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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 was 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 as 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.
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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."
Michael J. Kosares, the editor of USAGOLD
News, Commentary and Analysis,
is the founder of USAGOLD
and the author of "The ABCs
of Gold Investing - How To Protect
and Build Your Wealth With Gold."
Editorial questions and comments:
editor@usagold.com
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