Central Banks Buying Record Amounts of Gold
Gold has seen its role as a form of money reduced significantly over time.
The U.S. cut off its last link to the gold standard in 1971 under Nixon. There are no longer any significant currencies in this world that are fully or even partially backed by gold.
Yet it is a curious thing that central banks hold gold. Some central banks still buy gold for reserves.
In 2011, then-Congressman Ron Paul asked then-Fed Chair Ben Bernanke why central banks hold gold (as opposed to diamonds). Bernanke’s response was that it is tradition.
There could be worse answers... but why is it tradition for central banks to hold gold?
The reason is that it was widely used as a form of money, as determined by the marketplace, for thousands of years. Central banks still hold gold because of its history as money.
Even though there are no currencies backed by gold, gold reserves act as a backstop. It keeps an element of confidence in the fiat currency that is issued.
Based on the most recent data, here is a list of the top 10 countries with the largest gold holdings:
United States: 8,133.5 tonnes
Germany: 3,384.2 tonnes
Italy: 2,451.8 tonnes
France: 2,435.4 tonnes
Russia: 1,149.8 tonnes
China: 1,054.1 tonnes
Switzerland: 1,040.0 tonnes
Japan: 765.2 tonnes
Netherlands: 612.5 tonnes
India: 557.7 tonnes
The U.S. obviously holds the most gold by far. Of course, this is based on the official reporting numbers, and we can’t be certain of the true story.
German officials attempted to repatriate some of their country's gold from the U.S. but then suddenly stopped pursuing it. We don’t really know if the gold is there because there are no true audits done on the gold holdings. For all we know, it is possible most of the gold has been leased out.
We must also consider that the U.S. is the wealthiest country — although in terms of population and economic size, Switzerland’s holdings of over 1,000 tonnes is impressive.
The Swiss are set to vote on a gold referendum at the end of the month. While its chances of passing and actually being implemented are remote at this time, we can see that gold still plays a significant role in Switzerland.
The Peak of Central Bank Dumping
The end of the 20th century really marked the peak of the anti-gold movement. In 2000, the Swiss franc ended its last link to gold and became the last official fiat currency backed by nothing. This resulted in heavy gold sales from the central bank.
From 1999 to 2002, the U.K. sold about half of its gold reserves. This decision is credited to Gordon Brown, who was then the Chancellor of the Exchequer. His major blunder did not prevent him from later becoming the Prime Minister.
The turn of the century was the peak of bearishness for gold. It was also a great buying opportunity for gold investors, as the metal sat below the $300 per ounce mark.
For anyone who bought and held gold at these levels, I suppose you should send a thank you note to Gordon Brown for the buying opportunity of a lifetime.
With that said, things have shifted in the other direction more recently. Some central banks are actually buying gold again. Even supposedly communist and formerly communist countries are getting in on the gold action.
Just as gold acts as insurance for individuals, it also serves as a form of insurance for central bankers.
While China’s official gold holdings show 1,054.1 tonnes in reserve, some analysts believe the number is much higher — perhaps 2,000 to 3,000 tonnes.
Chinese officials show signs that they want a more respected currency that can compete with the U.S. dollar. Unfortunately, they can’t quite shake off their Keynesian/mercantilist tendencies, as they continue to inflate.
In addition, the yuan is not a freely floating currency, which means it will never be in high demand outside of China until this changes.
Still, the People’s Bank of China is believed to be purchasing gold and is expected to continue. It is more a question of how much.
Alan Greenspan recently noted that if China were to convert a modest portion of its $4 trillion in foreign exchange reserves into gold, then its currency could become unexpectedly strong. Greenspan abandoned his early views on gold and the free market with his actions as Fed Chair, but he still provides some interesting thoughts every now and then.
China has well over $1 trillion in U.S. government debt alone. It could sell about a quarter of its U.S. debt and would be able to afford to buy the equivalent of all of the official U.S. gold holdings of over 8,000 tonnes at today’s price.
Russia’s central bank has also been buying gold. Reports show it has accumulated about 115 tonnes in this year alone. This is up from 77.5 tonnes in 2013 and 75 tonnes in 2012.
Since U.S. sanctions were placed against Russia over the Ukraine situation, many Western banks are refusing to do business with Russian companies, even if it is not expressly prohibited. Since Russia has a large amount of gold production, the central bank has been buying up some of this production.
It should not surprise us if Russia continues to accumulate gold for reserves, particularly if the sanctions continue. It is a way to possibly weaken the dollar in the future, and it is also a possible way around some sanctions.
While gold is not used as a form of money in day-to-day trading between individuals, it can still be a form of money internationally. It should not surprise us if one day we hear that Russia and China are trading oil or some other commodity for gold. Something similar between Russia and India would not be out of the question, either.
A Ground Floor for Gold
Since gold is becoming popular to hold again for many central banks, it actually serves as support for the gold price.
While the dollar price of gold has been down lately, particularly due to a stronger dollar, the low prices may not last long if central banks continue buying.
The Chinese and Russian central banks are the biggest potential buyers of gold, but there is also India. And we can’t forget about Switzerland, although the upcoming gold referendum will be telling.
I recommend holding a permanent portfolio, which includes 25% in gold and gold-related investments. If you have been waiting to buy gold at a bargain price, you may not want to wait any longer.
There is certainly potential for the price to go lower in the short term, but the longer term looks promising. With a combination of monetary inflation and central banks buying gold again, it is bullish for gold investors who are willing to ride out this temporary rough patch.
Some investors were wise enough to see an opportunity 14 years ago when gold was $300 per ounce or less. Will we look back one day and talk about the opportunity investors had at the end of 2014 when gold was less than $1,200 per ounce?
Until next time,