SHOCKING BREAKDOWN OF CHINA’S FOREIGN RESERVES  By John Lee, CFA
Highlight includes:
Only less than half of China’s foreign-exchange reserves are liquid i.e. in the form of Treasury notes, cash, and gold.
China’s possible net capital flight is in excess of $800 billion in 2015, liquid reserves could be depleted sometime in 2017, which could spell market uncertainty ahead.
Watch for the pace of gold’s bullish trend and the RMB’s bearish trend to accelerate.
Gold and silver are both trading highest since January 2015

I want to focus on the composition of China’s foreign reserves, explain why the liquid portion of the reserves may be much smaller than widely believed, and how that situation is bearish for RMB and bullish for gold.

According to Wikipedia:

“The foreign-exchange reserves of China are the People’s Republic of China holdings of cash, bank deposits, bonds, and other financial assets denominated in currencies other than China’s national currency (renminbi). At the end of January 2016, the foreign-exchange reserves of China stood at US$3.23 trillion. The management of foreign-exchange reserves is governed by the State Administration of Foreign Exchange and the People’s Bank of China. The composition of foreign-exchange reserves is a state secret in China 1

1 https://en.wikipedia.org/wiki/Foreign_exchange_reserves_of_China

We managed to retrieve the following financial data from the China State Administration of Foreign Exchange (SAFE) website (www.safe.gov.cn):

???????2016.01 2016.05?
Official reserve assets

?? Item 2016.01 2016.02 2016.03 2016.04 2016.05
???
100million
USD
???
100million
USD
???
100million
USD
???
100million
USD
???
100million
USD
1.????
Foreign currency reserves
32308.93 32023.21 32125.79 32196.68 31917.36
2.????????
IMF reserve position
37.60 107.25 107.24 106.51 104.22
3.?????
SDRs
102.73 102.80 104.85 105.48 104.41
4.??
Gold
635.70 710.06 714.85 747.51 704.75
5.??????
Other reserve assets
-2.05 -3.30 1.72 5.16 5.71
     ??
Total
33082.92 32940.02 33054.45 33161.35 32836.43

??????????????
Template on International Reserves and Foreign Currency Liquidity

2016?4?30?
As at Apr 30 2016

???????????????????????
I. Official reserve assets and other foreign currency assets (Approximate market value)

?????
100million USD
A. ??????
Official reserve assets
33,161.35
     ?1? ???????????
Foreign currency reserves (in convertible foreign currencies)
32,196.68
          ?a???
Securities
32,028.18
                    ??????????????????????
of which: issuer headquartered in reporting country but located abroad
          ?b?????????????????
Total currency and deposits with:
168.50
               ?i??????????????????????
other national central banks, BIS and IMF
25.66
               ?ii???????????
banks headquartered in the reporting country
72.30
               ?iii?????????????
banks headquartered outside the reporting country
70.54
                    ??????????????
of which: located in the reporting country
70.54
     ?2? ????????
IMF reserve position
106.51
     ?3? ?????
SDRs
105.48
     ?4? ?????????????????????
Gold (including gold deposits and, if appropriate, gold swapped)
747.51
                    ????????????????
volume in millions of fine troy ounces
     ?5? ?????? ?????
Other reserve assets (specify)
5.16
                    ??????
financial derivatives
5.16
                    ????????????
loans to nonbank nonresidents
                    ??
other
B. ?????? ?????
Other foreign currency assets (specify)
2,042.43
          ????????????
securities not included in official reserve assets
1,967.70
          ????????????
deposits not included in official reserve assets
          ????????????
loans not included in official reserve assets
70.22
          ????????????????
financial derivatives not included in official reserve assets
4.50
          ????????????
gold not included in official reserve assets
          ??
other

As expected, this disclosure didn’t say a whole lot, as 97% of the reserves assets fall into category A(1) — “Foreign currency reserves (in convertible foreign currencies)”. Furthermore, 99% of category A(1) falls into the A(1)(a) “Securities” category.

So what’s in the “Securities” category?

The following article published September 2, 2015 in Nikkei Asian Review entitled “Does China really have $3.6tn in foreign reserves?” reported:

“Funds available for foreign currency purchases declined because the authorities had to sell Treasurys to meet demand for dollars and other foreign currencies associated with capital flight. ‘The PBOC has sold at least $106 billion of reserve assets in the last two weeks, including Treasurys, according to an estimate from Societe Generale,’ U.S. wire service Bloomberg reported Aug. 27.

According to data from the U.S. Treasury Department, China’s Treasury holdings — $1.82 trillion — were only about 45% of its total foreign reserves…

China invests some of that money in Euro bonds, Japanese government bonds and Japanese, U.S. and European stocks, but ‘it is unknown how China manages at least $1 trillion of foreign reserves,’ said a veteran market economist.” 2

2 Y.Takita, “Does China really have $3.6tn in foreign reserves?” Nikkei Asian Review (2 September 2015).

Through the US Treasury Department’s website ( https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx), I was able to plot the following:

China’s US Treasury holdings (in US$ Billions)

It’s clear China’s US Treasury holdings have held steady between US$1.2 and $1.4 trillion during 2010 to 2016, and likely comprise the single most significant portion of the category A(1)(a) “Securities”.

And what about the other US$2 trillion under “Securities”?

Based on publicly available information, the answer led us to China Investment Corporation (CIC), which is a sovereign wealth fund responsible for managing part of the People’s Republic of China’s foreign exchange reserves. CIC was established in 2007 with approximately US$200 billion worth of assets under management. 3 At the end of 2014, the CIC had over US$740 billion in assets under management.4 CIC’s holdings increased from US$200 billion in 2007 to over US$740 billion by means of capital gains, income gains or additional cash/asset injections by the People’s Bank of China/SAFE. If we assume CIC’s assets stay at US$740 billion today (although they are likely to have increased, as they have every year since 2007), they will make up over 23% of China’s total foreign reserves holdings in 2016.

3 https://en.wikipedia.org/wiki/China_Investment_Corporation.
4 China Investment Corporation Profile. Sovereign Wealth Fund Institute. July 2, 2008. Retrieved August 27, 2013.

Adding up the numbers, this leaves us with roughly US$1.2 trillion worth of unexplained assets remaining under “Securities”.

To answer the question of what these “Securities” are, we have to first examine what’s held in CIC, then we will come back to where we think the remainder of the “Securities” went, as I believe through my research, that those two issues are interlinked.

What makes up CIC’s fund?

We retrieved the following financial information from CIC’s latest annual report from its website, (http://www.china-inv.cn/):



The composition of the above 2014 Global Investment Portfolio Distribution pie chart is, I assume, a breakdown of the “Financial assets” under the balance sheet (i.e. 2014: US$225,321 million).

How about “Long-term equity investments” under the balance sheet (i.e. 2014: US$489,147 million)? This investment grew from US$171 billion to $489 billion in 2014, consistently generated 15% to 20% annual investment income, and is what drove CIC’s meteoric rise in

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