>China gold reserve increase a modest surprise

London - Spot gold rallied to a three-week high Friday after China announced its gold holdings are over 70% higher than it previously reported.

Prices eased later in the day as the market decided the increase, while bullish and somewhat higher-than-expected, was too modest and gradual to drive prices sharply higher.

State-run news agency Xinhua quoted Hu Xiaolian, the head of China's foreign exchange agency, as saying that China's gold reserves had risen 454 tons since 2003 to 1,054 tons, the first public acknowledgment in years that its reserves had changed.

Official Chinese data at the end of March showed the country's gold reserves stood at 600 tons.

Hu, head of the State Administration of Foreign Exchange, or SAFE, which manages the nation's foreign exchange holdings, said China increased its gold reserves gradually and had bought the metal domestically.

At Friday's spot gold price of $910.45 per troy ounce, up 1% on the day, the reserves were worth $30.87 billion.

China's announcement confirmed widespread expectations that the country had been increasing its gold reserves, which partly explained the muted price reaction.

"It's not surprising," said JP Morgan analyst Michael Jansen. "A lot of central banks are being advocated to collect gold."

Analysts have long speculated that China might diversify out of its massive foreign exchange reserves into hard assets like gold.

Comments by Chinese Premier Wen Jiabao last month expressing worries over its holdings of U.S. treasuries only strengthened those speculations. "They've hinted at this before that they're concerned about their exposure to dollars," said RBS analyst Stephen Briggs.

The long timeframe of China's gold purchases also tempered the market's enthusiasm. The amount roughly represents just 3% of the gold produced in the past six years and is less than European central banks that are signatories to the Central Gold Bank Agreement sell each year.

"I think as soon as people realized it's not a year-on-year increase, or a quarter-on-quarter increase, people realized it should not have that big an impact," said Standard Bank analyst Walter de Wet.

Compared with gold exchange-traded funds, which have increased their holdings by over 1,200 tons in just the past two years, the increase in China's reserves is modest, said Gerry Schubert, head of precious metals trading at Fortis in London.

Using the new figures, China became the fifth biggest holder of gold after the U.S, Germany, France and Italy.

Unlike these and most other countries, China's gold reserves are just a small fraction - around 1.5% - of its foreign exchange reserves, a ratio that declined in past years as its purchases of foreign exchange swelled to nearly $2 trillion. RBS estimates the world average is approximately 10%.

Many analysts doubt that China will substantially increase its ratio to that level, as the gold market is not large and liquid enough to handle the amount of buying this would entail, unlike the market for treasury bills, and prices would shoot up enormously.

"From a prudent risk-management perspective, it probably doesn't make sense to diversity too much into gold," said de Wet.

By purchasing from domestic producers, China demonstrated that it has the ability to acquire substantial amounts of gold in a way that is difficult for the international market to track and therefore not disruptive to prices.

Many central banks buy their gold reserves through the international spot market, which is more transparent to market players. "If it's done that way, a prime market counter-party is asked to quote," said Jansen. "People would find out about it and get excited."

The timing of China's announcement didn't appear driven by any obvious rationale, analysts said. UBS' Reade speculated China may be trying to assuage domestic calls for it to diversify into gold.

The announcement came less than a month after the IMF's proposal to sell 403 tons of its gold reserves was endorsed by the Group of Twenty countries at the G20 Summit. China was seen by analysts as a natural buyer for at least some of the gold, which could be done through an off-the-market swap.

China's announcement Friday indicates that while it has been a buyer of gold and may, therefore, be interested in the IMF's gold, it can also satisfy its needs domestically.

Source: COMMODITIESCONTROL