Why China’s Going for Gold

01/18/2011 1:02 pm EST

Focus: GLOBAL

Chris Gilchrist

Editor, The IRS Report

The precious metal is helping Beijing mop up excess liquidity as Chinese buyers hedge against inflation, writes Chris Gilchrist in The IRS Report.

The credit crunch provided the impetus for a huge extra leg of the long-running bull market in bonds, which have outperformed equities over the past decade. That would only be possible over the next decade if bond yields became negative or equities fell substantially.

Given the surprising strength of the world economy (roughly 5% growth in 2010 and the same expected in 2011) and the surge of inflation in the emerging economies, I think it is extraordinarily unlikely that bonds will provide positive real returns over the next decade.

I continue to believe that blue chip developed market equities are cheap and are the buy of the decade. But what else should investors favor now?

Gold is widely seen as a "fear" purchase, as insurance against political and economic disruption. But I think analysts have failed to see that gold is now a dream purchase—because of China. Chinese purchases of gold rocketed from 45 to 200 tons last year—and that was before recent moves to allow domestic banks to sell it to their customers.

Why should the Chinese authorities want to encourage their citizens to buy gold? I can think of three reasons. It takes money out of circulation, thus countering inflationary pressures arising from the huge credit boom of 2010; it reduces the trade surplus, taking some of the wind out of right-wing factions in the US Congress; and it provides people with an alternative store of wealth to residential property, where overheating is causing popular dissatisfaction. I think the gold bull market could surprise on the upside in 2011.

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