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China applies golden touch to diversify forex reserves

CHINA'S revelation that it has been stockpiling gold signaled it may accelerate the diversification of its foreign-exchange reserves as a hedge against the global economic downturn, but it's unlikely to stop buying US-dollar assets, analysts said.

China has added 454 tons to its gold reserves since 2003, bringing the total to 1,054 tons, through domestic purchases and the refining of scrap gold, Hu Xiaolian, head of the State Administration of Foreign Exchange, said in late April.

It was the first public comment on the top-secret gold holdings in the past six years. The figure confirmed what many gold bugs have suspected for years - that China has been quietly amassing a stockpile of the precious metal.

"The gold reserve increase doesn't come as a surprise given gold's safe-haven status," said Wang Lixin, China manager of the World Gold Council. "It's especially reasonable against the global financial crisis as China is seeking safe investments. Gold has outshone other assets in the global downturn."

China is the world's biggest gold producer. It now ranks fifth in gold reserves, behind the United States, Germany, France and Italy.

"Safety is the priority in forex reserves, and diversification is an effective means to hit your target," said Hu, who is also deputy governor of the People's Bank of China, the central bank.

China recently reported the change in its gold holdings to the International Monetary Fund and will include the figures in central bank reports and balance of payment statistics, Hu said.

Gold prices have more than doubled since 2003. In the past year, the precious metal has risen just under 4 percent after dropping to as low as US$712 a troy ounce in November and touching US$995 in February.

"We are closely monitoring developments at other central banks to determine whether they will follow China's bold leadership move, particularly those in Asia," said Aram Shishmanian, chief executive officer of the World Gold Council.

Still, gold remains a minor investment for China.

Despite the announced increase, China's gold stockpile amounts to less than 2 percent of its total foreign reserves, based on gold's current price of about US$900 an ounce.

The US had 8,133.5 tons of gold at the end of March, accounting for almost 79 percent of its total forex reserves, according to the World Gold Council.

In the eurozone, the European Central Bank has allocated 15 percent of its reserve asset portfolio to gold.

"China will stick to major currencies and high-quality assets when diversifying its foreign-exchange reserves," Hu said.

World currency

China holds the world's biggest foreign-exchange reserves, backed by its strong trade growth in the past decade. China's forex reserves stood at US$1.95 trillion as of the end of last year, up US$417.8 billion from the year earlier.

China managed to make money on its reserves last year despite the financial turmoil, Hu said, but she also noted that returns on foreign reserves slowed in 2008 from previous years against the backdrop of the worst financial crisis since 1929.

Hu said in late March that China will continue to buy US Treasuries but will monitor price fluctuations.

Premier Wen Jiabao said in March that China is concerned about its US-denominated assets, mainly US Treasury bonds, and wanted assurances about their safety.

More recently, China suggested a move toward a world currency system linked to the International Monetary Fund's Special Drawing Rights.

It was viewed as a move to get away from the greenback's dominance as a global currency.

Economists said China's concerns for its US-dollar assets are understandable since the US economy is experiencing a prolonged recession and financial market turmoil. Still, no one believes that China wants to see a major capitulation in its biggest export market.

"These worries are not expected to stop China from accumulating more assets in the US," said Sherman Chan, a Moody's economist. "It is in China's interest to support the US economy."

The central government has already announced a two-year stimulus package of 4 trillion yuan, or 16 percent of China's economy, to bolster domestic growth.

The health of the US economy is crucial to the global environment and has direct implications for international trade, analysts said. A sound recovery in China can't be achieved without the revival of US demand, they said.

"The longer the US stays in recession, the more stress is felt by China's exporters," Chan said. "A US recovery is the only cure for the tumble in exports and manufacturing.

"Knowing that the US government needs foreign funding to implement its stimulus measures, the Chinese have an incentive to get behind the plan," Chan added.

Based on Standard Chartered Bank's calculation, the total sum of China's US Treasury holdings is still rising, though growth in purchases has slowed along with exports and overall foreign reserves.

In the first quarter of this year, China's forex reserves grew about US$47 billion, compared with US$100 billion a year earlier, Standard Chartered estimated.

"China is not reducing its stock of US securities, but is switching from long-term to short-term securities, or tenures of less than one year," it said in a recent report.

Stephen Green, Standard Chartered's head of research in China, said the bank believes another big current account surplus is shaping up for 2009, so he still expects China's forex reserves to grow by US$400 billion this year.

"US Treasuries are still an investment safe haven. The relatively safer place for China to store its war chest for the long term is certainly the US," said Chan.


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