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Consider this from a recent World Gold
Council (WGC )report:
"Central banks continued to buy
gold; net purchases recorded during the [first quarter, 2012] amounted to
80.8 tonnes, accounting for around 7% of global
gold demand. Central banks from a diverse group of countries added to the
overall holdings of the official sector, with a number of banks making
sizable purchases. Diversification requirements and growth in foreign
exchange reserves of a number of countries point towards a continuation of
this trend."
 In keeping
with this analysis, the World Gold Council moved to "incorporate
official sector purchases as an element of gold demand" (my
emphasis) in its fundamentals table. Previously central banks occupied a slot
on the supply side of the ledger. "The net purchasing of gold by
the official sector," says the Council,
"is now an established trend, which is likely to remain in place for the
forseeable future." More than just a symbolic
change, the World Gold Council's alteration documents an important shift in
gold market dynamics. In 2002, central banks contributed 545 tonnes of gold to the supply. Ten years later, in 2011,
they purchased 440 tonnes -- a significant nearly
1000 tonne swing on the fundamentals table. Just as
significantly, "signatories to the third Central Bank Gold
Agreement," says WGC, "have almost ceased sales of their
gold."
Quite unexpectedly, except perhaps among
a handful of long-time gold advocates, gold is quietly and gradually moving
back to its centerpiece role in international reserves. Stretched and
threatened financially, nation states have begun accumulating gold for the
same reason private individuals do -- as portfolio insurance to cover a wide
assortment of economic uncertainties. What's more, this restoration has not
occurred formally as a result of an international agreement as has so often
the case in the past, but informally as a natural evolution in the way nation
states think about and react to the long-term value of currency reserves. As
such, it suits the times and suggests an authenticity that is likely to
transform the gold market at its core. In my view, this swing in the supply-demand
fundamentals will come to be recognized in future years the most important
gold market event since the Central Bank Gold Agreement (CBGA) of 1999 -- the
accord that many believe kicked-off the secular gold bull market. (The CBGA
capped the sales and leasing of gold by its signatories, the most active
central banks in the gold market at the time.)
The Asia gold call
In gold producing countries like China
(the largest producer) and Russia (the fifth largest) most, if not all,
domestic production is being converted directly to reserves. Other central
banks, like India, Mexico, Turkey, the Philippines and a growing list of
others (including some who probably would just as soon like to keep it quiet)
are buying gold on the open market when it becomes available. One has
dramatically reduced supply; the other has dramatically increased demand.
It took almost four years for the CBGA
to affect prices, and it may take that long for the full impact of the new
shift in central bank activity to render its effect on the current market.
However, times have changed, and we could be on a shorter fuse. Even now,
there are rumors circulating the market of Asian central bank purchases on
any drop into the $1500 to $1550 range -- a gold call of sorts that puts a
floor under the price.
Dan Norcini,
the well-known gold market analyst who plies his trade at Jim Sinclair's Mineset website, makes the following observation:
"Every time we've gone down below
$1,550 and dipped into this support level, we've had very strong, quality
buying emerge. Most of the time this type of buying is associated with
central bank purchases, particularly central bank buying coming out of the
East. The bottom line is there was some very powerful buying that came into
the gold market from some extremely strong hands. They were strong enough
that they could absorb hedge fund algorithm related selling, which is
significant right now across the commodity sector."
 It is
precisely because of the lack of readily available physical gold in size that
China and Russian have chosen to take the route of increasing their reserves
through domestic production -- a strategy, by the way, from which the United
States could benefit. The U.S. at present houses the largest gold reserve in
the world at over 8000 tonnes and hosts the world's
third largest mine production at 243 tonnes. It
could begin increasing its own reserves by simply offering to purchase
domestic production on a right of first refusal basis at market prices.* In
addition to China purchasing its own production, there have been consistent
reports of its interest in buying gold directly from foreign mining
companies, particularly in Australia and Africa. As the restoration process proceeds,
the price over time is likely to move progressively higher extending the
length of gold's bull market beyond anything most observers have thus far
contemplated, while at the same time enhancing the metal's status as a
reserve asset.
* Strongly positioned mining companies
with proven reserves and management that fully understands the evolving role
of gold in national reserves would be obvious beneficiaries under the
circumstances described. At the same time, mining companies should not be
owned to the exclusion of the metal itself. It should be kept in mind that
mining stocks are stocks first and a form of gold ownership second. Gold
coins and bullion are wealth insurance first and an investment
second. The first objective should be to secure one's portfolio. The second
should be avenues for potential profit.
Postscript
The vision of Nobel Prize laureate, Robert Mundell
 I do not
believe that some version of the gold standard is necessarily the best or only
approach to restoring gold's place in the monetary system. Simply using gold
as a reserve asset as Nobel prize-winning economist Robert Mundell suggested
many years ago could go a long way in restoring confidence in the various
currencies. Secondly, it would give the central banks some protection against
beggar-thy-neighbor currency policies that tend to undermine the value of
currency reserves. In other words, it would serve as a hedge. This is
precisely what Mundell envisioned when he recommended that Europe use gold as
a core reserve in establishing the euro.
Robert Mundell from a lecture delivered
at St. Vincent College, Latrobe, Pennsylvania (1997):
"I do not think that we will see
the time when either of those two great economic powers, the United States
and the European Union, will ever again fix their respective currencies to
gold as they have in the past. More likely, gold will be used at some point,
maybe in 10 or 15 years when it has been banalized
among central bankers, and they are not so timid to speak about its use as an
asset that can circulate between central banks. Not necessarily at a fixed
price, but a market price. . .Gold is going to be a part of the structure
of the international monetary system for the 21st century, but not in the way
it has been in the past. We can look upon the period of the gold standard,
the free coinage gold standard, as being a period that was unique in history,
when there was a balance among the powers and no single superpower
dominated."
Fifteen years later, as Mundell
predicted, gold is being bandied about as an important component in the
monetary system of the future. Ben Steill of the
Council on Foreign Relations, World Bank president, Robert Zoelick, former Kansas City Federal Reserve president
Thomas Hoenig and former Fed Chairman Alan
Greenspan -- all have spoken favorably of gold's restoration as a component
of central bank reserves. In a recent essay on a formal gold revaluation, Quaintance and Brodsky offer a strategy worth
contemplating: "We suggest one keep identities straight; invest with
central banks, not against them; and consider the hollow rhetoric of the
establishment that may temporarily suppress its paper price 'a gift.' They
are working for physical gold holders, not against them." It is a
long-term investment strategy worth contemplating.
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