Hedging Against Shocks

Is China preparing for a trade war by stockpiling strategic goods and minerals?

10 June 2024


China's growing demand for strategic goods and minerals has raised concerns in the West. The sources of these fears are either Beijing’s unexpected strategies to assert dominance over global markets or the preparations for a trade war and global conflict with Western countries. There are also growing expectations that China may make a new devaluation of the yuan, or plan to pay for an increasing number of imports using its local currency instead of the US dollar.

When China is the main consumer of a product, it has a strategic interest in keeping it well-supplied while also ensuring reliable payments for its imports. As a result, it is expanding its purchases of strategic goods ahead of a currency devaluation—and its expected repercussions for import prices—in the near future. Furthermore, increasing imports of critical goods protects the Chinese economy from potential shocks in the case of a trade war. It also serves to bolster Beijing's negotiating power with Western countries.

Gold Buying Spree

Amidst challenges in China's real estate and stock markets, gold assets have gained increasing attention from investors. Chinese gold exchange-traded funds (ETFs) saw steady monthly inflows throughout the first quarter of 2024, reaching 2.8 billion yuan (USD 386 million). Chinese gold ETFs have witnessed five consecutive months of inflows. Last April attracted 9 billion yuan (USD1.3 billion), the strongest month on record, pushing total assets under management to a record high of 46 billion yuan (US$6.4 billion).

In 2023, the People's Bank of China (PBOC), the country's central bank, purchased significant amounts of gold. This amounted to approximately 225 metric tons or nearly a quarter of the 1,037 tons bought by all central banks worldwide. The PBOC continued its gold buying streak for the eighteenth consecutive month in April 2024, marking the longest buying spree since it resumed announcing gold purchases in November 2022. China's official gold holdings currently stand at 2,264 tons, representing 4.9% of the PBOC's total foreign exchange reserves, the highest level ever. In 2024, China accumulated 29 tons of gold, and over the past 18 months, holdings have increased by 316 tons. 

Energy Products in High Demand

China's stockpiling spree has extended beyond gold to encompass other strategic commodities such as oil. Beijing's oil imports surged to their highest level in four years in April, rising by 5.45% compared to the same period in 2023, according to data from China's General Administration of Customs. An additional 830,000 barrels of oil per day were added to China's strategic reserves in April, up from 790,000 in March. Over the first four months of this year, China has added 700,000 barrels per day to its stockpiles.

In fact, a significant portion of the increase in China's crude oil imports in the first quarter of this year was attributed to abundant and inexpensive flows of Russian crude diverted from India due to US sanctions. Going forward, new fuel export quotas and the recent decline in oil prices could further incentivize crude oil purchases by Chinese refiners.

China imported 11.3 million barrels per day of crude oil in 2023, up 10% from 2022, as shown in the previous chart. Chinese refiners imported record volumes of crude oil in 2023 to feed the country's growing refining capacity to support transportation fuel needs and feedstock production for the expanding petrochemicals industry. Further fuel export quotas for Chinese refiners could incentivize more refinery output and product exports following a period of weakness in early 2024.

Beijing also boosted its imports of coal and natural gas in the early months of 2024, aiming to build up fuel stockpiles for power plants ahead of the summer season. This move comes as global prices for these fuels have fallen to nearly half of last year's levels in the first four months of this year. According to recent reports, China's natural gas imports jumped 21% between January and April 2024 compared to the same period last year, while coal imports rose 13%.

China's liquified natural gas (LNG) imports are expected to exceed their previous record set in 2021 this year, driven by strong demand from the industrial and commercial sectors. In 2021, China's LNG imports reached an all-time high of 78.8 million metric tons. Forecasts suggest that the country could import between 78 and 80 million metric tons of LNG this year thus taking advantage of lower spot prices compared to last year. 

Iron Ore Imports Surge

Expectations are mounting that China's iron ore imports in 2024 will reach an all-time high. According to some estimates, imports could rise by 15 to 50 million tons compared to 1.18 billion tons in 2023. The optimistic outlook stems from the fact that during the first four months of this year, China has already purchased 411.82 million tons of iron ore, an increase of over 7% from the same period last year.

The rise in the mineral’s imports comes amid improvements in logistics in the Black Sea, leading to increased supply from Ukraine after a two-year hiatus. Meanwhile, the rebound in iron ore prices from their lows in late March 2023 is encouraging Indian exporters to ship larger volumes to China. Data shows that around 92% of India's iron ore exports during the 11 months of fiscal year 2023/2024, amounting to around 40 million tons, went directly to the Asian giant. The increasing demand for iron ore may indicate that the Chinese economy is beginning to see a diversified pattern of growth drivers, amidst rising infrastructure investments and growing manufacturing sectors.

Record Grain Imports

Alongside gold and oil, China's grain and oilseed imports are expected to remain near record levels this year. This is driven by lower global prices, shortfalls in domestic production, increased government funding to bolster grain and oilseed stockpiles, and a growing desire for self-sufficiency in the face of potential external shocks.

Latest customs data shows that China's wheat imports from Australia in January and February 2024 nearly quadrupled compared to the same period last year. China's corn imports are also on the rise as feed producers take advantage of lower global prices. China imported 6.19 million tons of corn in January and February 2024, up 16% from the previous year. China has also snapped up Australian barley for malting and animal feed after lifting punitive tariffs on the grain in August last year.  In the first two months of 2024, China's barley imports nearly tripled compared to the previous year, reaching 2.71 million tons.

In order to protect Beijing against external shocks in case of currency devaluation, Chinese President Xi Jinping has been championing self-reliant agriculture in China if a trade war with Washington erupts. The Chinese government has approved genetically modified (GM) wheat and corn varieties for domestic cultivation, marking a step forward in becoming a global proponent of GM crops This decision has potentially positive implications for achieving grain self-sufficiency.

Strategic Motivations

Speculation is mounting about the real motives behind China's move to bolster its stockpiles of strategic commodities and metals. This could be a way to shield itself from the prospect of Western economic sanctions similar to those imposed on Russia, in case Beijing devalues the yuan again, potentially exposing it to a trade war. Alternatively, it could be to counter potential political and economic consequences if it decides to invade Taiwan. Additionally, the economic rationale behind the accumulated gold reserves could be the desire to hedge against external shocks resulting from over-reliance on Western currencies, especially the US dollar. Overall, China's motivations can be summarized as follows:

Dominating global gold markets: Beijing has long held significant influence in gold markets, driven by rising domestic demand and investment in the precious metal. However, the country's impact has become even more pronounced during this latest upward wave, with global prices surging by nearly 50% since late 2022. China has continued its aggressive gold buying, despite factors that would typically make the commodity a less attractive investment, such as high interest rates and a strong US dollar. As a testament to Beijing's dominance in global gold markets, prices rallied in April despite the US Federal Reserve signaling it would keep interest rates high for an extended period.

Diversifying reserves and reducing US dollar exposure: It can be inferred that Beijing is buying gold to diversify its foreign exchange reserves and reduce its reliance on the US dollar, which has traditionally been the dominant currency held in central bank reserves. China has indeed been reducing its holdings of US Treasury bonds. As of March 2024, China held around $775 billion in US debt, down by about a third from 2011 levels. 

Hedging against potential sanctions: The Chinese central bank's intensified gold buying comes in the wake of the US Treasury Department's decision to freeze Russia's US dollar holdings under sanctions imposed on Moscow. This has shaken the confidence of many countries in the current international monetary system. Central banks have been forced to protect their reserves with more diversified holdings, and the Chinese central bank has been at the forefront of banks replacing foreign currencies with gold. Therefore, China's intensive gold buying is seen as a hedging tool against the possibility of facing US restrictions due to its military ambitions and the ongoing trade tensions between the two countries. China's gold holdings could also serve as a warning that the country could use its large holdings of US government bonds as a weapon against Washington in a potential trade war, as China still holds a significant amount of US debt.

Alignment with BRICS goals: The Chinese central bank's goal of diversifying its foreign exchange reserves aligns with the objectives of other BRICS nations, that are projected to dominate the global economy by 2050. BRICS members have even suggested the idea of a future common currency, which could potentially challenge the US dollar. If such a common currency were adopted, BRICS members could conduct trade transactions without resorting to the US dollar. This could lead to a decrease in the demand for and, consequently, supply, of the dollar on the international stage, potentially weakening its value and eroding its position as the world's primary reserve currency.

Long-Term economic diversification: China has been buying gold for nearly 18 consecutive months. Yet, its gold reserves still represent a small portion of the PBOC's total reserves (less than 5% of total reserves), which is significantly lower than the levels held by central banks in developed countries. The World Gold Council expects central bank purchases, led by China, to continue for several years, affirming the commitment to diversification.

The shift in investor sentiment within China: Recently, Chinese investors have followed the lead of the central bank. They are seeking gold as a safe haven amidst a collapsing real estate market and underperforming stocks in the country, and uncertainty surrounding geopolitical turmoil in various parts of the world. China's gold imports have surged to record levels, gold bars in Shanghai have been selling at premiums, and there is evidence of speculation spreading in China's gold futures market.

Potential Implications

Conventional wisdom often suggests that China will continue to grow and consume massive quantities of natural resources, leading to higher prices for everyone. China's increased appetite for stockpiling strategic commodities is expected to have several potential implications, including: 

Rising global gold prices: China's gold rush is highlighting the enduring role of gold as a safe haven during times of economic and geopolitical uncertainty. The impact on the global gold market could be significant and is likely to influence other central banks around the world. The latter bought 290 tons of gold in the first quarter of 2024, the highest ever for that period. This has contributed to pushing gold prices to record highs, despite rising interest rates worldwide, which typically dampen demand for gold. Gold recently hit record highs above USD2,400.

Rising global oil prices: As the world's largest oil consumer, China's economic growth momentum is driving up its oil demand, boosting global oil prices. Recent data showed that China's factory output and investment exceeded expectations at the beginning of this year, indicating strong demand. Beijing's potential economic transition could further increase demand for crude oil in the coming months.

Weakening US dollar strength: Beijing has long sought to reduce the dominance of Western currencies, particularly the US dollar, by intensifying reliance on its local currency in trade, especially after the US sanctions imposed on Russia. Starting in March 2024, over 52.9% of China's payments were settled in renminbi, while 42.8% were settled in US dollars, a weakening share compared to the past five years.

Shifting away from traditional investments in China: The increasing gold buying by investors within China reflects a growing pool of money in the country seeking investment in more stable and growing assets. This comes amid the Chinese economy facing numerous risks and uncertainties, including the current real estate crisis, stock market volatility, geopolitical factors stemming from the Taiwan crisis, and demographic challenges. China’s rapidly aging population is attempting to strengthen retirement savings by investing in gold.

Eruption of a trade war: Recent announcements by the US administration under President Joe Biden, including raising tariffs by 100% on Chinese electric vehicles, 50% on semiconductors and solar cells, and 25% on batteries and port cranes, have contributed to escalating trade tensions between the two countries.