Gold and its connection to China’s social unrest

We are China bears, in case you didn’t notice.

Throughout much of the last two to three years, a key component in our analysis has been the simmering social tension and the potential for one of hundreds of thousands of “mass incidents” occurring each year to escalate beyond the control of Communist Party officials.

Such an event could really snowball and ripple through the Chinese economy very quickly.

I say that because the Chinese people are becoming impatient with current policies aimed at balancing inflation and growth. As you might have noticed, the balancing act isn’t quite as easy when the rest of the world isn’t cooperating with China’s modus operandi.

And citizens are realizing that amidst all the juggling of interest rates, stimulus money, investment projects, and currency management … they are getting the shaft. If you want more on why Chinese citizens are bearing the brunt of China’s growth management system and why China is facing a very rough future, stay tuned; we’re putting together something that runs the gamut on China, and we’ll be sending it your way soon.

But you’re reading today for the gold stuff …

Realizing that the balancing act will produce volatile inflation and growth rates, China has promoted a sort of insurance policy to its people (I suppose in the hopes of garnering some good will). That insurance policy is gold.

The government is trying to rid the system of illegal gold exchanges as it motivates investors to park some money in the yellow metal.

With the Shanghai Composite falling more than 20% in 2011, Chinese investors have needed an outlet that would offer something more stable than the casino-like stock market. Even though gold isn’t exactly a conservative investment (assuming a time-frame that doesn’t involve end-of-the-world rhetoric), there are plenty of appealing features that uncertain Chinese citizens are happy to buy in to.

I’ve have frequently mentioned to members of my Commodities Essential newsletter the connection between gold prices and Chinese inflation.

Naturally, if their government is currently seeking growth at all costs, inflation is going to rise and bite down hard on the average guy. Gold is perceived as a way to mitigate that pressure. Historically, the correlation between gold and US inflation is not extremely tight; but the recent correlation between gold and Chinese inflation has been.

With that in mind, I recently recommended a gold ETF trading idea to my members that targets this dynamic. [You can read more and subscribe to Commodities Essential if you're interested.]

So, with …

1) stocks down and volatile and

2) with inflation high or uncertain and

3) with policies and negative real interest rates that pressure the household sector and sap spending power

… where to go but gold?

This from Reuters:

“For my son, the idea is that he will get a nice stash of gold that he can cash out when he turns 21 or when he gets married,” said Ping, one of over 2 million people that have opened accounts in the past two years to accumulate gold at the Industrial and Commercial Bank of China (ICBC).

And this:

China, expected to overtake India as the world’s top gold consumer in the next few years, accounted for 23 percent of the world’s total consumer physical gold demand in the first three quarters of 2011, up from 19 percent in 2010, according to the World Gold Council (WGC).

Will consistent gold demand in China be enough to support the price? It seems so. New forecasts from big banks et al are calling for $2,000 an ounce this year.

The question is: what happens if China’s GDP falls more than expected and brings inflation down with it? It may reduce the inflation-hedge appeal; but it’s likely social tensions won’t be quelled anytime soon; it’s the wild card gold bulls may be clutching.

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