24/7 Wall St.

The Xinhua news agency reports that China imported just under 210 metric tons of gold in the first ten months of 2010. That is about five times the what it had during the same period last year.

It had not been clear how great China’s  appetite for gold was until recently. “Everybody in the gold market knew there was a surge in investment demand, but they didn’t know it was China,” said Jeff Christian, managing director at CPM Group, The Wall Street Journal reports. China also has its own gold mining capacity which makes its imports all the more mysterious.

Analysts who follow gold assume that China has bought all of this gold as a hedge against inflation. That would make some sense since inflation has begun to become a problem in China. That is not much of an explanation, however, because the gold holdings of the People’s Republic are very small in a nation with a rapidly growing GDP which was nearly $5 trillion last year.

One explanation for the Chinese purchases is it has bought so much gold because it can. China has a foreign currency surplus of more than $2 trillion. Much of that is invested in US sovereign debt–Treasuries. Some is invested in the sovereign paper of other countries such as Japan. Debt issued by slow growth nations has become less attractive because of fear about eventual default. The yield on US Treasuries is barely enough to make investing in them worthwhile.

China has run out of places to put its capital, it seems. It is such a large investor that almost any market is enters will be affected by its demand. This is probably true with gold.  The news of China’s investment makes gold seem even more attractive to some which pushes prices even higher. China has created a profit on its holdings simply by increasing them and making the purchases public.

Gold is only one example of China’s ability to sway markets. It has already affected the price of oil and certain ores. Factory and transportation needs will drive this demand even more.

China may be one of the possible causes of a growing worldwide inflation of raw material prices. It has created its own virtuous circle as it buys more gold, but the cycle has begun to turn vicious as it presses into other markets like oil. The Chinese economy may be huge, but it is not immune from the sharp increases in the price of imports–price increases it has been critical in driving.

Douglas A. McIntyre