The inevitable decline of the dollar has the chiefs of central banks around the world hitting the “buy dollar” button as their currencies are rapidly appreciating, in effect driving down their exports. Forexhound reports:

“European Central Bank President Trichet said “excessive volatility” in currency rates is “bad for economic development.” His comment was seconded by Jean-Claude Juncker who said “It’s a problem that worries us”.Concerns are being expressed by the ECB and other members of the Euro Zone because the recent appreciation of the Euro is hurting exports with the U.S. and China. In addition, the end result is a stronger Euro will threaten the Euro Zone’s recovery.”

In fact, the Eurozone slipped into a trade deficit in August as imports exceeded exports by €4 B. This is largely due to the appreciation of the Euro, which has gained 19% against the dollar since March this year. Daily Finance reports:

“We have to save the soldier dollar,” blares the headline in a recent economy column in France’s leading daily Le Monde. Columnist Pierre-Antoine Delhommais goes on to explain that if the dollar crashes, “exports would collapse, growth would sink and the unemployment rate would explode.”

While some countries are intervening in the currency market (India and South Korea have already been intervening), others are looking into the future to make sure that they won’t be the victim of a replay of the Asian crisis, during which the flight of capital forced the Asian currencies on their knees. From Bloomberg:

“Brazil will impose taxes on purchases by foreign investors of real-denominated, fixed-income securities and on purchases of stocks, Finance Minister Guido Mantega said. The measures are being taken “to avoid an excess speculation in the stock market and in capital markets,” Mantega told reporters in Sao Paulo.

The real has gained 35 percent since the beginning of the year, the best performer amid the 16 most traded currencies tracked by Bloomberg. The currency has gained 5.3 percent in the past month. The central bank started purchasing dollars (emphasis mine) on May 8 in a bid to temper the real gains. It was only last week that the demise of the dollar was the topic of choice, with Robert Fisk’s article being the tipping point of such discussions.”

What does all of this tell us? It tells us that even though the dollar is declining, it will be an orchestrated decline. It took the pound sterling almost 30 years to lose it’s reserve currency status (although it is still a reserve currency, it used to be the reserve currency of choice just like the US dollar has been for decades and still is today). Running away from the dollar is a must these days but don’t be on it dying tomorrow.

Over the recent week there have been many articles claiming that gold is up only due to a falling dollar. Of course, none those articles have a chart with them, which would point out the obvious folly. So, without getting into a discussion, here is the chart. There’s really nothing more to it than that.

Back in August, China started publicly endorsing gold and silver as an investment on state sponsored television. Western financial media, but in particular a lot usually made fun of, the gold bugs, were quick to pick up the story and flood every precious metals section on every financial news website with the news from China. Even I wrote a piece on it. I don’t consider myself a gold bug, but having taken a look at the fundamentals of gold and silver, I am as convinced as any gold bug that there is huge upside potential for gold and silver. Factor in the frantic money printing all over the world and global economic and social instability, a combination which has historically been positive for the price of gold, and you’ve got yourself a front page news story. But this is not the end of the story.

When I first wrote about the Chinese disclosing their gold purchases back in April, I was pretty sure that any upside potential these purchases might have were long gone. But then, stories about Chinese government officials openly decrying the US dollar started to surface. Officials from other countries followed suit and German Head of State Angel Merkel dismissed Obama’s cries to print more money. But the US didn’t care, it kept on monetizing debt and buying up toxic assets from insolvent companies. All of this was followed by the TV commercial story.

The TV commercial story, on its surface, is groundbreaking enough to put a smile on every gold bug’s face. But beneath the obvious is something much more powerful. From Lawrence Williams at Mineweb.com: “Chinese state endorsement of gold and silver as good investments means the country can no longer afford to let precious metals prices drop by any significant amount.”

If this doesn’t make you want to run to gold, consider the fact that the Chinese government has to manage it’s way around 1,338,000,000 people, according to the latest estimates for 2009. Civil unrest has been a problem for years with tens of thousands of protests each year occurring all over China, but it is only going to get worse as factories are being closed for various reasons and environmental degradation takes a toll on the health of citizens; unless the government acts in ways to mitigate those problems. One has to realize that the only objective of the Communist Party is to stay in power and the only way to do that is to keep the probability of a revolution, peaceful or not, as close to zero as possible. That government cannot afford to lose the trust of its citizens and it has to, and will, do everything in its power to keep that from happening. Keeping its promises and standing by its words (endorsing gold and silver as an investment) is a part of that.

One also has to consider cultural implications. “‘Losing face’ is an important aspect of Chinese psychology and if millions of investors lose out because state-promoted investment in precious metals is not borne out this would be a massive government loss of face and one which is certainly not beyond its capabilities of not allowing to happen.”

The Chinese have no problems with keeping a floor under the price of gold and silver, especially considering the huge currency reserves that they have accumulated over the years and their diversification plans which involve the central bank of China and an undisclosed number of Chinese sovereign wealth funds buying up domestic as well as international gold. In effect, the Chinese have issued a massive insurance policy on the price of gold and silver. So there you have it. Considering that China started promoting gold and silver as an investment back in August, one can assume that the current floor is around the price seen in August: 950 in US dollars, 650 in euros, 1130 in Aussie dollars, 1030 in Canadian dollars, 570 in pound sterling, 890,000 in Japanese yen. The price of silver was around $14 in August, which means that one ounce of gold bought you 67.85 ounces of silver (use that to calculate the price of silver in other currencies for the month of August). Over time, I would expect to see the floor price rise as more and more Chinese accumulate gold and silver at higher price levels.

“Gold is a commodity that combines the attributes of a currency, financial commodity and general commodity. Despite the declining function of gold as currency in the world, the activeness and development of investment activities with gold as the target indicates that gold still has a strong financial nature and remains an indispensable investment tool. In major financial centers in the world, the gold market, together with the money market, securities market and FX market, constitutes the main part of the financial market.”
- Dr. Zhou Xiaochuan, Governor of the People’s Bank of China, writing in the Alchemist (issue 36, 2004)

Fresh winds of optimism for gold and silver investors are blowing from China. For about a month now, the Chinese state television has been openly promoting gold and silver as an investment and a store of wealth. Not long ago, the Chinese announced that they had been “secretly” buying gold – starting from 2003 they had bought over 600 metric tons of gold, bringing the gold to cash reserve ratio from 1.3% to 1.7%. Of course, the Chinese are awfully good at smoke and mirrors and so it is not clear whether the numbers that were published back in spring are the real numbers. The real gold purchases could in theory be much greater than the Chinese officials are publicly admitting, especially as the free export and import of gold (and silver) is not allowed in China. There is no way to confirm the numbers because the Chinese central bank has been buying locally mined gold only. What is interesting is that China is the biggest gold miner in the world, overtaking South Africa who was the world leader for over a century as China’s gold production reached 270 (metric) tonnes in 2007. As the export of gold from China is very difficult and the industrial demand for gold very limited inside China, the most likely buyers are the People’s Bank of China, Chinese sovereign wealth funds and to a small degree the Chinese public.

Silver will be bigger than gold

What’s more interesting than that gold story, is of course the silver story.  Silver is an industrial as well as a monetary metal, but it’s price hasn’t really reflected the monetary aspect until about a few years ago. The recent shortage of silver bullion coins and bars is one sign that people have realized the monetary value of silver. After all silver is much like gold, only cheaper in today’s money. It is also less plentiful which means that any jump in demand will have an explosive effect of the price of silver. With the Chinese state television announcing silver bullion as an investment vehicle for the masses there is no doubt in my mind that silver has regained recognition as money and is headed for much larger gains than the 100% rise from the bottom in March.

Of course, the Chinese don’t need the government to tell them where they should put their money. The Chinese are not stupid, they have lived through the communist “industrial revolution”, a cultural revolution and many more repressive events in recent history which have brought death, misery and starvation. History has taught them that for immediate needs and expenses, cash is king but long term savings are best kept in gold, silver or other valuables that cannot be debased by the government or any other organization, for that matter. For thousands of years the Chinese have used silver coins as money and the Chinese still recognize the monetary role of silver.

But the recent ads on China’s state television is a clear sign that China wants the people to put their money away in safe assets. Whether this is to decrease the amount of money available for banks to avoid the formation of an investment bubble, to safeguard the populace cumulative inflation, which wipes out savings in any economy that is growing as fast as China or to prepare the people for a major crisis is really not important from an investment point of view. It could be another, seemingly irrelevant reason but for all we know from information out there is that gold and silver are going to be in very high demand over the coming years.

So what effect would the Chinese populace have on the precious metals? Well, for starters, there are 1,345 million Chinese, which means that even if they started* buying gold and silver in tiny amounts, the prices of the two precious metals would surge dramatically (*started is really not and adequate word here as the Chinese have been buying gold and silver for decades, I used it for illustrative purposes). But what if every Chinese were to buy one ounce of pure silver and one ounce of pure gold per person? Well, they would gobble up two years worth of annual silver mine production and a staggering 17 years worth of gold production, and that’s without taking into account the fact that gold production has fallen around 9% since its peak in 2001. Let’s not forget that the Chinese aren’t the only ones buying gold. One of the telltale signs of a major move back to gold is that the Germans have been installing gold coin vending machines all over Germany’s train stations. If there ever was a clear market call for gold and silver then this is it.

It is not wise to fight large numbers. A 1.3 billion strong market mover is not something you would want to miss, much less stand in the way of. The price of gold usually reflects trust in the government and the fiat currencies and clearly trust is not on the upswing, especially if an increasing number of Chinese government officials are publicly announcing their lack of trust in the dollar. The world hasn’t yet seen a time when hundreds of millions of people are scared of losing their savings, thus buying gold and silver. Since the last spectacular moves in gold and silver the amount of available gold has increased only by a tiny amount and silver supplies have actually decreased. But the world population is much bigger; imagine what this uncontrollable force will do to the price of gold and silver when it’s determined to buy it at whatever cost. It will be a mania. If you don’t own physical gold, it’s time to buy some.

Additional reading:
Hong Kong recalls gold reserves, touts high-security vault (MarketWatch)
China pushes silver and gold investment to the masses (Mineweb)
China’s Gold Production
World Gold Demand
Must see: China encourages Silver Bullion for investment

Whether or not the price of gold, as many have been arguing here and elsewhere, is being manipulated or not, interestingly enough, doesn’t matter.Gold is told to be an excellent preserver of wealth, especially in rough times like these and I agree with that but I don’t think the manipulation hypothesis should be given as much focus as it’s been given so far, simply because there is nothing wrong with central and commercial banks occasionally pushing the price lower.

Why? Well, the central banks, led by the Federal Reserve, have been printing huge amounts of new ‘money’ and as soon as it gains velocity, inflation will propel gold to new highs. One way to preserve wealth is to buy gold and the best time to do it is before inflation kicks into high gear. Let’s assume that the manipulation hypothesis holds true and the price of gold is being artificially suppressed. As an individual who is trying to buy gold I could not wish for a better setup, I would be glad to be able to buy gold at a suppressed price.

If gold exploded in a manner that it did almost 30 years ago, the hypothetical manipulators would be unable to hold the price of gold down. Margin calls would be all over the place and the hypothetical manipulators would have to exit positions en masse. That is very likely the scenario that would play out during another violent push higher. If you factor in the amount of deliveries that would be taken in the case of a price explosion, there would be nobody left to manipulate the price of gold.

If the price of gold will not explode, I still won’t be worried about the effect of the alleged manipulation because even the ‘manipulators’ have been unable to stop the price from rising so far. I will preserve my wealth with or without intervention by the banks.

Manipulation or no manipulation?

I’m not saying the manipulation hypothesis holds true. I’m not saying it is completely wrong either. In fact, I don’t even care much because in the long run, it really doesn’t matter. If there is merit to the manipulation argument, I don’t care because I can’t do anything about it (let’s face it, manipulation hypothesizers, you’ve been all over it for years and you haven’t had any influence on the CFTC). If the manipulation hypothesis is just that, a mere hypothesis, I don’t care either. All I care about is the price of the yellow stuff and as I pointed out earlier, the ‘manipulators’ have been unable to keep gold price from rising from the low $200s to almost $1000.

There are much larger forces in play that will determine the price of gold in the coming years. We have all heard the inflation story, but added to that are growing signs that China is diversifying its foreign reserves away from the dollar and into gold. The population of the planet is in an uptrend and will continue climbing for the foreseeable future, this means that there will be less ounces per capita – more wealth and more people makes for a greater need for wealth protection. Of course, I haven’t listed all the factors that contribute to the rise of the yellow metal and that is not the point of this article. The point I would like to make is this: buy gold when it dips and don’t fret about the manipulation hypothesis. We are in a secular bear market for stocks and a secular bull market for gold (see the chart of DJIA/gold) and market intervention, real or not, doesn’t make a difference.

Disclosure: long AUY and silver bullion.