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Commentary: Does China need to buy more gold?

By Zhang Zhouxiang (China Daily)

08:07, October 10, 2012

For global investors holding gold, the past few weeks must have been a happy time. Since the United States Federal Reserve announced a new round of "open ended" quantitative easing, or QE3, on Sept 13, gold prices have risen from $1,730 to $1,775 per ounce.

On Oct 2, Deutsche Bank even raised its 2013 gold price outlook to $2,113 per ounce, claiming in a research note that, "a surge in the gold price above this level ($2,000 per ounce) is only a matter of time".

Should this grab the attention of China?

Its gold storage of 33.9 million ounces, although the fifth largest in the world, accounts for only 1.7 percent of its $3.3 trillion foreign reserves, much lower than the 75.4 percent of the US and 72.3 percent of Germany. So should China buy more gold?

Not necessarily, say Campbell R. Harvey, a professor at Duke University's Fuqua School of Business, and Claude B. Erb, managing director at First Chicago NBD Investment Management Company. In their opinion, "as long as China follows sound economic policies", there is no compelling necessity for it to buy gold.

In their newly released research paper, The Golden Dilemma, Harvey and Erb have analyzed what they call "the myths of gold", namely that it is regarded as a hedge against inflation and an alternative to low-return assets, and they discuss whether central banks in emerging markets should increase their gold stocks.

According to their research, gold as an honest currency can be a hedge against inflation, but it is more effective in the long term rather than the short term. Besides, as an honest currency, gold is more effective against hyperinflation, in which situation the public loses most, if not all, confidence in bank notes.

That is not the situation today, say Harvey and Erb, as the impact of QE3 will probably be similar to the impact of QE1 and QE2, both of which aroused worries though not noticeable worldwide inflation. As QE3 is to be implemented in almost the same way as the previous two rounds of quantitative easing, they believe it "a good bet" that QE3 would not result in higher inflation in the short term although the price of gold will rise.

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