Bling Dynasty: Will China Force A Gold Standard By Cornering Gold?

Forbes.com: Matthew Schifrin, 12.3.10

One month ago, Forbes Fixed Income columnists and editor of Forbes/Lehmann Income Securities Investor wrote an interesting story on our Intelligent Investing contributor page called Opium Wars Revisited: Will China Corner The Gold Market? It obviously struck a chord because it got the most clicks of any story on that very active contributor page.

This morning I open up the Wall Street Journal on the way to work and I see a story on page C-1 entitled, China Buys In to Gold's Allure. The story reports that China has increased its purchases of gold five-fold in the first 10 months of this year and that they sucked in 210 metric tons of the shiny yellow metal. Apparently the Chinese absorbed all of the gold the IMF shed and then some. The amount they bought in just ten months also ''dwarfs'' the total amount bought by the biggest gold ETF trading on the market SPDR Gold Shares (GLD). It's seems like Richard could be on to something.

Why would China want to corner the gold market? Because they have purchased so much of our paper (think Treasurys) and because Bernanke keeps printing more of it. That makes China seemingly vulnerable to Helicopter Ben's moves. Indeed anyone holding dollar denominated paper is at risk. The solution for China could be to effectively control the price of gold using dollars.

Here is how Richard predicted things could play out if China secretly were cornering the gold market:

''One alternative for China is to declare itself the buyer of last resort for gold, i.e. it will buy all that is offered for sale at their specified dollar price. This is not going on the gold standard, but rather, it's a hijacking of the valuation process for both the dollars and gold. To implement such a policy, they should currently be busy secretly buying all the gold they can. When their buying finally attracts world attention, they would announce the new policy. With the announcement would also be the setting of this month's dollar denominated benchmark gold price. As frequently as they need to, they can ratchet this price upward to preserve the buying power of their combined gold/dollar reserves or to gain other advantages yet to be discovered.''

If this whole scenario doesn't have our central bankers a bit worried then I donít know what would. I don't think anyone wants China effectively controlling the value of our currency.

What should an investor do? Well the obvious answer is to buy gold. With that in mind I checked in with Andrew Swann an outstanding self-directed investor profiled in The Warren Buffetts Next Door who happens to specialize in gold and other precious metals stocks. He has made a killing in junior miners and is well known for his expertise on the Web community ValueForum.com.

In the book, Swann talks about his activist approach to buying junior gold mining stocks and warrants but warns that this is risky for passive, casual gold investors. Instead Swann mentions two exchange-traded funds for passive gold investors that he thinks are better plays than GLD or IAU. Swann favors Market Vectors Gold Miners (GDX) and Market Vectors Junior Gold Miners (GDXJ), which are up 28% and 56% respectively year-to-date.

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