Is China Buying Gold to Challenge the U.S. Dollar?

“International supervision over the issue of U.S. dollars (NYSE:UUP) should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country.” -China’s official news agency Xinhua

Gold (NYSE:GLD) and silver (NYSE:SLV) are often viewed by investors as a hedge against uncertainty. Although the two precious metals (NYSE:DBP) can cause heated debates about their role in an individual portfolio, many would agree even a small percentage of a portfolio should be in gold or silver. A study released earlier in the year by Oxford Economics recommends holding at least 5% of your assets in gold. What if countries apply these principles to their reserve holdings? The rising price of gold and silver has caught the attention of economic powerhouse, China (NYSE:FXI).

It is said that gold prices have not increased, fiat currencies have decreased. This is a concept not lost on the Chinese. A new Wikileaks release reveals the thought process behind gold and fiat currencies such as the U.S. Dollar and Euro. The new release says, ” China increases it gold reserves in order to kill two birds with one stone. The China Radio International sponsored newspaper World News Journal (Shijie Xinwenbao)(04/28): According to China’s National Foreign Exchanges Administration, China’s gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the U.S. and European countries. The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold’s function as an international reserve currency. They don’t want to see other countries turning to gold reserves instead of the U.S. Dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaing the U.S. Dollar’s role as the international reserve currency. China’s increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.”

Looking at the latest world official gold holdings from the World Gold Council, China is currently ranked 6th in gold holdings with 1,054 tonnes. This represents only 1.6% of their total foreign reserves. The United States still maintains a significant lead on China in terms of gold reserves. Per the same World Gold Council report, the U.S. has 8,133 tonnes of gold, which represents 74% of total foreign reserves. Germany is the closest to the U.S. with 3,401 tonnes, representing 71.4% of total foreign reserves. China still has a large amount of gold buying (and U.S. Treasury selling) to do if they hope to challenge the world reserve status of the U.S. Dollar. However, if China continues to demand gold, current gold prices will look quite cheap further down the road. Consumers in China are demanding gold as inflation and other economic worries linger. China’s share of global demand for gold has increased from just 6% in 2000 to 18% in 2010.