AFTER THE BUST: What China's slowdown means for the value of your stocks, your house and the security of your retirement savings

In this Report

  1. The Downward Slide Has Begun
    (1) Why the big trend has changed and your investments should too
    (2) The lowest risk, highest value investment you can make today
    (3) Finally, some answers to the single biggest challenge facing Aussie investors today

  2. 2013: The Year the Financial Crisis Comes to Australia
    (1) Why it's time you accepted that the great resources boom is over
    (2) With every new trend comes a new opportunity — this is no exception
    (3) The stakes couldn't be higher for Australian investors

  3. 'People Before Profits': Why Chinese Demand for Aussie Resources is Bogus
    (1) The myth behind China's 'miracle economy' exposed
    (2) Two huge problems for China...and YOU
    (3) Forget Greece, Spain and Italy...THIS is the next financial crisis

  4. Three Financial Landmines We're About to Stand On
    (1) What China's bust means for Aussie interest rates, stock prices and property
    (2) Politicians will tell you falling rates is good news — IGNORE THEM
    (3) China is screwed...and what this means for you

  5. China's Golden Endgame:
    (1) Why Beijing is secretly hoarding gold and what it plans to do with it
    (2) Financial attack on the West: the biggest 'transfer of wealth' in history is underway
    (3) Gold at $5,000 an ounce or higher in the next five years

  6. An Investment Strategy For a New World Order
    (1) How to protect what you've got now
    (2) Three unprecedented profit opportunities amid the chaos
    (3) Three 'long-term ten-baggers' to buy now

Chapter One:

The Downward Slide Has Begun...

These are tough times for Australian investors. It's not the same world it was five years ago, one year ago, or even a few months ago.

The reason is simple. Financial markets move in long cycles. While we don't always know exactly where we are in a particular cycle, the overall patterns remain remarkably clear.

This is why the idea that you can just 'buy it and forget it' — whether we're talking about Aussie shares or property — is wrong.

You'll only make real financial progress if you buy and forget it during an up-cycle.
Get the timing wrong and your investment will go down — or nowhere.

I believe that, here in Australia, we have entered a long downward cycle. It is directly linked to the economic slowdown in China. What happens in China in the next three months could be key to what happens to your wealth and retirement for all of 2013, and beyond. I'll explain why in just a moment.

If I'm right, many of the investments we've come to rely on for our retirements will be financial disasters. In particular, there are three popular sectors you most likely have money in that I urge you to look at now.

When the big trend changes, your investment approach ought to change too. That's why, in this white paper, I'm also going to explore a few key investments that should be good for this cycle.

These are the investments I recommended to Australian investors when I published the conclusions of my year-long research on the dangers we now face.

Since the publication of my report — China's Bust — on the 7th July, a few of those investments have already started to soar.

One has gone up 20%. A second is up 25%. And a third is up 40%.

I believe these price moves are only the beginning. There's still time for you to take advantage...although the clock is ticking.

Events are unfolding quicker than even I anticipated.

Consider what's happened in the last three months...
  • Iron ore prices have dropped to their lowest levels since 2009...

  • BHP Billiton has mothballed projects valued at more than $50 billion...

  • And even Australia's Resources minister Martin Ferguson went on record in August announcing 'the end of a bull run in commodity prices'.
Since the April 2010 post-GFC peak the ASX200 is down 10%. And more than five years after its pre-GFC highs, the Aussie stock market is still 30% down. In fact, despite the recent market rally, the index is at the same level it was back in late 2005. That's zero capital gain in 7 years.

But in the midst of all this, there is one investment class that is still in a long-term bull market. The upward cycle is intact and it's getting stronger. And the investments I'm recommending to steer a path through this rapidly deteriorating crisis are up an average of 14.6% since July.

You'll discover more about these investments in the report that follows.

Among them you'll find what I believe is the lowest-risk, highest value investment you can make today — an investment you should be able to hold for the next five to 10 years while this long cycle plays out. But it's a cycle that very few people have identified, much less understood.

If I'm right, you could end the period wealthier than you thought possible.

Your family and friends will most likely tell you not to bother. They'll tell you it is too risky. And besides, they'll say, the economy is picking up, things are looking better.

But 21 years of uninterrupted economic growth can breed a deep complacency amongst investors. This complacency means they cannot see that Australia's long economic prosperity is coming to an end.

That major trend has reversed.

It's critical you understand this.

What worked in the recent past simply won't work in the next decade.

Now, you can no longer simply buy BHP, the Commonwealth Bank, or real estate and count on a bull market in stocks to raise prices.

Now, stock prices are more likely to go down than up.

Now, you have to choose your investments more carefully.

You have to think a little harder in order to make sure you are not just blindly buying a stock whose long-term trend has changed.

That is why I decided to publish this white paper.

Read on and I'll explain how China got to where it is today, why its economy is in the midst of a slow motion train wreck...and what it all means for Australia.

I'll show you exactly what China is doing to rescue its failing economy. You'll discover parallels from history that make Beijing's motives remarkably clear.

Finally, I deal with the investment implications...and what you should do urgently to address any imbalances in your portfolio that will soon become shockingly apparent.

I'll give you my detailed plan for escaping the downturn that I think is coming in Australian stocks, and for profiting handsomely from the few investments I think will soar when capital makes its inevitable 'flight to safety'.

I hope it gives you plenty to think about.

But most of all, I hope it gives you some answers.

Chapter Two:

2013: The Year the Financial Crisis Comes to Australia (And it's all thanks to China)

There's a time for everything, as the saying goes.

The time to buy the Aussie dollar was in the year 2000. The AUD was cheap, trading as low as 50 cents to $US1. Today the ratio is almost at parity.

The time to buy iron ore was in the early 2000s too — the red dirt was selling for a ridiculously low price of around $20/tonne. By mid-2011 it traded above US$180/tonne. Although the price of iron ore has fallen a long way in the last six months, it's still trading around $115/tonne.

These moves are a direct consequence of the break-neck growth of China's economy.

The wealth it created filtered through all walks of life in Australia. It raised our national income, the Treasury's tax revenue, our wages and the prices we paid for our properties.

But this trend went into overdrive in 2008–2009, during the global credit crisis.

You see, when global economies went into recession, China's export growth model was exposed as a one-dimensional growth strategy...

Faced with collapsing exports and rapidly falling national income, China's leaders unleashed a huge stimulus programme.

They ordered their banks to lend. And lend they did.

As the Wall Street Journal reported in 2010, 'the stimulus opened a credit floodgate that so far has proven impossible to turn off.

' According to Fitch Ratings, bank lending expanded by an amount equal to 42% of GDP in 2009 and 2010.

These numbers are so massive they probably don't mean anything. To give you some perspective, it would be the same as Australia's banking system increasing lending by around $555 billion in one year!

RBA charts
In short, it created a massive credit boom, which relative to the size of China's economy, was bigger than the credit boom that caused the subprime crisis and the property bubble in the US.

Just where did all this credit go?

Mostly into property and fixed asset investment. 'Fixed assets' refers to all kinds of bridges, roads, shopping centres, whole cities in fact.

And for a simple reason: politics. As you'll see in the next chapter, the last few years haven't been about sustainable economic growth in China at all. It's been about political any cost.

This is why most Aussies were oblivious to the Global Financial Crisis of 2008...

In fact, ours was the only country in the western world that didn't enter a technical recession, thanks largely to Chinese demand for our resources...and a government that handed out millions in cash.

In short, it was China's massive 2009 stimulus efforts that leaked into the Aussie economy and bailed us out.

In each of the charts to the right, you can see that in 2008, just as commodity prices (especially coal and iron ore) were correcting sharply lower...and just as Australia's record terms of trade began coming off the boil, China revved up the engine with a huge cash injection into their economy.

As a result, Australia is now entering its 21st straight year of economic expansion.

So, with this in mind, let me ask you this...

What effect would a sudden and violent downturn
in China's economy have on Australia?

I believe it's time to accept that the great resources boom is over.

It's not an easy thing to do. People still believe Chinese demand for Aussie resources will somehow last forever.

As a result, we invest heavily in the Aussie firms who supply China with raw materials, without really paying attention to the story behind the headlines.

Many of us have made huge 'all-in' bets on China sustaining rapid economic growth...either intentionally because we see a bull market we want a piece of, or unwittingly as passive investors in the share market.

It's like Hugh Hendry, CEO of hedge fund Eclectica Asset Management, told the Financial Times in May:

'There is a near consensus that China will supplant America this decade. We do not believe this.

'Those taking big bets on several more years of rapid Chinese investment growth are vulnerable to big losses.'

The problem for you is: this is money you are counting on to help you out in retirement.

That's why I hope you'll forgive me for being blunt. Even if I'm only half right that this China-led boom has ended...
  • Australian jobs will disappear...

  • The ASX — already down 6% in three years — will not 'recover'.

  • The Aussie dollar will nosedive...

  • The already-faltering housing market will collapse...

  • Overextended borrowers will default on their mortgages, directly hitting the bottom lines of the Big Four Banks...

  • And most resource stocks — already hit hard by the first stage of the China slowdown — will experience further falls.
Finally, the 'GFC' will arrive in Australia. In fact, my colleague Dan Denning predicts that 2013 will be the year the GFC becomes the 'AFC' — the Australian Financial Crisis.

It sounds grim. But it's not all bad news.

With every new trend, there are always opportunities. And this is no exception. In fact, I discuss a few of them in more detail in Chapter 6.

But in order to know where these opportunities are, you first have to understand the shift that's taking place in China today. A shift that has...

Massive implications for Australia

Many people assume investment in infrastructure can only be a good thing. That's understandable. Infrastructure projects create jobs and produce a tangible achievement.

But that assumption fails to recognise that large scale, state-directed spending is usually wasteful and unproductive.

And from an investment point of view, borrowing money to create an asset that fails to generate a real return for investors is the equivalent of economic suicide.

That's what China has been doing.

The government has been lending money hand-over-fist to keep unprofitable businesses afloat.

They employ heaps of people to make heaps of stuff.

But no one is buying it anymore.

Now here's the thing...

I believe that at some point in the last couple of years China's leaders realised this model of growth was leading straight to a disaster.

Not just an economic disaster...but a political one too.

And it's led to a series of decisions within Beijing to try to rebalance their hopelessly warped economy.

As a result, they've unwittingly set in motion a financial force that will have a dramatic impact on the Australian investments that have profited so handsomely during the boom years of the last decade.

If I'm right about this — and events so far have proven me correct — the stakes couldn't be higher for Australian investors.

Before I explain, you need to understand why...

Chapter Three:

People Before Profits:
Why Chinese demand for Aussie resources is BOGUS

For most of the 30 years since the start of the country's 'Reform Era' in 1978, China grew by following one simple growth strategy:

Sell things cheaper than everyone else.

This one single idea turned the country into an export powerhouse — the biggest manufacturer in the world.

Why am I doing this?
By Greg Canavan

I've been observing and writing about investment markets for many years now.

In that time I've seen global asset markets become increasingly unstable and volatile. I've also watched the rise of unprecedented 'activist central banking' and increasing government influence in the markets.

The two trends are not coincidental.

To many people, the influence of central banks and governments is nothing to worry or be remotely concerned about. The finance industry fuels this view because it directly benefits from central banking largesse.

But I've learned over the years it is anything but. Interference in the markets by only makes things worse.

Whether out of self-interest or just plain ignorance, mainstream analysis fails to alert investors to the dangers. Miners, politicians and a great deal of investors continue to believe China will grow for decades and be the buyer of last resort for our commodities for year to come.

I don't.

China is one of the most manipulated economies in the world. It is centrally planned and highly artificial. It has huge economic imbalances...imbalances that the mainstream brushes aside in their effusive praise for the Middle Kingdom.

That's why I publish my own research and advisory service called Sound Money. Sound Investments. I apply unconventional economic analysis to situations like China and come up with very different conclusions to the mainstream.

That's what my readers expect me to do — that's what they pay me for.

If I help you make and protect your money, you'll most likely keep reading my research. That's the way it should be. No hidden interests...or secret agendas.

Right now, I believe the single biggest threat to your investments and retirement plans is the looming crisis in China. But it doesn't have to be a threat. In fact, if you make a few key moves, it could actually be a great opportunity.

For details on these investment moves, simply click here and begin your 60-day no-obligation trial of my Sound Money. Sound Investments. newsletter service.

I hope you'll give my research a look.


Greg Canavan
By selling things cheaper than everyone else, China's leaders achieved their most important goal.

It wasn't an economic goal. It was political.

The activity generated by China's export machine — even when it was not profitable — ensured employment in the factories for millions of farmers moving to the cities from the country.

You see, in China it's always been about jobs, not profits.

And for a simple reason: people with jobs are too busy to cause any trouble. As long as the Communist Party of China (CPC) could deliver jobs to the millions moving to the cities, it guaranteed political and social stability.

That stability is pretty important in a country where over 500 million people have moved into cities in the last 30 years. It's the largest mass-migration in human history. Social stability has always been a much more important goal to the CPC than profits.

Don't get me wrong. China's transformation has been remarkable.

Gleaming new cities now stand where rice paddies lay before. Towering skyscrapers fill a once empty skyline. Their National Highway 010 alone would stretch across the whole of Europe — from the west coast of Portugal all the way to the Ural Mountains in eastern Siberia.

China built everything...from new bridges to railways, roads, airports, shopping centres and vast housing complexes.

On the surface this all looks like a once-poor country working hard to become prosperous.

But there's a much darker side to this story...

The myth behind
China's 'economic
miracle' exposed

One of the most basic mistakes you can make about China is thinking that it's performed an economic miracle.

It hasn't. In fact, if you take only one thing away from this presentation, let it be this...

China's expansion is POLITICALLY — not economically — motivated.
The last few years haven't been about sustainable economic growth at all. It's been about political any cost.

Beijing has one motive: maintaining the rule of the Communist Party.

Doing this requires maintaining social stability.

And that means putting wages in people's pockets — even if it's totally unprofitable to do so.

For example, in a recent article in China's leading business magazine, Caixin, a manager at an unnamed steel company said:

'We're under a lot of operating pressure right now. Because it's related to employment, we cannot just cut production. We're now in a situation where we lose several hundred yuan on a ton of steel.'

This is what I mean when I say that in China 'people come before profits'.

Making money is not the number one priority for China.

Maintaining a high level of employment is.

It's absolutely critical you understand what this means.

If Chinese business operated by the normal rules of capitalism and had to run at a profit, it's likely their demand for key Aussie resources would be much lower. In fact, if profits came before social stability, there probably would have been no commodity boom at all!

That's why, if you have even a shred of interest in your future financial security, I urge you to take this warning very seriously:

Chinese demand for Aussie resources is not real. It's fake. And it could be taken away just as easily as it's been manufactured.

Now you may be wondering how this is even possible. In a normal capitalist system, businesses that run regular losses go out of business.

It's simply not sustainable.

That is, it's not sustainable UNLESS the entire banking system of a country is mobilised to support a political goal.

I believe that's what's happened in China.

In fact, the International Monetary Fund's first ever review of the Chinese banking system late last year proves this is exactly what's happened.

As a result, it says, China's banks are facing a 'steady build-up of financial sector vulnerabilities'...

'The system is becoming more complex and inter-linkages between market, institutions, and across international borders are growing. In addition, informal credit markets, conglomerate structures, and off-balance sheet activities are on the rise...

'If several of these risks were to occur at the same time...the banking system, could be severely impacted.'

Put simply, loans from government-controlled banks have allowed China to temporarily suspend the laws of capitalism.

This has created two huge problems for China

I say temporarily for a very good reason. At some point in the last three years, China's leaders realised this economic strategy was leading straight to a disaster. Specifically, it created two huge problems.
  1. The first was a banking system bloated with bad loans.
  2. The second problem was huge exposure to the US dollar.
Everything China has done since it realised its huge economic error has been designed to solve these two problems.

The original strategy worked quite well, for a while...

The banking system provided these companies with cheap loans. And China's State Owned Enterprises used these funds to create employment, as per the government's directive.

Now many of China's biggest firms are haemorrhaging money. For example:
  • China's Ministry of Railways lost 7 billion yuan in the first quarter of 2012, according to a ministry financial statement released on 2nd May.

  • The once thriving shipyard industry along the Yangtze River is sinking fast. 'We haven't received a new order in 2012, and we had only four orders for ships last year,' says Chen Junfu, Chairman of Jiangshu Jiuzhou Shipyard Co. Ltd.

  • In fact, according to the World Bank, one in four of China's state-run firms lose money. Yet they get preferential treatment by state owned banks (that's all of them), even when they're in financial distress.
In short, years of loaning huge sums to loss-making firms has finally caught up with China.

Add up all the local government debt — mostly loans made by Chinese banks to governments for infrastructure projects — and you have one of the most fragile and vulnerable financial systems in the world.

As the New York Times reported last year, this 'could set off a wave of loan defaults and hobble [China's] banking system.'

According to Zerohedge if there are enough defaults, many lenders could exit the market...

'This could result in a credit contraction in the economy which may lead to incomplete projects, fire sale of assets by developers, depressed property/land prices, stress on bank balance sheets and ultimately a possible capital flight as investors/depositors lose confidence in the banking system...'

Forget Greece, Ireland, Italy and Spain. China's banking system is a ticking time bomb. It's sitting on enormous sums of huge non-performing loans.

A recent Reuters article highlighted the problem:

'A senior Chinese banking executive has warned against the proliferation of off-book wealth management products, comparing some to a Ponzi scheme in a rare official acknowledgement of the risks they pose to the Chinese banking system.'

This threatens China's entire financial system and social stability.

What does it mean for you?

Read on and I'll explain...

Chapter Four:

Three Aussie Financial Landmines We're About to Stand On

I believe the biggest risks from a big China slowdown will manifest in three specific Australian sectors:
  1. Resources and mining
  2. Residential property
  3. And the Aussie banking sector
All these sectors are vulnerable right now.

Why? Well one of the things that helps push asset prices higher is income growth. Higher incomes support rising debt levels.

Now, keep that in mind as we look at China's influence on Australia's national income. Over the past decade, China's growth has had a huge impact on Australia.

That impact comes through the 'Terms of Trade'. The chart below shows Australia's Terms of Trade as of October 2012.

They're at the beginning of what could be a major long term correction.

Australia's Terms of Trade as of October 2012

Simply put, the terms of trade measure the price of Australia's exports relative to the price of its imports.

When it's rising, it means we can buy a greater amount of imports with the proceeds of a given level of exports.

Iron ore and metallurgical coal prices, both crucial inputs into the steel-making process, are the driving force behind the parabolic rise you see in the chart...especially since late 2008.

It's all because of China's fixed asset investment boom.

Building more apartments, cities, railways and roads than are really required soaks up a huge amount of steel, which in turn soaks up a huge amount of iron ore and coal.

If China's investment boom is unsustainable, then so is the demand for — and prices of — Australia's bulk commodities.

In 2008 the terms of trade spiked up, but then pulled back sharply as the global credit crisis kicked in.

Instead of stabilising, the terms of trade quickly reversed its falls, following the Chinese government's ordering of the banks to lend.

The stimulus was so great the terms of trade soared past the 2008 highs.

As you can see from the chart, the latest move has been parabolic. But now it's started to fall.

Where does that leave us now?

What this means for Aussie interest
rates and the stock market

We're already seeing evidence of a sharp slowdown in China during 2012.

Commodity prices have tanked across the board. Many companies have abandoned marginal projects. Smaller companies can't raise capital. And consider the performance of BHP and Rio. Their share prices are trading around levels last seen in 2009.

China's continuing slowdown will have an ongoing effect on commodity prices and our terms of trade.

As a result, Real Gross Domestic Income (GDI) growth (a proxy for a country's national income) could turn negative, taking interest rates down even lower.

You may think falling interest rates are good news. That's the way the media will portray it. But lower rates were not good news in 2008 and they won't be in the next few years either.

If I'm right about China's current vulnerability, Australia's national income as measured by Real GDI will fall.

In other words, the falling terms of trade is about to give Australia a pay-cut.

Given the household sector's huge debt load (around 105% of GDP) this will have far-reaching effects.

That's because income — whether at an individual or national level — is needed to service debt. When your income falls, it's harder to keep up with debt repayments. If this happens, bad debts in the banking system will begin to rise.

Lower interest rates are an attempt to offset the fall in national income.

While such a policy response will certainly help, it won't help those who lose their jobs (income) from the coming downturn.

Still, the general consensus is that even if China does get into economic difficulty, the central government will be able to 'do something'.

This is no different from the faith investors had in the US Fed Reserve Bank as the US housing bubble was popping in 2007.

Everyone thought the Fed would 'contain' the problem.

They didn't. They couldn't.

And neither will China's central planners be able to contain China's emerging problems.

As China's investment bubble pops, its banking system will hold huge amounts of bad debts.

The banking system is largely state owned, so the state will effectively absorb those debts via a bailout.

This won't be pain free.

Any bailout will effectively be subsidised by the household sector — everyday, working Chinese families. Well the Chinese families have been subsidising exports and investments for years (which is why domestic consumption as a share of GDP is so small) and they're about to get screwed again.

It will be interesting to see what that does to China's 'social harmony', because at the same time many people will be hurting from falling property values.

Remember, Beijing's key motivation is social stability.

When the Global Financial Crisis kicked off in 2008 that stability was threatened.

Faced with a collapsing export market, China's leaders ordered their banks to local governments, to the big State-Owned Enterprises, to property developers.

Essentially, it created its own boom to replace the US consumption boom.

The result is a banking system rife with bad loans

If you add up all of China's debt — existing central government debt, local government debt, Ministry of Railway debt, etc. — some observers reckon China's debt-to-GDP ratio could be as high as 80%.

That's dangerously high for a developing nation.

But still, doesn't China own trillions of US dollars saved in reserve?

Yes. They do. In fact, that's what most people point to when they talk about China...their $3.73 trillion in foreign currency reserves.

Mainstream pundits talk about this pile of money as if it's an asset.

But it's not. It's debt.

Do you think China would be able to swap their US Treasury debt for actual US assets? Or sell those assets to bail out its banking sector?

Not a chance.

And this is the crucial thing you need to understand.

In reality, the US owes more to the Chinese than they can ever hope to repay...and the Chinese have nothing more than a pile of IOUs they can neither get rid of, nor cash-in.

In short, China is screwed. It knows it too. And this means...

China's old 'fixed investment' growth model is dead

Now China finds itself with high debt levels, a hopelessly unbalanced economy and a fragile financial system (the big state-owned banks have huge bad debts — as yet unacknowledged — due to the credit boom).

China's household sector is 'financially repressed' too. That's a fancy way of saying the interest rate on deposits is below the rate of inflation. And there's nothing savers can do about it.

Capital controls, which restrict the flow of domestic currency, trap savings inside the banking system. These controls provide banks with a cheap source of funding, which they lend out freely to other state-owned companies for the purposes of employment and investment.

The concept of risk doesn't get a look in.

Everything is done with a view to maintaining a 'harmonious society'.

Therefore, much of the investment is uneconomic. That's why, despite the biggest credit boom in China's history, economic growth is slowing and the Chinese stock market continues to languish.

The irony is that Chinese households, via the policy of financial repression, subsidise this retarded economic structure. That is, to keep the social mood subdued, 'society' foots the bill.

And it's why you shouldn't expect the Chinese economy to magically rebalance from investment to consumption.

Thanks to the wasteful policies of the Communist Party, Chinese households are not as flush with cash as you think.

So what can China do about its various problems?

How can it reduce its dependence on Western consumption and maintain growth in the face of high debt levels and a fragile financial system?

The answer is: It can't.

China's going to go through several lean years as its economy adjusts and rebalances.

But it CAN mitigate some of the fallout. It can ensure the foundation of its economic structure remains intact.

In fact, China's been working toward this for a few years...but no one has really noticed...

Chapter Five:

China's 'Golden Endgame'

There is an old saying — origin unknown — that says, 'He who has the gold, makes the rules.'

It's known as The Golden Rule.

China knows this, and has a grand plan to support its fragile economy and untangle itself from the Western banking system (and US dollar dominance) by carefully and quietly accumulating a huge gold hoard.

Sound like a stretch? Stick with me. If you follow the story to the end it all makes perfect sense.

That's why China is buying up as much of the world's gold as it can without giving the impression it is doing so. It wants to make the rules and not be at the mercy of the US-dollar-based banking system.

I'll discuss just what 'rules' China is considering in a moment. But first, you need to understand what China is doing to accumulate gold.

Consider these facts:

China has invested heavily in gold production over the years. In 2007, it became the world's largest producer of gold — it has maintained that position ever since and in 2011 produced 355 tonnes of gold, ahead of second placed Australia, which produced 270 tonnes.

But China's production does not make it into the gold market. It is hoarded instead.

China does not allow its domestically produced gold to be exported.

So the world's largest gold producer does not add an ounce of new supply to the market.

Does that not sound strange to you?

And despite being the world's largest gold producer, China imports an increasing amount of gold too.

According to the World Gold Council, China's gold demand in 2011 was 770 tonnes, more than double its domestic output.

So where is all that gold going?

Chinese citizens are encouraged
to hoard gold too — but why?

Clearly the Chinese population is accumulating gold too.

In 2009, China's state-owned TV network broadcast ads encouraging citizens to buy gold (and silver). In contrast, advertisements in Australia (and I guess other Western countries) encourage you to sell your gold for paper money so you can 'buy things'.

Why would the Chinese government tell its people to buy precious metals when Western central bankers consider these metals a 'barbarous relic'?

The answer will become more than apparent as our story reaches its conclusion.

The Chinese are playing a long and patient game in the precious metals market...while the West focuses on discrediting gold and silver and continually kicking the can down the road.

While China exhorts its citizens to accumulate precious metals, the actions of the government itself are shrouded in secrecy.

China's last announcement on its official gold holdings was in April 2009, when it announced a near doubling of its reserves to 1054 tonnes. That was the first announcement on gold reserves since late 2002.

With China absorbing all its domestic production and more, you can bet its gold reserves are much higher than 1054 tonnes. But don't expect a reserve update anytime soon. Doing so would move the price big time. China would lose the advantage of being able to buy cheaply.

China, Gold and Gresham's Law

You see, China knows the Western banking system manipulates the price of gold.

It knows that gold is 'on sale'.

Consider this statement, made in 2009 in the Chinese language World News Journal and passed on from the US Embassy in Beijing to the US State Department in Washington. Wikileaks revealed the cable last year (emphasis added is my own):

'According to China's National Foreign Exchanges Administration China's gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the U.S. and European countries. The U.S. and Europe have always suppressed the rising price of gold.

They intend to weaken gold's function as an international reserve currency. They don't want to see other countries turning to gold reserves instead of the U.S. dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar's role as the international reserve currency.

China's increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.'

Wikileaks supplied another cable sent to the State Department from Beijing in February 2010.

It reveals commentary from Chinese media and is very telling (again, emphasis mine):

'China must be clear on discovering what the U.S. goals are behind its tough stances against China. In fact, a fierce competition between the currencies of big countries has just started. A crucial move for the U.S. is to shift its crisis to other countries -- by coercing China to buy U.S. treasury bonds with foreign exchange reserves and doing everything possible to prevent China's foreign reserve from buying gold.

The nature of such behavior is a rogue lawyer's behavior of 'ripping off both sides': taking advantage of cross-strait divergences, blackmailing the Taiwan people's wealth by selling arms to Taiwan, and meanwhile coercing China to buy U.S. treasury bonds with foreign exchange reserves and extorting wealth from the mainland's people.

If we [China] use all of our foreign exchange reserves to buy U.S. Treasury bonds, then when someday the U.S. Federal Reserve suddenly announces that the original 10 old U.S. dollars are now worth only one new U.S. dollar and the new U.S. dollar is pegged to gold, we will be dumbfounded. Today when the United States is determined to beggar thy neighbor, shifting its crisis to China, the Chinese must be very clear what the key to victory is. It is by no means to use new foreign exchange reserves to buy U.S. Treasury bonds.'

The mainstream press does not report on these issues. They are too big and too controversial. But make no mistake — this is the financial war going on in the background between great powers. China and the US know the power of gold. It is the 'key to victory'.

Although not reported in the mainstream press, it is common knowledge in the gold watching community that gold and silver prices are 'managed'.

It would be another subject entirely to explain the complexities of how this is done. But believe me, the Chinese know it is happening.

Gold price manipulation can only exist as long as there is an adequate supply of gold within the Western banking system. Through the use of derivatives and futures, the physical gold within the banking system has multiple owners. And each owner thinks they are the sole owner.

So there are multiple claims on the same ounce of gold, meaning the Western bullion banks 'create' a paper supply of gold to satisfy rising demand. Without this paper supply, the price of physical gold would be many times higher.

China knows this, and appears content to be the marginal buyer of additional mine supply. While prices remain cheap, it will continue to buy whatever it can get without pushing prices up too much.

This is the process of gold (and silver) moving from weak hands to strong hands. It's Gresham's Law in action...a process whereby bad money drives out the good.

Those holders of the good money (the precious metals) hoard it until market prices reflect its true value.
What is true value?

The answer to that question comes at the end of our story...and we're getting close to the end.

But there are a few other pieces of the puzzle that need to click into place before we consider China's grand monetary strategy.

China's financial attack on the West

China has spent the past few years setting up bilateral trading arrangments with many of its trading partners.

Its aim is to promote the yuan as a trade settlement currency. That is, China wants its trade finance denominated in yuan, not US dollars.

Achieving this goal would reduce its reliance on the Western banking system...and reduce the dominance of the US dollar.

Let me make it clear — China doesn't want to have the world's reserve currency. With a closed capital market and a small and poorly functioning bond market, it couldn't achieve that aim even if it wanted to. The greatest strength of a reserve asset is strength and liquidity.

The yuan cannot offer that just yet. But with China on the way to accumulating significant amounts of gold, it's positioning its currency to do so. That's because gold provides strength and liquidity. Owning the gold allows China to make the rules.

Think about what China is doing here.

Instead of trying to create a debt-based reserve currency like the US, it's attempting to build a trade-based currency backed by gold.

If China can achieve this, over the next decade or two the world's financial system will morph from a US dollar standard — based entirely on debt — to one characterised by trading bloc currencies backed by gold.

Could we see gold at $5,000 an ounce?

We are nearly at the end of our story.

But there's one final piece to fit in before you can view the puzzle that is China and gold.

I've showed you how the overriding aim of China's leadership is to maintain social does this at the expense of economic profits and sensible economic management. It does this purely for self-preservation purposes.

I've explained how China plans to gain economic power and re-write the rules of global finance by accumulating gold at bargain prices. But that's only part of the plan.

The final step for China — once it has accumulated sufficient gold — is to force a large upward revaluation in the gold price and affect a global transfer of wealth on a scale never seen before.

My theory is that in the next five years China will announce updated gold reserves — probably in the vicinity of 5,000 tonnes or more, making it the second largest official owner of gold in the world.

This will send the price of gold soaring, and all attempts by the West to hold prices down will prove futile.

China will probably make this announcement on a weekend. By the time trading resumes, the gold price will have 'gapped up'. My guess is that US$5,000 an ounce is entirely possible.

Such a revaluation would put the size of the gold market on par with the size of the US debt market.

This move would be devastating for the US dollar.

US Treasury yields would absolutely soar.

In effect, wealth would instantly transfer from bondholders to gold holders. That would neutralise (to a large extent) the losses China would incur on its Foreign Currency (FX) reserves. But one way or another, they'll get screwed on those holdings anyway.

The revaluation would also come with the added bonus of creating wealth for all the Chinese citizens who took their benevolent party's advice and accumulated gold and silver.

This would offset the public outrage resulting from the loss on their FX reserves, basically the savings of the Chinese people. If China plays it right, it might just manage to maintain a harmonious society and change the rules of the game to its benefit.

Look, this is a big picture idea. They don't get much bigger.

But the whole reason for having a strong position in precious metals is precisely because of these big picture forces. And even if I'm wrong about China's revaluation plans, the fundamentals for gold remain strong.

There are major undercurrents in the global economy...flowing deep beneath the surface of the day-to-day market noise.

I believe there are a number of moves you should be making right now to help protect your wealth — and profit — from this trend...

Chapter Six:

An Investment Strategy for
a New World Order

The fact is, China's economy is going through a painful readjustment.

It's been built on the manipulation of a government hell-bent on staying in power at any cost.

Beijing won't let China go completely broke, though. There's too much at stake.
  • They have already set in motion a grand plan to rescue their dangerously indebted banks...and hopelessly warped economy.

  • The effects of this plan will severely disrupt the balance of global financial power.

  • It will be dire news for the Australian economy.
We benefitted greatly from China's old model of growth...

For the last 10 years our stocks have gone up, our currency has stayed strong, our house prices have tripled and our wages have risen.

I hope you took advantage of the big China-led boom...and cleaned up.

But now the big trend has changed, and that means your investments need to change too.

So what should you do?

There are a few options you can take to both protect your wealth and also ride the bull market in gold.

The first and most obvious thing is to buy gold and, to a lesser extent, silver bullion.

This is a very low risk way to preserve your wealth. In fact, I recently published a guide to show you everything you need to know about buying physical gold.

It's called Buying Bullion.

This six-page report explains how and where you can get the best deal on acquiring and storing physical gold and silver.

It's yours with my compliments if you'd like to give my newsletter Sound Money. Sound Investments. a try for the next 60 days.

You may think gold fluctuates in price but, as you'll see in this report, in reality it is the price of paper currencies that move around.

Gold represents stability.

But while I think physical gold provides the opportunity for big gains in the years to come, it's the gold stocks that provide the potential for the biggest gains.

That's especially the case now.

Relative to the gold price, gold stocks are selling at their lowest levels in many, many years.

The sell-off over the past 12 months has been savage. Although the bottom is now in, and for the past few months gold stocks have made some good early gains.

This is where the opportunity lies

I've been helping investors take advantage of this opportunity through my newsletter Sound Money. Sound Investments.

And I'd be delighted to help you too.

I'd like to invite you to take a look at my strategy and research in more detail...and take a trial membership of my newsletter over the next two months — obligation free.

As soon as you do, you get access to my complete research report on the unfolding China Bust: Red Alert: What You Must Do To Survive and Prosper in the Coming China Crash.

In this report I reveal the detailed action I believe you need to take right now.

You see, owning bullion is just one part of the strategy you'll need to steer a path through this China-led crisis.

There are other ways to protect your wealth that could open you up to the kinds of returns you only see in bull markets.

Be clear: we are not in a bull market now.

But gold certainly is.

And if I'm right about China's new strategy — which I'm certain I am — gold's going higher still...maybe as far as $5,000 an ounce, or even higher.

That doesn't mean all gold stocks are good buys.

But there are a few select Aussie gold producers that I believe are showing huge value right now...and should steadily benefit as this story plays out.

If you can handle volatility, you may be in for some big gains.

Some could be potential '10-baggers'. For example:
  • One of these companies is already a highly profitable gold producer with a strong growth profile. It operates two mining centres in Western Australia. Following a recent plant expansion, one of those sites is on track to produce more than 150,000 ounces in 2013, up from around 100,000 ounces in 2012.

  • Another is a gold miner with exciting growth prospects. I consider it higher risk because the company still needs to complete feasibility studies to bring those growth plans to fruition. But it currently has steady production of around 120,000 ounces, mostly from open pit sources. Right now it's developing a number of underground prospects in the same region in WA that should add to production and profitability in the years ahead. So far, the drilling and development news has been very encouraging, and I see no reason why it won't achieve its goals.

  • A third recently moved from developer to producer and is currently in the 'commissioning phase'. That's generally the highest risk phase for any miner, as early production problems tends to surface. And this firm has suffered from a few commissioning setbacks. Right now the market clearly doesn't think the company will achieve its target. And that's fair enough, given the setbacks so far. But I believe this company's fortunes could change — you'll see why in the report. It's very cheap at these levels.
I'd be delighted to send you the full details of these stocks and more.

Remember there's no commitment whatsoever.

You'll have the next 60 days to review every aspect of my research...and try my service out.

If you are not happy with anything for any reason...just let me know in that time and you'll receive a full refund for every cent of your subscription, and we'll part as friends.

To read about what I do in Sound Money. Sound Investments. and what it could for you for you in the months and years ahead, simply click here.

I hope you enjoyed this report.


Greg Canavan signature
Greg Canavan
Sound Money. Sound Investments.

Greg Canavan
About the author:

GREG CANAVAN is the foremost authority for retail investors on value investing in Australia. He's the former head of Australasian Research for a major asset-management group and a regular guest on CNBC, Sky Business's 'The Perrett Report' and Lateline Business. Greg shares his insight, ideas and investment recommendations with readers of his Sound Money. Sound Investments. newsletter. He also helms The Daily Reckoning twice a week.

Calculating Your Future Returns: The value of any investment and the income derived from it can go down as well as up. Never invest more than you can afford to lose and keep in mind the ultimate risk is that you can lose whatever you've invested. While useful for detecting patterns the past is not a guide to future performance. Some figures contained in this report are forecasts and may not be a reliable indicator of future results. All advice is general advice and has not taken into account your personal circumstances. Please seek independent financial advice regarding your own situation, or if in doubt about the suitability of an investment. All figures accurate as of 18th October 2012.

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