Flight to Safety, China’s Forex Play, Gold Bazaar, Eagle Demand, and More!

• Dow back below 10,000… What’s different about 2010’s version of the “flight to safety”
• Trading dollars for real assets: China confirms persistent rumors about forex reserves
• Inside China’s bullion bazaar… and the reasons everyday Chinese are rushing to gold
• Update on the U.S. Mint Gold Eagle sales confirms record monthly pace
• Readers write: Hyperinflation, 401(k) confiscation rumors

   Well, that didn’t take long.

The Dow Jones industrials plunged 250 points in the first three minutes of trading this morning. Not only are we below 10,000, we’re below 9,900. The VIX jumped 12% in the first half hour of trading.

Blame Spanish banks, this time. Or tensions between North and South Korea. Blame it on the Case-Shiller Home Price Index, if you like.

Whatever the reason, the “flight to safety” trade is on again. The dollar index has zoomed past 87. A 10-year Treasury note yields a paltry 3.12%.

   What about gold? Once again, the trend of 2010 is in place: Gold and the dollar are showing strength at the same time. Gold is just a couple of bucks away from $1,200 again.

“You could see gold go up another $1,000,” says Evan Smith at U.S. Global Investors, a key member of Vancouver favorite Frank Holmes’ team. Smith nailed it in 2006 when he said gold would reach $700 within two years. “All of the turmoil and problems we’ve seen in Europe is just another reminder that there’s a lot of value in gold as a safe haven.”

Ah yes, safe havens.

   Let’s say, for the sake of argument, you’re sitting on about $2.4 trillion in assets. And let’s say that to pay the bills, you need only about a quarter of that – $600 billion – in ready cash.

What do you do with the rest?

   As you might guess, this is not a hypothetical question. $2.4 trillion is what China holds in foreign exchange reserves. And it needs only about a quarter of that to handle three months of imports and short-term external debt.

While we were in China last week, we got an official answer to that question.

The Caixin news agency reported that China’s State Administration of Foreign Exchange has begun using some of that money for loans to foreign governments. And when China makes those deals, it’s usually for something tangible in return.

Right now, that something tangible is oil.

   In the last 18 months, China has signed loan-for-oil agreements worth more than $60 billion with Russia, Kazakhstan, Turkmenistan, Brazil and Venezuela, among other countries. The deals represent more than 500 million barrels of crude every year.

In just one of those deals, China agreed in February to provide $25 billion in long-term loans to Russia in exchange for 100 million barrels a year between 2011-30.

The deals haven’t been a secret. But the Caixin report confirms something that’s only been rumored to this point: China is drawing on its forex reserves to make these deals happen. That is, China is using its paper reserves to buy real assets in the ground.

Nearly half of China’s forex reserves are in U.S. dollars.

   This quest for real wealth extends to everyday Chinese. Hence, the bustling Cai Bai gold market Chris Mayer, Joel Bowman, Bill Bonner and I visited last week.

There was a noisy crowd of people buying gold in all its forms from jewelry to bars.

We tried to show you the bustling scene with the iFlip, but security put a quick stop to that. So… we’ll settle instead for a report from Britain’s Sky News channel, which apparently jumped through the bureaucratic hoops last week to bring you the mayhem:

   “Housing speculators from Wenzhou City in southeastern China,” reports China’s state-owned CCTV on the same beat, “are switching their money from property into gold, following government restrictions on the real estate market.”

“We often heard on our trip,” commented Chris Mayer, “that the Chinese buy empty apartments and just sit on them, treating the investment as a store of value. The other favorite place to park cash is gold.

“As gold investors, there is an interesting dynamic at work here. It also gives us another big catalyst for a higher gold price – a buying surge from the Chinese.”

The sale of gold bars in China has doubled from a year ago.

   As if we didn’t have enough catalysts already. “Speculators are buying gold faster than the world’s biggest producers can mine it,” reports Bloomberg News, “as analysts forecast a 27% rally that may extend the longest run of annual gains since at least 1920.”

Mine supply has fallen in five of the last eight years, according to GFMS, the London-based consultancy. That’s why mines in South Africa are digging 2.4 miles deep into the earth – not unlike the quest for oil in deep water.

ETFs and similar gold-backed products now sit on a record 1,938 tons of metal. Only four of the world’s central banks hold more. The buying has accelerated all this month, a pace not seen since the first quarter of 2009.

Investment demand now exceeds jewelry demand for the first time since those heady days of early 1980, when gold touched $850.

Even central banks want gold again. Last year, they switched from being net sellers of gold to net buyers. The last time that happened was 1988. And the amount they accumulated was the most since 1964.

   Hardly a week passes by anymore in which we don’t hear about some hedge fund giant piling into gold. The latest is Thomas Kaplan of Tigris Financial.

“I’ve reached a point where I feel the only asset I have confidence in is gold,” he tells The Wall Street Journal. He has almost all his holdings in gold and gold mines, totaling $2 billion. Kaplan won’t say how much of that is bullion.

   There’s also this curious nugget. In 2001, we remember writing about the infamous gold bug James Sinclair giving a keynote address at a conference in Kuala Lumpur when then Malay president Mahathir Mohamed proposed the Islamic world begin using the ancient “gold dinar” to settle trade contracts again.

The idea was intriguing for those investors quirky enough to be interested in the barbarous relic, but soundly quashed by the IMF as illegal, of course.

Last week, the idea surfaced again. A “gold dinar” was openly discussed at a meeting of the Organization of the Islamic Conference – a group of 57 nations that have permanent representation at the United Nations.

   Closer to home, the U.S. market for bullion coins remains on track for a record. Here’s an updated edition of a chart we first brought you two weeks ago…

“Precious metals had a disastrous week,” reports CoinNews.net, “yet U.S. Mint-authorized buyers ordered more bullion American Eagle coins during the third week of May than in each of the prior weeks when metals were rallying.”

For the first three weeks of this month, orders totaled 139,500. As we forecast, this pace will see a new monthly record – surpassing the one set in December 2008.

What’s more, if you combine American Eagles and American Buffaloes, “nearly one-fourth of all gold bullion coin purchased from the U.S. Mint this year were made during the past 13 days,” according to the website.

   There’s no indication, at this point, that the U.S. Mint is about to start rationing supply to its authorized dealers. But “during the widespread panic of late 2008,” we quote The 5 from May 13, “demand spilled over into certain types of collectible coins. In the United States, proof and uncirculated U.S. Gold Buffaloes sold out. In South Africa, Mandela commemoratives flew off the shelves.”

If you recall, we recommended a set of “First Strike” Chinese Gold Pandas that we had arranged to offer you through our relationship with First Federal Coin. That offer ends today. What’s left of their cache will be liquidated through the open market starting tomorrow. If you’re at all interested in these coins, we suggest you take a look here.

   “First of all,” a reader writes, “let me say thanks again for providing all of the services that you do. I’ve been a Reserve member now for three years or so and it’s been worth every penny. That said, I have a scenario for which I’d like some feedback.

”Let’s say that today I have $500,000 in mortgages and 100 gold coins worth $100,000. (I’m keeping the math simple). Let’s say that the hyperinflation many Austrians are predicting comes to pass. Let’s also say that gold goes to $10,000 an ounce as a result of this.”

“Now I have $1,000,000 in gold, but I still have only $500,000 in mortgages. So I sell 50 pieces of gold, pay off my mortgages with worthless dollars, and still have 50 pieces of gold.”

“This is the whole point of owning gold, right?”

The 5: In a case of extreme hyperinflation, yes.

   “You guys do a great job of cutting through the crap. Thanks for all you do.”

The 5: Heh. Thanks… we think.

“I read in The New York Times,” the reader continues, “‘The Department of Labor and the Department of Treasury are reviewing retirement plan rules to determine if the retirement security of participants could be enhanced with arrangements aimed at providing a lifetime stream of income after retirement.’

“What does this mean? Do we need to be worried about the government confiscating our 401(k)s in return for a sustenance check?”

The 5: Umn… not yet. We’ve been on top of this since the first proposals for “guaranteed retirement accounts” were floated in 2008. So far Congress has been content fouling up other things like “health care” and “financial” reform. When and if they get around to cleaning up their own books… that’s the time to get nervous.

Regards,

Addison Wiggin
The 5 Min. Forecast

P.S.: On the subject of the government taking over the effort to stop the Deepwater Horizon blowout in the gulf, our Byron King gets the last word in a front-page Washington Post story today:

“‘If you could control an oil spill with lawyers and regulation writers, and by signing papers and obtaining court injunctions . . . then maybe the U.S. government could do something,’ said Byron W. King, an energy analyst at Agora Financial. ‘But really, Uncle Sam has almost no institutional ability to control the oil spill. For that, you need people with technical authority, technical skill and firms with industrial capabilities.’”

Heh.

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P.P.S.: Remember, today’s the last day for Gold Pandas, click here.