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Gold appears to be headed for an
impressive price appreciation for the second half of 2012. Since the
beginning of July, gold is up almost 10 over the same time frame. What is
noteworthy here is that in recent months, fears of a worldwide recession have
increased markedly. It used to be considered axiomatic that recession created
adverse conditions for commodities (a reality that has helped push down the
price of crude oil thus far in 2012). How then can we understand the movement
in gold?
Reports have recently been released that
throw particular light on the degree to which central banks around the world
are accumulating gold. These activities must be playing a significant role in
keeping the heat turned up when it may be otherwise cooling down. Given the
extraordinary degree of insight that central bankers are expected to have,
what do they see that drives them to buy gold when classically the metal
should be falling in times of recession?
As we have said many times, there are
two fundamental investment reasons to buy gold. The first is as a hedge
against the loss of purchasing power of fiat currency, caused either by
inflation or currency debasement. The second is as insurance
against political and financial uncertainty or collapse. Central bankers are
not giving either scenario much lip service.
By the latest analysis, it appears that
the European Union (EU) is headed toward depression. After twelve years of
stagnation, the Japanese economy remains flat at best. With an Obama victory
at the polls, Obamacare, and massive tax increases
threatened, the U.S. economy looks set increasingly for recession. If
recession hits the world's two largest economies, the EU and U.S., the
international economy, including that of China and its prime raw material
suppliers such as Australia, Brazil and Canada, can't be expected to grow
robustly. Runaway inflation, according to the models to which most central
bankers subscribe, would then be considered a distant risk. Is it possible
that these individuals, at the apex of the economic and financial worlds,
don't trust their own policy papers?
Perhaps they understand the net effect
of massive quantitative easing and the distortions being made by the
ultra-low interest rates that have been held far too low for far too long.
The unconventional monetary policies unleashed on the world since the
beginning of the Great Recession have upended the financial rule book. But
don't expect central bankers to openly acknowledge this change. Instead, they
will talk loudly about the threats of deflation while quietly expanding gold
reserves.
At present, these loose monetary
policies are actively debasing currencies like the U.S. dollar and euro. In
order to protect their exports into those economies, other hard-currency
countries have engaged in competitive currency devaluation. Examples would
include Switzerland, Japan and China.
Even in the absence of high inflation,
currency debasement has contributed to a higher gold price. This, in turn has
encouraged some central banks to increase the proportion of the gold content
and decrease the amount of fiat currency in their reserves. This is somewhat
surprising given that many countries had agreed to sell gold under the
Central Bank Gold Agreements (CBGA's) I and II.
Russia, Ukraine, India, Turkey and the Kyrgz Republic have all increased their gold holdings
recently. Turkey has even gone so far as to demand an increase in the
proportion of gold held by its commercial banks as part of their reserves.
Perhaps most important of all, James Rickards, a
CIA and Pentagon senior advisor, released data recently showing that, in
2009, China secretly possessed gold holdings of 1,054 tonnes,
or some 450 tonnes more than previously disclosed.
This places China as the seventh largest holder of gold, or some 14 tonnes ahead of Switzerland. Perhaps this explains the
recent news that gold is now the #1 Australian export
to China, passing coal this year.
China's gold holdings amount to a
relatively small 1.8 percent of her foreign currency reserves. This is far
behind the largest holders. The U.S. has 8,133.5 tonnes,
or 78.3 percent of its reserves; Germany has 3,412.6 tonnes,
or 69.3 percent, the IMF 3,217 tonnes; and even
Italy, in fourth place, has 2,451.8 tonnes or 66.5
percent.
Clearly, China has a long way to go
before challenging the United States' vast holdings. However, China appears
to be set upon a course of serious gold accumulation. Now the world's largest
gold producer, China retains all its domestic production and buys additional
tonnage on the international market.
The crucial message that many central
banks are buying gold has not been lost on the private sector. The Exchange
Traded Fund (ETF) SPDR has some 1,120.6 tonnes,
making it the world's sixth largest holder and excludes other privately held
accumulations.
Central banks are at the epicenter of
the apparently coordinated unconventional monetary policies of quantitative
easing and distorted low interest rates. The fact that many of them are
buying gold surely carries a generally bullish message for the yellow metal,
despite the increasing signs of worldwide recession or even of depression.
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