China is Taking Revenge

It was announced that China had sold $34.2 billion of Treasuries in December, effectively making Japan once again the largest holder of U.S. Treasuries. The battle between China and Japan for the title of largest holder of this dubious asset is not very interesting. What's more interesting is the question of where China is instead opting to invest. After all, $34.2 billion is a fair chunk of change, and China's overall reserves are growing and now total $2.4 trillion.

The People's Bank of China usually keeps its holdings a carefully guarded secret, much more so than for most central banks. However, we can make some inference from the holdings of China Investment Corp. (CIC), the country’s $200 billion sovereign wealth funds.

CIC got heavily involved in the U.S. financial business in 2007, buying a $3 billion stake in The Blackstone Group LP and a $5 billion stake in Morgan Stanley - in both cases, 9.9% of the outstanding common. Neither of those investments turned out particularly well - Blackstone is down about 60% from CIC's buy price while Morgan Stanley is down about 40%. More recently, CIC has turned toward natural resources, in 2009 buying 17% of Teck Resources Ltd. and 13% of Singapore-based Noble Group. Teck Resources is a major diversified mining company, while Noble is a global commodities trading/supply-chain manager with $36 billion in sales.

So which do you think the Chinese government is motivated to invest in - the staggering titans of U.S. financial services or rapidly growing commodity producers? That's without taking into consideration the fact that China has an ever-increasing thirst for commodities, because of its rapid growth, whereas it has perfectly competent banks of its own.

Let's not get carried away. The People's Bank of China is a central bank, not a sovereign wealth fund, and it couldn't invest $2.4 trillion in Teck Resources shares if it wanted to.
So given that central banks don't generally buy stocks (that's what sovereign wealth funds are for), or dabble in commodity futures, there are really only two decent alternatives into which China could sink that amount of money: gold and silver.

China already owns some gold, but not much, compared to the size of its reserves - 1,054 tons at March 2009, worth about $37 billion at today's prices. At 1.5% of its reserves, that's pathetic, though it's up 76% since 2003. On average, international central banks hold 10.2% of their reserves in gold. To get to that level, China would have to buy more than $200 billion worth - about two years' global mine output.

Silver is not is a significant part of most countries' reserves, but China is historically an exception, since in Imperial times it was on a silver standard rather a gold standard, and so retained substantial reserves. Early in the 2000s it was a major seller, selling 50 million ounces in each of 2001 and 2002, at the then-prevailing prices of below $5 an ounce. After that it stopped selling.

Then, in September 2009, the Chinese government passed a decree encouraging Chinese savers to buy silver, issuing publicity explaining that buying silver was a good deal since the gold/silver price ratio at 70-to-1 was historically very high, offering them convenient small-value ingots with which to buy it, and prohibiting the export of silver from China.

With this information, I know which way I'm betting.