To those following the stealthy Chinese incursion into currency markets as a dollar alternative, this is not news: already we know that China and Japan have bypassed the dollar entirely and now engage in direct bilateral trade using JPY and CNY (even as most other nations in Asia have developed bilateral agreements to transact in a non dollar basis). This is merely the latest incremental step which will see China become the dominant player in the currency arena, and further puts to doubt the fate of the US Dollar as the default currency. Of course, the market will not acknowledge any of this until the developing (i.e., non-insolvent world) is transacting entirely with US intermediation. And at that point, the US will be merely another Zimbabwe case study, where it can print all the money it wants to fund its deficit, and the only ones who care will be wheelbarrow manufacturers.

From the FT:

The China Development Bank will sign a memorandum of understanding in New Delhi with its Brazilian, Russian, Indian and South African counterparts on March 29, say people familiar with their talks. Under the agreement CDB, which lends mainly in dollars overseas, will make renminbi loans available, while the other Brics nations? development banks will also extend loans denominated in their respective currencies.

The initiative aims to boost trade between the five nations and promote use of the renminbi, rather than US dollar, for international trade and cross-border lending. Under 13 per cent of China?s Asia trade is transacted in renminbi, according to Helen Qiao, chief Asia economist for Morgan Stanley. HSBC estimates that the currency?s share of regional trade could swell to up to 50 per cent by 2015.

BNDES, Brazil?s development bank with a loan book about four times the size of that of the World Bank, and South Africa?s finance ministry said they expected a master agreement to be signed in New Delhi that would include the lending pledge, with details to be ironed out during a summit. ?We will discuss the creation of structures and mechanisms for lending in local currencies in order to maximise economic and financial transactions between the countries that are members of the accord,? BNDES said.

CDB declined to comment. Other signatories will include Russia?s Vnesheconombank, Export-Import Bank of India and the Development Bank of Southern Africa.

Next up, China announces that it was only kidding about its gold holdings, which suddenly are reported to have doubled or tripled, and the trap will be officially sprung.

Last month, China’s “Fort Knox” got several million ounces bigger…

On February 24, Venezuela announced Citic ? the Chinese state investment company ? would help develop Las Cristinas, the largest undeveloped gold deposit in South America and a classic “trophy” asset.

Las Cristinas contains at least 16.9 million ounces of gold. (And that calculation is based on a $550 per ounce gold price… At today’s $1,700 an ounce price, its reserves should be much greater.) And it will be a simple, giant open-pit mine. The capital cost will be just $356 million. So once the trucks start hauling off its ore, Las Cristinas will be wildly profitable…

It’s exactly the kind of gold deposit China wants to bolster its gold holdings. The deposit used to belong to a Canadian mining company, Crystallex. With the prized Las Cristinas at the center of its portfolio of assets in 2007, the $1.2 billion company looked like a company on the rise…

But then Venezuela’s strongman president, Hugo Chavez, decided he had other plans for the resource. Suddenly, Crystallex’s environmental permit application had mysterious problems. The government blocked the development of Las Cristinas and dragged the process out over years.

Finally, in February 2011, the Venezuelan government canceled Crystallex’s contract. Chavez literally confiscated the gold deposit without explanation. Crystallex’s market value fell to $23 million. It shut its doors for good, delisting from the Toronto Stock Exchange before the year ended.

And look who Chavez brought in to develop the project…

Chavez and the Chinese go way back… China lent Venezuela more than $30 billion in 2007 to develop oil projects. And it became officially involved in Las Cristinas in June 2010, when Crystallex announced a deal with China Railway Resources Group to “help” the company develop the project.

Last month, Chavez handed the Chinese exactly the kind of trophy asset the Chinese are scouring the world to find. What’s happening to Las Cristinas is just another chapter in the big story we introduced last month…

China is engaged in a huge, shadowy program to accumulate as much of the world’s gold supply as it can. This “gold grab” has provided a huge source of buying support for physical gold… and made China the No. 1 gold-producing country in the world, as well as one of the largest shoppers for the world’s best gold deposits. This month, we’ll look into a great value play in this story…

China Picks Up Another Asset in its Gold Binge

China is trading its dollars for gold as fast as it can. (It owns fewer Treasurys now than it did a year ago.) Bullion, individual gold mines, or entire companies… it doesn’t matter. China wants gold in massive volumes…

You see… over the last 30 years, China’s overwhelming success selling its exports to the world has resulted in a massive foreign currency reserve, equal to about $3.2 trillion… Roughly half of that is in U.S. government bonds… But the United States’ policy of printing endless new dollars to pay off its mountainous debts has created a problem for China.

If China hangs on to those bonds… it could see their value “inflated away.” But if it tries to dump those bonds, it would flood the market. And the value of its bonds would collapse… So instead, China is trying to secure the value of its reserves against inflation by buying gold. The country has official gold reserves of 33.9 million ounces. But it plans to get more…

But part of China’s strategy is to comb the globe for world-class gold deposits it can buy for cheap. We saw it in action in November 2011, when the government-owned Chinese gold company Shandong Gold Group bought gold company Jaguar Mining for $1 billion. And we saw it again with Las Cristinas.

China’s concerted effort to acquire valuable gold properties around the world will increase the value of many mining companies… whether or not they are targeted directly by the Chinese. To take advantage of the trend, we want to own world-class, trophy gold deposits now.

Is it worse to be the conman or the dupe?

The United States has racked up more than $15 trillion in debt… Our government’s debt is almost certain to exceed the U.S.’ annual gross domestic product (GDP) in 2012. And in the last 100 years, no government that accumulated debts exceeding 80% of GDP has ever repaid those obligations in sound money.

Add to that the personal debt (credit cards, car loans, etc.), state and local government debt, and corporate debts… and America’s total debt comes to about $56 trillion. The GDP of the entire world is only $64 trillion. So what the U.S. owes represents nearly 90% of the entire world’s GDP.

Surely, no one can imagine the U.S. will pay off its debts honestly and fairly… We can’t. It would take generations to work off those debts, and our political climate has no tolerance for the hopeless economic stagnation that would represent.

No, our choices are outright default or creating colossal sums of money and inflating the debts away.

That’s the con… By severing the dollar’s tie to gold and borrowing seemingly infinite amount of money over the past 40 years… the U.S. government is now about to leave its creditors around the globe in the lurch.

The predicament will inflict severe consequences on the U.S. and its citizens’ standard of living… but it also leaves our creditors in a Catch-22… They could insist on repayment in some kind of sound money… and essentially force a default. That would leave them with staggering losses to their treasuries. Or they can stand by as we devalue the dollar and repay them in near-worthless dollars.

It’s a bind… But one of our creditors ? the Chinese, who currently hold about $1.5 trillion in U.S. debt ? has other ideas. They don’t intend to be anyone’s patsy…

China’s $3.2 Trillion Crisis

China has a huge, $3.2 trillion problem.

Over the last 30 years, China built a massive economy on its exports. Its companies sell cheap goods to developed economies like the U.S. and Europe. From 1980 to today, China’s foreign currency reserves have swollen from $2.5 billion to $3.2 trillion… Now, China has to figure out what to do with all that cash.

Initially, China bought U.S. government bonds… about $1.5 trillion worth. Now, the U.S. dollar is trying to inflate away those debts. So now, China faces a huge problem. As economist John Maynard Keynes famously said, “If I owe you a pound, I have a problem. If I owe you a million [pounds], the problem is yours.”

If China hangs on to those bonds… it could see their value greatly “inflated away.” But if China tries to dump those bonds, it would flood the market. And the value of its bonds would collapse…

Instead, China plans to “safeguard” the value of those reserves against inflation. That means one thing… buying gold. The country has official gold reserves of 33.9 million ounces. But it plans to get more…

It’s an initiative we’ve dubbed “China’s Fort Knox,” after America’s iconic gold storehouse. For generations, the U.S. backed its dollar with gold. The so-called “gold standard” required the nation to keep immense amounts of gold in reserve. By 1971, when President Nixon ended the dollar’s last tie to gold, America owned the largest government hoard of gold in the world. (And we still do). The bulk of it was kept in Ft. Knox in Kentucky.

Now, China wants to do essentially the same thing… More than simply hedging its reserves against U.S. dollar inflation… It’s clear China has set in motion a plan to accumulate so much gold that it will be able to restore the convertibility of its currency into gold…

An editorial released by China’s official Xinhua said as much. Published in August 2011, in the wake of the credit-ratings agency Standard and Poor’s downgrading the U.S.’ credit, Xinhua stated (emphasis added), “International supervision over the issue of U.S. dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country.”

Remember… China has spent many of the past 30 centuries as the world’s largest and most powerful economy. But around the time Europe began “stretching its legs out” and building overseas empires in the 17th century, China started a long decline. It suffered humiliating military defeats in the mid-1800s… which resulted in European occupation and the seizure of one of its most prized harbors, Hong Kong. (Imagine how Americans would feel if a foreign country seized Manhattan.)

In the 20th century, China suffered further humiliations and defeats from Japan. It spent the decades after World War II mired in communist hell. Much of the country’s wealth, including its gold, was plundered during these years.

But in the early 1980s, the Chinese government began freeing up the economy. Since then, the resurgence of China is one of the greatest economic growth stories in history. It’s returning to power.

But to join the ranks of the world’s elite powers, China knows it needs a strong currency (its money is called either the “yuan” or the “renminbi”)… one backed by huge amounts of gold. This is why China “fast tracked” its gold industry and became the world’s largest producer. It’s why it has bought massive amounts of physical gold over the past decade. It’s why it’s getting interested in overseas gold deposits.

And the iconic financial historian Richard Russell wrote recently: “China wants the renminbi to be backed with a huge percentage of gold, thereby making the renminbi the world’s best and most trusted currency.”

Keep in mind… China making a play to boast the world’s reserve currency is no “fringe” idea. Just a few months ago, the idea was the cover story of the highly respected financial journal Barron’s.

It’s an amazing turn of events. China has spent much of the past 300 years being brutalized, humiliated, and looted. But the Dragon has risen. And it wants its gold back.

China’s Grand Gold Strategy

As part of its strategy for building its own Ft. Knox-like gold hoard… China is buying tremendous amounts of gold. Consider this… In the six years from 2003 to 2009, China increased its official gold holdings by 75% via secret purchases.

These purchases moved China into sixth position on the list of countries with the most gold reserves. Even with these giant purchases, China’s gold holdings represent less than 2% of its currency reserves (compared with the U.S. and Germany, which hold more than 70% of their reserves in gold).

Although China hasn’t disclosed any gold purchases since 2009. It surely has continued its purchasing. Just over a week ago, news outlet Bloomberg reported mainland China bought 3.6 million ounces of gold from Hong Kong over the past few months… that’s 483% more than during the same time the year before. The data come from the Census and Statistics Department of the Hong Kong government. The Chinese government does not make such information public.

So that’s one way China is amassing its hoard of gold… But it’s taking another simultaneously. China is trying to buy gold deposits in the ground. The Chinese government is quietly buying up all ? or several large ? stakes in many of the best gold-mining companies in the world.

And it’s this part of its strategy that we’re most interested in… It’s this part of the strategy that we can invest alongside to protect our wealth and profit as China tries to establish its renminbi as the world’s foremost currency… I believe investing now in the right gold stocks could yield triple-digit gains as China hits the world market to bid up the value of these stocks.

The Script for China’s Gold Buying Spree…

China doesn’t do things half-heartedly. When it wants something done, it goes “all-in.” It throws all of its considerable wealth at accomplishing its goal. Investors who know how to hitch a ride on one of these juggernauts can make a fortune.

This is particularly true in commodities and resources. We’ve seen the incredible influence China can wield when it decides to build its holdings of assets like copper, oil, uranium, coal, or iron ore. And now, China has set its sights on gold.

As China grew richer over the last two decades, it used large chunks of that wealth to acquire resource projects around the world. The reason is simple… China wants to control the flow of resources to the motherland.

Between 1992 and 2000, China’s foreign-exchange reserves rose from $20.6 billion to $165.6 billion. During that period, its investments in foreign resource assets stayed at $900 million per year all through the 1990s. (This represents the funds it spent either acquiring resource companies outright or buying large stakes in them.)

But starting in 2000… China broke out the checkbook. Its investment in global resources rose from $900 million in 2000 to $12.1 billion in 2005. And since 2005, the country has spent $443 billion on resource investments outside its borders, including $94 billion in 2011…

When China decides it needs a lot of a given resource, it follows a familiar script that goes like this…

• Consolidate the domestic industry.
• Dramatically increase imports.
• Go on a foreign-asset spending spree.

We’ve seen it repeated across the resource spectrum. In 1992, China’s oil consumption exceeded its domestic production for the first time. China’s government realized that its future growth would hinge on resources outside its borders.

To satisfy that need, it created some public companies to go out and acquire resources. Over the next nine years, Chinese oil companies crossed the globe… throwing money at valuable assets…

Consider the China National Offshore Oil (CNOOC). In 1999, the Chinese government allowed a 30% share of CNOOC to list on the New York Stock Exchange in 2001. It was worth $7.9 billion at that time.

We have data on its oil reserves back to 1998. At the start of that period, CNOOC had 1.74 billion barrels of oil equivalent (oil and gas together). By the end of 2010 (our most recent data), it had 2.99 billion barrels of oil equivalent.

That 72% reserve growth in 12 years is outstanding. To put it into perspective, ExxonMobil only grew its reserves by 20%. Petrobras, the Brazilian national oil company, made one of the largest offshore oil discoveries in history and only grew its reserves by 53%. CNOOC was exceptionally aggressive. Here’s what it did…

From 2009 to 2011, CNOOC made seven international acquisitions. Among them…

• CNOOC paid $2.1 billion last July for OPTI Canada… a company in Alberta, Canada generating petroleum from the region’s “tar sands.”
• It spent $525 million in June 2010 to acquire Devon Energy’s 25% interest in the Panyu oilfield out in the South China Sea.
• In May 2010, it put together a $3.1 billion deal to create a 50-50 joint venture with private South American energy investor Bridas Energy Holdings. The new company, called Bridas Corp., is a private independent energy exploration company focused on Argentina, Bolivia, and Chile.
• In 2010, CNOOC acquired a 33% stake in U.S. natural gas giant Chesapeake Energy’s Eagle Ford shale acreage in Southeast Texas.

Now, look at how China’s influence in a resource market can pay off for investors… In March 2011, copper prices were mired in a bear market. And shares of copper producers were slumping. Australian-listed Equinox Minerals, which owned Africa’s largest copper mine, Lumwana, was no exception. The copper producer closed at a six-month low on March 14 at C$4.84 a share.

However, on April 2, Minmetals Resources, a division of China’s largest metals trading company, offered C$7 per share for the company. That was a 45% premium from the recent low. But it gets better…

Rather than let Equinox get bought uncontested, gold miner Barrick Gold came up with a counteroffer and eventually bought the company for $8.10 per share. That represents a 67% premium to Equinox’s March 14 price in just six weeks.

Over the last five years, there are countless examples of Chinese government-owned companies buying up resources in copper, uranium, and iron ore. And now…

It’s Happening in Gold

On November 16, 2011, shares of a small gold company named Jaguar Mining skyrocketed 45% in a single day.

It was one of the most extraordinary gold stock moves of the year.

The reason for the surge was a “takeover” offer… That’s when another company, usually a larger one, offers to buy another company.

Takeovers, which cause fireworks like Jaguar’s 45% surge, are common in the stock market. But there was something usual about Jaguar’s takeover… something “sinister,” some folks might even say. As I write, this takeover offer is one of the most controversial topics in the gold industry…

You see, Jaguar is a U.S.-based company. It’s headquartered in the beautiful city of Concord, New Hampshire. But while Jaguar is based in the U.S., Jaguar’s mines are in Brazil.

The offer to buy Jaguar’s assets didn’t come from a larger gold company, like Barrick Gold or Newmont Mining. And it didn’t come from a Brazilian billionaire or the government there.

The takeover offer was extremely rich… And it came from the Chinese government.

According to Bloomberg, the $786 million offer (a 74% premium to Jaguar’s market value) is the highest premium ever offered in a cash takeover of a gold miner with more than $500 million in market cap.

As you can see, this story could help usher in a new era of gold stock gains… one I estimate could produce hundreds of percent returns for investors in the right place at the right time.

Jaguar Mining bills itself as the fastest-growing gold company in Brazil. It has three operating gold mines in the “Iron Quadrangle” mining district ? Turmalina, Paciencia, and Caete. These are just north of Rio de Janeiro in southeastern Brazil. The company has its fourth mine, Gurupi, under development.

In my opinion, Jaguar is a crappy little gold miner that struggled to turn a profit in 2011. The company owes $404 million in debt and has just $102 million in cash.

And yet, according Toronto’s Globe and Mail newspaper, the Chinese government-owned Shandong Gold Group has offered $1 billion ? about $9.30 per share in cash ? to take out the company. That represents a 74% premium to its closing price on November 15, the day before the news broke.

Shandong Gold Group is the parent company of China’s second-largest gold producer by market value, Shandong Gold Mining. Its offer for Jaguar represents the largest acquisition by a Chinese gold miner outside China.

Shandong can’t be interested in the company… because the company is terrible. It must be interested in the gold.

At $1 billion, Shandong agreed to pay $6,667 per ounce of gold production. On a reserve basis, it agreed to pay $235 per ounce of gold.

That’s the key to this investment… buying gold cheap. The business side doesn’t matter, because Shandong will change all that. What matters is Jaguar owns three gold mines Shandong can buy cheaply.

The Jaguar deal is like the starter pistol on a huge asset grab for China. The country is about to start scouring the globe for gold assets it can buy. A lot more of these deals are in the offing. And if we position ourselves now… we could enjoy huge returns as China starts bidding up the value of gold deposits around the world…

As we said, China follows a simple, three-step process in resources. First, it consolidates its domestic production.

As I told you in the special report titled, “Government-Backed Gold and Silver: How to Make a Fortune in China,” China lacked a modern mining sector as recently as the 1970s. So in 1979, China opened a tiny region to foreign companies for mineral exploration. It wanted to bring modern Western exploration and production techniques into the country. The program was so successful, China opened up the whole country to foreign companies by 1997.

This freedom accounted for a massive surge in gold production. By 2006, its gold production rose 15% compared to a decline of 3% in the rest of the world. By 2007, China eclipsed South Africa, to become the world’s largest gold producer.

In 2011, China produced 11.4 million ounces of gold… That almost doubled China’s 2002 production of 6.2 million ounces.

The domestic consolidation began in full force in 2005. China National Gold Group (CG), a private government-owned company, spent more than $476 million on five gold mining companies in the past four years.

The acquired companies range in size from junior exploration companies to interest in $1.2 billion major integrated mining companies.

• On August 27, 2007, CG spent $4.1 million to acquire 61.9 million shares (5%) of the $116 billion Zhongjin Gold Corp. (This Shanghai-listed company is the largest public gold miner in China.)
• Also in 2007, CG paid $5.3 million for 65% of the Geophysical Exploration Institute of Hei Long Jiang Province. (This is a small gold-mining company focused in Hebei province.)
• In May 2008, CG bought a large minority stake in then-Canadian-listed junior gold miner Jinshan Gold Mines for its mine in Inner Mongolia, China. CG later took over the entire company and renamed Jinshan Gold as China Gold International Resources (TSX: CGG). China Gold International remains a Canadian-listed company that produces almost 125,000 ounces of gold per year.

• In August 2008, CG spent $293.2 million on a partnership with Gansu Jinchuan Group. This company operates base-metal (nickel, copper, and cobalt) mines.
• In 2009, CG spent $154.4 million for two additional gold mining companies, including Zhen’an Gold Mining Co.
• In 2010, CG purchased an additional 149 million shares of Zhongjin Gold Corp., which it first invested in 2007. This time, CG spent $422.5 million to increase its interest in Zhongjin to 49.6%.
• In 2011, CG purchased its second Canadian-listed junior mining company, Mundoro Mining. It paid $14.7 million to acquire the company for its Maoling Gold Project in China. The Maoling mine is under construction and is expected to produce 328,000 ounces of gold per year.

This domestic consolidation is part of what we focused on in our initial 2009 China gold report… Longtime S&A Resource Report readers will recognize Jinshan’s name…

We bought shares in July 2009 not long after CG’s initial investment. We booked a 339% gain nine months later when the Chinese government announced its intention to turn Jinshan into China Gold International. I’m proud to note my Jinshan call is among the most profitable trades ever produced by my publisher, Stansberry & Associates Investment Research…

And it’s the kind of gain we want to make again on China’s burgeoning gold sector.

So Step 1 is done. What about Step 2, China’s gold imports?

It was illegal to own gold in China prior to 2007. When that law was changed, it opened the floodgates.

China imported a record 56.9 metric tons of gold in September 2011. That’s six times as much as it imported in September 2010. It imported 140 metric tons from July 2011 to September 2011. While the data is incomplete, the estimate for China’s total gold imports for 2011 is 350 metric tons. That’s a lot of gold.

Consider that the world’s miners outside China only produced 2,155 metric tons in 2010. China bought the equivalent of 16% of the world’s 2010 gold production last year.

It’s more gold than Canada, Chile, Ghana, and Brazil combined produced in 2010. It was more gold than any single country produced in 2010… even the world’s largest producer ? China ? which produced 345 metric tons.

In 2011, it passed India to become the world’s largest consumer of gold. For many people in the gold market, this was a big shock ? India has always been the world’s leading gold buyer. In India, people traditionally save and display their wealth in gold. Their entire financial culture is based on gold. Historically, silver has played the same role in China… but not anymore.

The demand hasn’t slowed at all. The Shanghai Gold Exchange (SGE) had its busiest month ever in January 2012. It averaged 392,239 ounces per day for the month.

The World Gold Council developed a program with the Industrial and Commercial Bank of China where citizens can convert their savings to gold. Approximately 2.3 million Chinese citizens are participating.

So we’ve seen consolidation in China’s domestic gold sector and an explosion in its gold imports… That means China should be gearing up for the third step… a big spending spree.

The time is now fast approaching when all debt will be defaulted on. In our perverse monetary system, one party’s debt is another’s “money.” A debtor’s default will impact the creditor (who is usually also a debtor to yet other creditors), causing him to default, and so on. When this begins in earnest, it will wipe out the banking system and thus everyone’s “money.” The paper currencies will not survive this. We are seeing the early edges of it now in the euro, and it’s anyone’s guess when it will happen in Japan, though it seems long overdue already. Last of all, it will come to the USA.

The purpose of this article is to present the early-warning signal and explain the actual mechanism to these events. Contrary to popular belief, it will not happen because the central banks increase the quantity of money to infinity. The money supply may even be contracting (which is what I expect).

To understand the terminal stages of the monetary system’s fatal disease, we must understand gold.

Defining Backwardation

First, let me introduce a key concept. Most traders define “backwardation” for a commodity as when the price of a futures contract is lower than the price of the same good in the spot market.

In every market, there are always two prices for a good: the bid and the ask. To sell a good, one must take the bid. And likewise, to buy the good, one must pay the ask. In backwardation, one can sell a physical good for cash and simultaneously buy a futures contract, and make a profit on the arbitrage. Note that in doing this trade, one’s position does not change in the end. One begins with a certain amount of the good and ends (upon maturity of the contract) with that same amount of the good.

Backwardation is when the bid in the spot market is greater than the ask in the futures market.

Many commodities, like wheat, are produced seasonally. But consumption is much more evenly spread around the year. Immediately prior to the harvest, the spot price of wheat is normally at its highest in relation to wheat futures. This is because wheat inventories in the warehouses are very low. People will have to pay a higher price for immediate delivery. At the same time, everyone in the market knows that the harvest is coming in one month. So the price, if a buyer can wait one month for delivery, is lower. This is a case of backwardation.

Backwardation is typically a signal of a shortage in a commodity. Anyone holding the commodity could make a risk-free profit by delivering it and getting it back later. If others put on this trade, and others, and so on, this would push down the bid in the spot market and lift up the ask in the futures market until the backwardation disappeared. The process of profiting from arbitrage compresses the spread one is arbitraging.

Actionable backwardations typically do not last long enough for the small trader to even see on the screen, much less trade. This is another way of saying that markets do not normally offer risk-free profits. In the case of wheat backwardation, for example, the backwardation may persist for weeks or longer. But there is no opportunity to profit for anyone, because no one has any wheat to spare. There is a genuine shortage of wheat before the harvest.

Why Gold Backwardation Is Important

Could backwardation happen with gold? Gold is not in shortage. One just has to measure abundance using the right metric. If you look at the inventories divided by annual mine production, the World Gold Council estimates this number to be around 80 years.

In all other commodities (except silver), inventories represent a few months of production. Other commodities can even have “gluts,” which usually lead to a price collapse. As an aside, this fact makes gold good for money. The price of gold does not decline, no matter how much of the stuff is produced. Production will certainly not lead to a “glut” in the gold market pulling prices downward.

So, what would a lower price on gold for future delivery mean compared to a higher price of gold in the spot market? By definition, it means that gold delivered to the market is in short supply.

The meaning of gold backwardation is that trust in future delivery is scarce.

In an ordinary commodity, scarcity of the physical good available for delivery today is resolved by higher prices. At a high enough price, demand for wheat falls until existing stocks are sufficient to meet the reduced demand.

But how is scarcity of trust resolved?

Thus far, the answer has been: via higher prices. Higher prices do coax some gold out of various hoards, jewelry, etc. Gold went into backwardation for the first time in December 2008. One could have earned a 2.5% (annualized) profit by selling physical gold and simultaneously buying a February 2009 future. Gold was $750 on December 5, but it rocketed to $920 ? a gain of 23% ? by the end of January.

But when backwardation becomes permanent, then trust in the gold futures market will have collapsed. Unlike with wheat, millions of people and many institutions have plenty of gold they can sell in the physical market and buy back via futures contracts. When they choose not to, that is the beginning of the end of the current financial system.

Why?

Think about the similarities between the following three statements:

• “My paper gold future contract will be honored by delivery of gold.”
• “If I trade my gold for paper now, I will be able to get gold back in the future.”
• “I will be able to exchange paper money for gold in the future.”

The reason why there was a significant backwardation (smaller backwardations have occurred intermittently since then) is that people did not believe the first statement. They did not trust that the gold future would be honored in gold.

And if they don’t believe that paper futures will be honored in gold, then they have no reason to believe that they can get gold in the future at all.

If some gold owners still trust the system at that point, then they can sell their gold (at much higher prices, probably). But sooner or later, there will not be any sellers of gold in the physical market.

Higher Prices Can’t Cure Permanent Gold Backwardation

With an ordinary commodity, there is a limit to what buyers are willing to pay based on the need satisfied by that commodity, the availability of substitutes and the buyers’ other needs that also must be satisfied within the same budget. The higher the price, the more holders and producers are motivated to sell, and the less consumers are motivated (or able) to buy. The cure for high prices is high prices.

But gold is different. Unlike wheat, gold is not bought for consumption. While some people hold it to speculate on increases in its paper price, these speculators will be replaced by others who hold it because it is money.

Once the gold owners have lost confidence, no amount of price change will bring back trust in paper currencies. Gold will not have a “high enough” price that will discourage buying or encourage selling. Thus gold backwardation will not only recur, but at some point, it will stay in its backwardated state.

In looking at the bid and ask, one other observation is germane to this discussion. In times of crisis, it is always the bid that is withdrawn ? there is never a lack of asks. Permanent gold backwardation can be seen as the withdrawal of bids denominated in gold for irredeemable government debt paper (e.g., dollar bills).

Backwardation should not be able to happen at all as gold is so abundant. However, the fact that it has happened and keeps happening means that it is inevitable and that, at some point, backwardation will become permanent. The erosion of faith in paper money is a one-way process (with some zigs and zags). But eventually, backwardation will become deeper and deeper (while the dollar price of gold is rising, probably exponentially).

The final step is when gold completely withdraws its bid on paper. At that point, paper’s bid on gold will be unlimited, and this is why paper will inevitably collapse without gold.

Conclusion

Permanent gold backwardation leading to the withdrawal of the gold bid on the dollar is the inevitable result of the debt collapse. Governments and other borrowers have long since passed the point where they can amortize their debts. Now they merely “roll” the debt and the interest as they come due. This leaves them vulnerable to the market demand for their bonds. When they have an auction that fails to attract bids, the game will be over. Whether they formally default or whether they just print the currency to pay, it won’t matter.

Gold owners, like everyone else, will watch this happen. If government bond holders sell their securities in response to this crisis, they will only receive paper backed by that same government and its bonds. But the gold owner has the power to withdraw his bid on paper altogether. When that happens, there will be an irreconcilable schism between gold and paper, with real goods and services taking the side of gold. And in a process that should play out within a few months once it gets started, paper money will no longer have any value.

Gold is not officially recognized as the foundation of the financial system. Yet it is still a necessary component. When it is withdrawn, the worldwide regime of irredeemable paper money will collapse.

The ways to really profit on gold?s backwardation are to start accumulating physical gold now.

With many global investors still concerned about the price of gold and silver, today King World News interviewed the ?London Trader? to get his take on these markets. Here is what the source had to say: ?Yesterday when we dropped through $1,700, you would not believe the amount of physical tonnage orders that filled. US centric traders tend to concentrate on the COMEX, but the real market is made in London.?

The London Trader continues:

?The commercials have been covering their short positions and the local traders are all short at this point. All of the guys who were long and vulnerable at the highs, are now short and vulnerable and this exactly what we need to make a bottom.

These momentum traders ran into a very large sovereign order near the $1,680 area. When gold broke through $1,680 there were layered physical orders. Over 40 tons of physical gold were filled below $1,680….

?These physical orders increase exponentially in size going all the way down to $1,650. The bullion banks know that these orders are down there, but obviously it?s all about where the lines cross. So, as I said, these bullion banks are covering like crazy right now.

These high frequency traders and locals are so lopsided short at this point that they are just being used by the commercials. So, not only are the commercials heavily covering short positions, but the actual amount of paper tonnage that was converted to actual physical on that dip yesterday is significant.

Some of it, no doubt, is to pay for some of the leases that were underwater from the bullion banks. A big chunk of it though, is physical metal that is going to disappear to Eastern vaults.

What?s also happened is a lot of the spot buyers, who have not converted to physical yet, have indexed themselves to spot and are now converting those spot contracts in to physical and will continue to do so for the next three to five days. So these paper raids have an enormous impact on the underlying physical market.

This morning on the am fix in London, a very large number of spot indexed buyers converted to physical. At the pm fix today in London, a very large number also converted to physical. What is happening over here in the physical market in London is totally missed by the US centric short-term day traders.

Right now the high frequency traders are doing all of the work for these guys (commercials). Paper is being converted into physical. This is being done by the bullion banks covering shorts and also very strong physical buyers accumulating at these levels.

Anyone in the know is accumulating physical and the shorts are just pressing down on a spring here. It?s like anything with leverage, once it unwinds, it unwinds rapidly. We saw that on the top end and we will see it from the bottom end. The shorts now face larger and larger sovereign orders for physical metal to get the price lower.

You have to remember the bullion banks are naked short the gold and silver markets and they are losing the very ammunition they need to manipulate price. They have to be careful not to lose more on the physical market than they profit on the paper market.

What these sovereign entities are doing to take metal from the physical market is they are buying on the spot market on dips, quietly accumulating spot, on the long side. Then, on dips in premiums, they are converting that into physical gold and that has a lagging effect under the market that is yet to feed through.

During this entire takedown in the gold market there has been absolutely no selling of physical gold, only accumulation. You see people saying gold is headed to $1,620, $1,600, $1,500. I guarantee you these individuals do not know what?s going on in the physical market.?

The London Trader also added: ?There is a massive fight going on and if we hold above the 200 day moving average for a COMEX close (the virtual market), the bottom is in. Commercials would rather cover shorts below the 200 day moving average. These high frequency traders and weak handed traders are now selling. The fact is they are being used by the bullion banks so the bullion banks can cover their short positions.

And so it should come as no surprise that after a 200 point sell-off in the Dow yesterday, they’re already feeding their unofficial PR spokesman, Jon Hilsenrath of the WSJ, the latest new weapons specs:

Federal Reserve officials are considering a new type of bond-buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.

The dollar was immediately smashed on that news – and here’s how the commodity markets reacted…

From MarketWatch:

Crude-oil and gold futures traded higher Wednesday, leaving behind their anemic floor-trading opening as investors cheered a Wall Street Journal report that Federal Reserve officials are considering a new type of bond-buying program. Gold for April delivery rose $15, or 0.9%, to $1,686.90 an ounce on the Comex division of the New York Mercantile Exchange. Crude for the same month’s delivery rose $1.10, or 1.1%, to $105.80 a barrel on Nymex.

The Fed is not playing games, guys, they want this market rolling higher. Fight it at your own peril.

The Federal Reserve?s explicit goal is to devalue the dollar by 33%.

As Forbes? Charles Kadlec notes:

The Federal Reserve Open Market Committee (FOMC) has made it official: After its latest two day meeting, it announced its goal to devalue the dollar by 33% over the next 20 years. The debauch of the dollar will be even greater if the Fed exceeds its goal of a 2 percent per year increase in the price level.

***

The Fed has announced a course of action that will steal ? there is no better word for it ? nearly 10 percent of the value of American?s hard earned savings over the next 4 years.

While that is stunning, it is actually par for the course for the Fed:

Here?s a chart of the trade weighted US Dollar from 1973-2009.

And here?s a bonus chart showing the decline in the dollar?s purchasing power from 1913 to 2005:

The giant banks ? through their treasury borrowing committee headed by JP Morgan and Goldman Sachs ? are also demanding the issuance of negative yield bonds.

In other words, the too big to fail banks want Americans to pay to have the luxury of holding their money in bonds.

American savers ? and especially those living on fixed incomes and pensions ? are going to get creamed.

China has longstanding relationships with many African countries, dating back decades. Currently, those relationships manifest themselves through resource-backed development loans. China offers market-rate loans, which would otherwise be nearly impossible for many of the small, volatile states like the Democratic Republic of Congo to get. In exchange, China asks for repayment in natural resources.

Since 2005, China has invested $53.5 billion in Africa.

And those investments were all about resources. Chinese companies bought iron mines, coal mines, oilfields, and copper mines. They loaned money to build railroads to get the resources from the mines to the coast for shipment. China’s banks loaned money to build power plants… so that the mines would have stable power supplies.

China is cozying up to Africa for its resources.

And as you probably know… Africa has lots of gold. I believe China will target gold projects in Africa. I can’t say if it will be this year or later. However, the data shows us that China isn’t afraid to buy assets in Africa.

According to the World Gold Council, Chinese consumption of gold reached 770 metric tons in 2011, up 20% from the year before. Demand is so strong that, even though China is the world?s largest gold producer, it still imported a record amount of gold last year.

Here is an interesting quote from a Chinese newspaper that I regularly read:

?To witness the frenzy firsthand, head to Beijing?s Caishikou Department Store, a four-story gold emporium that rang up sales of $1.5 billion last year. Visitors be warned: sharpen your elbows and be ready to push.

?To buy a necklace, shopper Wang Li recently fought her way through a scrum of cash-waving customers hanging over a glass counter loaded with gold chains, Mao pins, pendants of Christ on the cross and more.?

(You can see the article in the Los Angeles Times here.)

Have you ever had any doubts about gold? Does it sometimes feel like it should be performing better? Are you concerned about its volatility? Do you worry about how it might perform in the future? Have you ever wondered about its true purchasing power? Maybe you?re nervous about a big drop in price again? I decided to go directly to the source to address these concerns: Gold himself. He put his arm around me and asked me to tell you a few things…

? Jeff Clark, Casey Research

I hear that you?ve had some worries about me. I understand. Your world is a very uncertain place right now. And when it comes to money, it looks as though your leaders don?t understand some basic monetary principles, making things even more unsettling.

But I want you to know that the problems you?re experiencing are actually nothing new. I?ve seen these monetary, fiscal, and economic difficulties many times before. And I can tell you this: you?re safe with me. That?s a bold proclamation, but I?ve provided monetary protection numerous times throughout history ? too many to count, in fact. I?ve served all kinds of people over the centuries, from kings and counts to serfs and servants.

To put your mind at ease, let?s review my core characteristics, along with some history, to show how I can protect you against the monetary danger that?s likely to worsen in your near future. We?ll also take a look at your peculiar set of circumstances to see how I can be of service. By the time we?re done, I think you?ll feel much better about my ability to help your portfolio withstand whatever is thrown its way.

Enduring Characteristics

Let?s start with the basics. I have some characteristics that no other matter on Earth has…

I cannot be:

• Printed (ask a miner how long it takes to find me and dig me up)
• Counterfeited (you can try, but a scale will catch it every time)
• Inflated (I can?t be reproduced)
• I cannot be destroyed by;

Fire (it takes heat at least 1945.4 degrees F. to melt me)
Water (I don?t rust or tarnish)
Time (my coins remain recognizable after a thousand years)
I don?t need:

Feeding (like cattle)
Fertilizer (like corn)
Maintenance (like printing presses)

I have no:

• Time limit (most metal is still in existence)
• Counterparty risk (remember MF Global?)
• Shelf life (I never expire)
• As a metal, I am uniquely:

Malleable (I spread without cracking)
Ductile (I stretch without breaking)
Beautiful (I am the ultimate accessory)

As money, I am:

• Liquid (easily convertible to cash)
• Portable (you can conveniently hold $30,000 in one hand)
• Divisible (you can use me in tiny fractions)
• Consistent (I am the same in any quantity, at any place)
• Private (no one has to know you own me)

I am internationally accepted, last for thousands of years, and probably most important, you can?t make any more of me.

And by the way, don?t fret about those who say I?m not as good an asset as an income-producing vehicle. They misunderstand my role. I?m not trying to be a stock, for example. My function is as money and a store of value, so the proper comparison is to your dollars, or what you call Treasury Bills (of similar nominal value). And here is where I excel and serve my purpose: since 1913, the US dollar has lost 96% of its purchasing power. I have lost none.

Remember, I am the only financial asset that is not simultaneously someone else?s liability. I don?t require the backing of any bank or government.

The History Lesson

Because I am eons old, I?ve observed something throughout history that you may not be aware of: government fiat currencies are a relatively new invention, and none has endured.

Eventually, they have all failed. Me? I?ve never been defaulted on or worth zero. Remember this the next time you have any doubts about my long-term worth.

You can rest assured that over time, I will hold my value. And when you near the end of your life, you can pass me on to your loved ones, knowing full well they will have something that cannot be devalued, debased, or destroyed.

What Color Is Your Money?

Like you, I?m concerned about the current state of fiscal and monetary affairs. It seems your government leaders have boxed themselves into a corner. They?ve incurred too much debt and are spending too much money. It?s important that you understand some lessons from history about this kind of behavior so that you?re certain of what I can do for you.

The common denominators that lead to the downfall of every fiat currency are the two big Ds: debts and deficits. With that in mind, consider the following:

Detailed studies of government debt levels over the past 100 years show that debts have never been repaid (in original currency units) when they have exceeded 80% of GDP. US government debt will exceed 100% of GDP this year.

Investment legend Marc Faber reports that once a country?s payments on debt exceed 30% of tax revenue, the currency is ?done for.? By some estimates, the US will hit that ratio this year.
Peter Bernholz, a leading expert on hyperinflation, states unequivocally that ?hyperinflation is caused by government budget deficits.? Next year?s US budget deficit is projected to be $1.3 trillion.
The solution many of your leaders are pursuing is to create more currency units. The US monetary base has exploded 205.8% during the last three years, while my price is only up 65.8%. This fact, alone, implies that my price in dollars is likely to climb much higher.

This is also the reason why I?m not in a bubble, as some have tried to claim. It is your central banks and bond markets that are in a bubble. The fact that my price is rising is a warning that what your leaders are doing is unsustainable and potentially dangerous to your currency.

Think about this: the US has debt backed by debt, based on debt, dependent on debt, and leveraged with debt. You can, for example, buy a bond (i.e., lend money) on margin (i.e., with borrowed money). This is not a sound way to run financial markets.

Meanwhile, the warning bells continue to sound regarding Europe?s debt crisis. In just the past 30 days:

Moody?s cautioned that it may cut the triple-A status of France, Austria, and the UK; and it downgraded six other European nations including Italy, Spain, and Portugal.
Standard & Poor?s cut the triple-A status of France and Austria, while Italy, Spain, Portugal, Cyprus, Malta, Slovakia, and Slovenia were downgraded.
Fitch downgraded Belgium, Cyprus, Italy, Slovenia, and Spain, and stated there was a 50% chance of further cuts in the next two years.
Standard & Poor?s downgraded 34 of Italy?s 37 banks.
Moody?s warned just last week that it may cut the credit ratings of 17 global financial institutions and 114 European ones.
The European crisis is far from over; and the path of least resistance for politicians is to create more currency units. This action can and will have clear and direct consequences: currencies will devalue, and inflation ? perhaps hyperinflation ? will result.

Once again, I encourage you to use me to protect some of your wealth.

How Much Is Enough?

Given the state of your monetary system, you should accumulate me (and silver) on a regular basis. Just buy some every month and put it in a safe place. After what I?ve witnessed throughout history, and based on the current path your government leaders insist on pursuing, I suggest using me as your savings vehicle instead of putting dollars in a bank.

If you don?t own enough of me when these fiscal troubles really accelerate, I fear you will regret it. I?ve warned many in the past about the dilution of nations? currencies, and those who didn?t heed my warnings experienced severe financial pain. Excuses won?t pay the mortgage nor feed the family when the effects of currency debasement hit your home and pocketbook.

Make sure you own enough of me to make a difference to your portfolio. This means having more than a couple coins or a few shares of GLD, the latter of which is only a proxy for my price.

How do you know if you own enough? Ask yourself:

• If inflation returns, or even hyperinflation hits…
• If the economy is flat…
• If uncertainty and fear continue around the globe…
• If stock markets languish…
• If the amount of spending from the world?s governments proves futile…
• If government interference in the economy continues to increase…
• If the value of the US dollar takes a major fall…
• If the world enters a recession or depression…
• If you wonder if you have enough ?safe? money…

..would you feel that you own enough of me?

Buy a sufficient amount so that as your currency continues to lose value, your portfolio won?t. If you do your part, I promise I?ll do mine.

Your monetary friend,

Gold

For more than 30 years, since the start of the country’s “Reform Era” in 1978, China has been selling (exporting) more goods than it has imported.

That’s allowed the nation to stockpile trillions of dollars ? more money than our entire monetary base totaled before the recent financial crisis.

The way it works is simple to understand. When a Chinese business earns dollars by selling overseas, the law requires the company to hand those dollars over to the country’s central bank, the People’s Bank of China (PBOC). In return, the business gets Chinese currency (called either the “yuan” or the “renminbi”) at a fixed rate.

There’s nothing fair about this. The Chinese people do all the work, and the Chinese government keeps all of the money. But that’s the way it goes.

At first, the dollar inflow was small because trade between the two countries was tiny. In 1980, for example, China’s foreign currency reserves stood at approximately $2.5 billion. But since then, the amount of foreign currency reserves held by the Chinese government has gone up nearly every year? and now stands at $3.2 TRILLION. That’s a 127,900% increase. It’s simply astonishing to look at the chart of the increase in currency reserves?

As I mentioned yesterday, the group in China that manages these foreign reserves is called the State Administration of Foreign Exchange (SAFE). This group is engaged in a full-fledged currency war with the United States. The ultimate goal ? as the Chinese have publicly stated ? is to create a new dominant world currency and dislodge the U.S. dollar from its current reserve role.

And for the past few years, SAFE has had one big problem: What to do with so much money?

SAFE decided to use most of these reserves to buy U.S. government securities. As a result, the Chinese have now accumulated a massive pile of U.S. government debt. In fact, about two-thirds of China’s reserves remain invested in U.S. Treasury bills, notes, and bonds. The next biggest chunk is in euro. Of course, all this money is basically earning nothing to speak of in terms of interest? because interest rates around the world are close to zero.

And while the Chinese would love to diversify and ditch a significant portion of their U.S. dollar holdings, they are essentially stuck. You see, if the Chinese start selling large amounts of their U.S. government bonds, it would push the value of those bonds (and their remaining holdings) way down. It would be like owning 10 houses on the same block in your neighborhood? and deciding to put five of them up for sale at the same time. Imagine how much that would depress the value of all the properties with so much for sale at one time.

One thing China tried to do in recent years was speculate in the U.S. stock market. But that did not go well? The Chinese government bought large amounts of U.S. equities just before the market began to crash in late 2007. It purchased a nearly 10% stake in the Blackstone Group (an investment firm)? and a similar stake in Morgan Stanley. Blackstone’s shares are down about 46% since the middle of 2007, and Morgan Stanley is down about 70% since the Chinese purchase.

The Chinese got burned big time by the U.S. equities markets and received a lot of heat back home. They are not eager to return to the U.S. stock market in a meaningful way. So China’s U.S. dollar reserves just keep piling up in various forms of fixed income ? U.S. Treasury bonds, Fannie and Freddie mortgage bonds, and other forms of debt backed by the U.S. government. These investments are considered totally safe ? except that they’re subject to the risk of inflation.

According to a statement by the government: “SAFE will never be a speculator. It mainly seeks to protect the safety of China’s foreign exchange reserves and ensure a stable investment return.”

If the Chinese won’t buy stocks and the only real risk to their existing portfolio is inflation, what do you think they will do to hedge that risk?

They will buy gold? lots and lots of gold.

It was no surprise to us when, in 2011, China became the No. 1 importer of gold. For many people in the gold market, this was a big shock ? India has always been the world’s leading gold buyer. In India, people traditionally save and display their wealth in gold. Their entire financial culture is based on gold. Historically, silver has played the same role in China? but not anymore.

In fact, not only has China become the world’s leading importer of gold, it was already the world’s leading producer? by far. According to the most recent figures from the World Gold Council, China produces nearly 50% more gold (about 300 tons per year) than the second-place country? Australia. And guess what? Every single ounce produced in China ? whether it’s dug out of the ground by the government or a foreign company ? must, by law, be sold directly back to the government.

The Chinese are now clearly on a path to accumulate so much gold that one day soon, they will be able to restore the convertibility of their currency into a precious metal? just as they were able to do a century ago when the country was on the silver standard.

The West wasn’t kind to China back then. The country was repeatedly looted and humiliated by Russia, Japan, Britain, and the United States. But today, it is a different story?

Now, China is the fastest-growing country on Earth, with the largest cash reserves on the planet. And as befits a first-rate power, China’s currency is on the path to being backed by gold.

China desperately wants to return to its status as one of the world’s great powers? with one of the world’s great currencies. And China knows that in this day and age ? when nearly all governments around the globe are printing massive amounts of currency backed by nothing but an empty promise ? it can gain a huge advantage by backing its currency with a precious metal.

As the great financial historian Richard Russell wrote recently: “China wants the renminbi to be backed with a huge percentage of gold, thereby making the renminbi the world’s best and most trusted currency.”

I know this will all sound crazy to most folks. But most folks don’t understand gold, or why it represents real, timeless wealth. The Chinese do. And in tomorrow’s essay, I’ll provide more evidence of how they are carrying out the largest gold accumulation plan of all time.

Good investing,