China may slow down its U.S. debt buying. Will gold rally or plunge, then?

Dragons Love Hoarding Gold and Not Only

Dragons love gold. In Greek mythology, dragons were set by the gods to guard golden treasures. It makes perfect sense, since it would be rather difficult to find better guards. Everybody who watched The Hobbit series knows that this is true – the powerful Smaug hoarded a lot and was really obsessed with his shiny treasure.

The Chinese dragon is also believed to hoard a lot of gold. With more than 1,800 tons of gold officially owned, China has the fifth largest gold reserves in the world (and many analysts speculate that the country’s true gold reserves might be much higher than the official number). The impact of Chinese holdings on gold prices is rather questionable, but the importance of China’s economy for the global markets is beyond doubts. Three years ago, the stock market crisis in Shanghai caused the global stock market sell-off in August. 2016 started with a Chinese bang, when the global stock markets – worried about an economic slowdown in China – plunged.

Will China Dump U.S. Treasuries?

Now, concerns arose that China could stop or slow U.S. Treasuries buying. Is there anything to worry about? Yes. And no. Let’s see. China is one of the largest official holders of U.S. assets and world’s biggest foreign holder of U.S. Treasuries. As one can notice in the chart below, China’s foreign reserves excluding gold exceed $3 trillion.

Chart 1: China’s foreign reserves excluding gold from 1980 to 2017.

According to Bloomberg, “senior government officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries”. The report sent U.S. Treasury yields higher. As the next chart shows, the yields had already been rising due to less intense buying from central banks and the expectations of widening fiscal deficits. On Wednesday, the 10-year Treasury yield jumped even further, reaching a 10-month high.