by Louis Golino for Coin Week

On September 3 the financial web site, ZeroHedge , ran an important story on a U.S. government memo recently made available by WikiLeaks that is from the U.S. Embassy in China and which deals with China’s gold policy (http://www.zerohedge.com/news/wikileaks-discloses-reasons-behind-chinas-shadow-gold-buying-spree).

This document is eliciting interest among gold analysts, who feel it is very bullish for the outlook for gold, though it has not been covered in the mainstream press as far as I know.

It shows that China’s goal is to keep increasing its gold reserves and acquiring as much gold as it can to help drive the price higher and higher with the ultimate purpose of ending the U.S. dollar’s reserve currency status.

China is the largest gold producer and buyer in the world. It has long sought to have the dollar replaced by a new international currency centered on the Chinese Renminbi.

Ending the dollar’s reserve currency status would be a severe blow to the U.S. economy, which may help explain why U.S. officials get worried when gold hits new highs.

Particularly when combined with the recent downgrading of our debt by S&P, this action would cost the taxpayer dearly because it would end up sharply increasing the cost of financing our growing national debt.

At the moment investors still have an appetite for U.S. treasuries despite the recent downgrade, but an eventual loss of the dollar’s reserve position, if it happened, combined with interest rates that simply have to increase at some point, does not bode well.

According to Chinese sources, as quoted in the leaked U.S. government memo, “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.”

This key passage from the memo adds a new twist to old allegations of U.S. government suppression of gold prices.

About a year ago I first became familiar with the argument that the U.S. government regularly acts in conjunction with large banks involved in the gold trade to suppress the price of gold.

Many precious metals analysts including Patrick Heller, who also owns the largest coin and bullion dealership in Michigan, have been making this case for several years.

Their basic argument is that the price of gold is a kind of report card on the U.S. government’s handling of the economy, and that rising gold prices are viewed as a negative development by U.S. government officials.

According to this perspective, when gold begins to rise in price very sharply, the U.S. government works with large American banks such as J.P. Morgan to suppress the increase in prices by having those financial institutions increase their gold shorts.

I was initially suspicious of this argument because I felt that fluctuations in the price of gold were more likely explained by demand and supply fundamentals, profit taking when prices peak, reactions to margin requirement increases, etc.

But over time, I have learned that there may be something to the suppression argument. There are times when price developments in precious metals, including the gold and silver markets in particular, seem hard to explain by the fundamentals.

In addition, Mr. Heller and others have explained that frequent margin increases, as occurred in the spring to bring silver back down to the low $30 range after briefly surpassing the $50 level in late April, are a favorite suppression tactic.

Last year some evidence did come to light on silver price suppression as a result of an investigation by the CFTC (Commodities Futures Trading Commission). Comments from CFTC member Bart Chilton, and some e-mails from a former British metals trader turned whistleblower named Andrew Maguire, supported the notion that silver prices are suppressed. Although I have not heard of similar evidence about gold price suppression, that does not mean it does not exist.

So with this background in mind, the leaked memo is especially interesting.

If it is true that China’s mania for gold is partly driven by a desire to end the dollar’s reserve status as well as the need to diversify from dollar-denominated debt, which seems likely, and if it is also true that the U.S. government has worked for years to suppress the price of gold, then the chances of gold surpassing $2,000 and more are much higher.

As the author of the ZeroHedge piece, Tyler Durden, suggests, gold could surpass $5,000 an ounce once this information about China is more widely known, and provided it leads pension fund managers to make substantial investments in gold. At the moment, only one-third of one percent of pension funds are invested in gold, according to Shayne McGuire author of a 2010 book called “Hard Money: Taking Gold to a Higher Investment Level.”

Barry Stuppler’s prediction in a Wall Street Journal piece a couple years ago that gold would hit $2011 by 2011 is looking like a distinct possibility despite the bearish predictions of the anti-gold crowd, who continue to say it is in a bubble and headed for a major fall.

The signs do seem to point towards an ongoing rally in gold. It could be due for another correction, but I suspect it would be short-lived like the one a couple weeks ago since the fundamentals supporting gold continue to look very strong.

The more mainstream analysts and publications keep pushing the view that gold is a bubble despite all the evidence that shows how under-invested most individuals and pension funds are in gold, the more I am inclined to side with the bulls.

Louis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, and a number of different coin web sites. His column for Coin Week, “The Coin Analyst,” covers U.S. and world coins and precious metals. He collects U.S. and European coins and is a member of the ANA, PCGS, NGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.