Beijing fuels old debate about gold's true value

9th July 2010 By: Matthew Hill

In a musing about the value of gold, the late financier and adviser to US Presidents Bernard Baruch once opined that, when something holds good for 2 000 years, "I do not believe it can be so because of prejudice or mistaken theory." He also noted that gold had "worked down from Alexander's time".

However, the value of gold is always a contested subject - a reality that became apparent again this week, when the Chinese government said that it was not going to dump the US dollar and go on a great golden shopping spree. The price of the yellow metal subsequently slipped below $1 200/oz, from over $1 265/oz just days before.

The Chinese government said in a statement: "Gold is globally recognised as a store of value and can be used for urgent payment, but there are some limits to investing in gold, and it cannot become a main channel for investing our foreign exchange reserves."

This is an obvious statement. Firstly, there's not enough gold in the world for it to become a central pillar of Beijing's investment holdings. Secondly, if China said that it was going to become a major investor in gold, the price would arguably go through the roof.

China's State Administration of Foreign Exchange (Safe) highlighted the fact that even if it doubled the 1 054 t of gold it holds, it would have a negligible effect on its portfolio. Safe holds nearly $2,5-trillion, and 2 000 t of gold would be worth about $77-billion.

There is the school of thought that if Safe were to gradually grow its gold reserves, it wouldn't have much of an effect on the gold price.

The argument goes that China is the biggest producer of gold; therefore there is no requirement to buy the yellow metal from other countries.

But the Asian powerhouse is also the world's biggest producer of coal, and that hasn't stopped it from importing large amounts of the fuel. And, while Chinese gold production may be on the up, places such as South Africa have shown massive declines.

In fact, figures from consultancy GFMS show that global supply contracted by three per cent in 2008.

According to the World Gold Council, China's demand for gold grew by 11% in the first quarter of this year to 105,2 t, notwithstanding the higher prices.

But while Safe argues gold investments don't pay dividends (though the investor has to pay storage and insurance costs), the metal has held it's value over the last 2 000 years, as Baruch said.

Not many companies are still around from Alexander's time that you can still buy shares in - can't think of any paper currencies either.