China Will Continue To Buy Gold and Silver As A Hedge Against Its Dollar Exposure

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November 28, 2012 2:43pm NYSE:GDX NYSE:GDXJ

Steven Orlowski: Gold is supposedly back and as appealing as ever. Of course it never went anywhere, but the constant barrage of gold bears has often dampened the outlook for what is likely to be a continuation of the global rally in gold that is now 12 years old.

Recent headlines have touted the increased commitment to gold by countries and investors alike. Of great interest to emerging markets investors is the revelation that China is stockpiling gold as a hedge against a falling US dollar.

However the China story is an obvious one. China owns a lot of US dollar-denominated debt and is therefore greatly exposed to the effects of a falling dollar. While extremists anticipate an overnight collapse of the dollar at the hands of the Chinese, this is not reasonable.

Even if China wanted the dollar to collapse overnight it would work to support the dollar because of its own exposure to the US currency and its ongoing, if slightly reduced, obligation to continue purchasing new US debt. China still needs the US to buy what they manufacture and China therefore needs to keep investing in US treasuries.

As such China does not want to see the dollar collapse. China does however recognize the risk of owning US dollar-denominated securities and is therefore hedging. One hedges currency risk by owning other currencies or by owning commodities that trade in the currency one is hedging: own dollars, buy gold; dollar down, gold up.  It’s that simple.

China will continue, as will other countries, to buy gold, silver and other hard assets in order to reduce and hedge against its dollar exposure. The US is still facing strong headwinds (that’s putting it lightly) and with a debt situation that is expected to worsen over the next decade gold is likely to rise much further in dollar terms.

Assuming this analysis is accurate then it is logical to own gold and gold-related businesses.  The most commonly traded gold ETF is GLD, the SPDR Gold Trust ETF (NYSEARCA:GLD).  This is a popular way to profit from an increase in the price of gold.  There are many other gold ETFs some of which provide specific exposure to physical holdings of gold, but GLD is very liquid which is helpful when actively trading the shares.

Since the reelection of President Obama GLD has resumed its upward trajectory.

As GLD has resumed its rise so have the companies involved in the mining and production of gold. GDX, the Market Vectors Gold Miners ETF (NYSEARCA:GDX), has some catching up to do.  The miners have been lagging the price of gold, so the opportunity for investors may be better in GDX than GLD.

Often the biggest opportunity lays in the junior miners, the smaller still exploratory mining companies. GDXJ, the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ), also is trailing GLD and could provide the best profits as gold rises.

There are other gold miner ETFs as profiled here previously.  Some of those ETFs have greater emerging market exposure.  But the correlation between the Miners ETF (NYSEARCA:GDX), Junior Miners ETF (NYSEARCA:GDXJ) and the others is quite positive. Given relative illiquidity with some I would advocate using the mining ETFs that trade more frequently. Ultimately the outlook for gold is positive. Every investor should have some exposure to gold.

Related: iShares Silver Trust (NYSEARCA:SLV), Ultra Silver Trust (NYSEARCA:AGQ).

Written By Steven Orlowski From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.

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