China currently produces 340 tonnes of gold annually. This may increase by up to 100 tonnes a year or more. It imported 210 tonnes in 2010. The demand for gold is increasing in China and this is likely to continue in line with the growth of the Chinese Middle classes. We do not know for sure how much the People's Bank of China took into its reserves and are only likely to know in two years time. Russia produces around 250 tonnes of gold per annum. It increases its reserves by 152.4 tonnes by January 1st 2011.

These two nations present different requirements from the local and international gold markets, but does it make a difference where the gold is bought?

Local Production and additions to national reserves

China

China's central bank, the People's Bank of China, does not disclose the annual amount it purchases for its reserves, but uses an agency to make these purchases for it. Every five years, this agency delivers the gold bought to the bank, which then announces its increase. The last time it did this was three years ago and it reported an increase of 454 tonnes, averaging out to 91 tonnes a year.

If this amount had been bought from local production, it would equate to the amount of local production over those five years. As the People's Bank of China does not want to disclose how much gold is bought locally and how much, if any, is bought in the international market, we will never be sure.

Russia

Russia produces in the order of 250 tonnes [2010 approximation up from 184.49 tonnes in 2009 - 38% increase] locally. Russian central bank purchases have been rising steadily [25% per annum] over the last two years, but not as fast as local production. There is scope for the central bank to increase the volume of local purchases and keep it at 50+% of local production.

Vladimir Putin, Russia's Prime Minister [but the power behind the throne] had previously stated that Russia would be buying on the international market. One of the Deputy Chairmen of the Russian central bank said the bank had bought its added reserves from local production. Is one right and the other not, or are both right?

What dictates where the gold is purchased?

The London Gold Market -International physical gold market

90% of the world's physical gold sales in the international market take place in London through the five bullion banks that make up the gold Fixing. The two Daily Fixes account for the vast majority of these deals, taking place at 10.30 a.m. and 3.00 p.m. London time. Each of the bullion banks has their own clients and does their best to hide their identity from outsiders. But experienced dealers can sense the presence of a central bank in the market.

One of the ways they can tell is by the way the banks deal in gold for them. A central bank does not want to chase prices, so will buy gold offered to it, rather than make a large offer, which may well drive prices up. A Chinese central bank official made the comment some time ago that it is difficult for a central bank to buy gold in the international market. But a central bank will do it if the amount purchased or sold is not sufficient to affect prices. If it is a large amount, then sales or purchases will be spread out over time so as not to affect prices unduly. This may hide the presence of a central bank.

The moment it gets out that a central bank is in the international market prices will rise or fall more than is usual. This is the deterrent to China in particular, which is very concerned with its privacy.

Advantages and Disadvantages of buying internationally or locally

Newly mined gold production is above 2,400 tonnes per annum. The international gold market is the place to source large amounts of gold.

• Any amounts needed above locally produced volumes must come from this market or direct from refiners such as the Rand refinery in South Africa.

• Purchasing gold outside a nation requires foreign currency from foreign exchange reserves and not the local currency. With a tonne of gold around $45 million apiece, using local currency can be inflationary [it requires the injection of that currency into the local economy].

• Where a dealer is able to guard its client's identity and purchase large volumes of gold, central banks will do better to use the London gold market, even if it has local production, for it does not have to wait for the local gold to be available.

• Buying locally produced gold involves a local producer and the central bank with a price set for each transaction only by reference to international prices no matter how large the volume of gold involved.

• There is little to no immediate impact on international prices as the international market does not 'see' the transaction. The only way local deals impact international prices is through the absence of that local supply from the international market.

• Local production is a certain source of supply. When supply is tight in the international market buyers will have to raise prices to bring out additional supplies. Even when international markets have a tight supply situation local production remains on tap to a central bank.

• In the case of China where local supply is insufficient to supply the retail & institutional market as well as the central bank, central banks can ensure that they manage their purchases well when they buy locally and leave the retail & institutional buyers to get the balance of their purchases from the international markets via imported gold.

As you can see it generally pays a central bank to buy local production if it is there. It is easier, private and more manageable in terms of prices. China in particular appreciates the control it retains over the disclosure of purchases.

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