French government's insistence in the late '60s and early '70s on taking delivery of the metal in lieu of US dollars that eventually forced the US off the gold standard in 1971. The US didn't have the physical metal to back the quantity of dollars it had put out. Gold quickly went up tenfold. Perhaps Hong Kong is taking delivery while it still can.

Just a few days later, Barrick, the world's largest gold producer, announced plans to eliminate its gold hedges. (Hedging is when a miner sells its metal before it has actually been mined in order to lock in a price. This can work well in a falling market, as you have sold your metal for a higher price than it is when you actually mine it; but it can be a disaster in a rising market because you miss out on the higher prices). Barrick's hedging strategy has rightly attracted a great deal of criticism. The company failed to recognise a bull market and sold its gold too cheap. The chart below shows what a costly error this has been.

The black line shows how the gold price has performed over the past ten years. The blue line shows the rise in the HUI, the index of unhedged gold miners. The comparatively feeble-looking yellow line shows Barrick's woeful share price performance over the same period. If only it hadn't hedged, it'd be up some 500%

So costly has been Barrick's hedging strategy, a contrarian might argue that their now eliminating their hedges could mark the top of the market.

But what's interesting is that, rather than deliver the gold it has sold forward, Barrick has chosen to raise cash by issuing shares and using the money some $3.5bn to pay off its obligations. In other words, the largest gold miner in the world thinks that it's worth buying its way out of the hedges with cash now, because it'll get a better price for its gold in the future.

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Why the Chinese government is telling its people to buy gold

Meanwhile, we hear that China has doubled its reserves to 1,054 tonnes. They are buying gold, "carefully so as not to stimulate the market" says Chinese economic ambassador Cheng Siwei, reports Ambrose Evans-Pritchard in The Telegraph. Siwei continues: "Credit in China is too loose. We have a bubble in the housing market and in stocks so we have to be very careful, because this could fall down."

Is the risk that "this could fall down" the reason that the Chinese authorities are pushing their citizens so hard to buy gold so that they have some protection from any credit bubble collapse? Analyst Paul Mylchreest notes in his Thunder Road Report that the main state-owned television company is promoting gold and silver as an investment. The government is telling its people to buy gold. What's more, every bank will sell gold and silver bullion bars in four different sizes to individuals, and China's largest bank, the ICBC, is setting up a precious metals department to handle growing investor demand.

Where is all this gold going to come from? Well, if 1.3 billion people start buying one-ounce coins, heaven only knows. China is already the biggest gold producer, last year superseding South Africa. Pretty soon it will replace India as the largest consumer.

And if the Chinese authorities are pushing gold as an investment to their citizens, it obliges them to 'protect' the gold price, as Lawrence Williams of Mineweb notes. It would be tantamount to a betrayal if it fell, never mind the loss of all-important face that would result. Just as the US and the UK stepped in to bail out its banks, so China will be duty bound to prop up gold.

But the surprising strength we have seen in gold over the summer we never really got the summer low I was looking for suggests that somebody is already 'buying the dips' anyway. Indeed, the gold price has this week repeatedly gone through $1,000 during overnight trading, only to fall back when the US markets open. That indicates that the buyers are out east somewhere. I have written about this before: Gold is shifting from West to East along with the balance of power.

$1,000 an ounce is just the start

There are some who argue convincingly that the $1,000 will mark a double top in gold, and then we'll go down from here. There are other technical indicators that suggest a top.

But there is too much impetus to force the price higher. We may hover around here for a while - in spring 2008, oil spent almost six weeks bouncing between $95 and $100 before bursting through and $100 oil is like $1,000 gold. Indeed, there is a little bit too much bullishness about the place at the moment, so a pullback would be healthy. But once we have a break above $1,000 and a weekly close above the old high at $1,032, the news on gold will be splashed everywhere. It all points to much higher prices in time.

Of course, that'll be good for gold stocks - in fact I've recently released a report detailing my six favourite gold stocks to capitalise on gold's next big move.

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