Central Gold Fundamentals
Gold seems to make fresh news headlines every day, and there is plenty of active desire to know the price. Like most commodities, that price is based upon changes in the forces of supply and demand. Gold is different: First because gold production is comparatively stable and unlikely to change much in the near future, and second because the supply and demand remains very liquid, although at times very sensitive and subject to rapid changes. Much demand for gold characteristically comes from investors and buyers of gold jewelry. Investors frequently favor gold as a store of value during times of economic stress. There is another large holder of gold deposits: Central banks in their reserves. Let's review how much gold there is in central banks and what actions to expect by those who own it.
The role that central banks play is not always clear. They exist to manage a nation’s currency. They perform this function by controlling their country’s supply of money and thus influence interest rates by their actions. There are other tricks they can perform (quantitative easing comes to mind) but while they continue to own vast amounts of gold holdings, they do not use the gold standard any longer. Instead they maintain gold reserves as credibility, preferring to exchange currencies with one another. Do you remember the old axiom that “money doesn't grow on trees”? It doesn’t; it gets created by central banks. The gold they hold is more of a backstop, or last line of defense.
What about that central bank gold; what do they do with it? In the currently financially stressed macro environment what actions might central banks take?
Gold pays no interest or dividend, so there is wide spread acceptance that gold prices can be tied to actions taken by central banks regarding modifications towards monetary policy. Loose monetary policy can serve to enhance economic growth - although it can raise inflation fears -while tight monetary policy can slow economic growth. This means it is often action taken by central banks that spur investors towards or away from gold speculation, causing prices to rise or fall. For this reason gold, still gets treated almost like a currency in many circles. This is why some analysts suggest it may be the ultimate currency.
Most of you are familiar with the Federal Reserve and its Chairman Ben Bernanke. There is also the European Central Bank, which has been playing a leading role along with the IMF regarding the debt problems in Europe. They are among the top holders of gold deposits in the world. Other examples include the Deutsche Bundesbank, or (DB) Germany's central bank, which is considered the most prominent and influential member of the European System of Central Banks, along with France, Switzerland and Italy. Together central banks maintain reserves in excess of 30,000 metric tons of the world’s gold, or about 20-25% of above ground supplies. That’s a lot of metal, and what they do with it can engage the price in the market for gold.
Among that group, the only significant gold seller in the past decade was the IMF. Back in 2009-2010 the IMF did sell some of its holdings. According to their website, they sold a total of a little more than 400 metric tons, and that supply was negotiated responsibility to avoid causing disruptions to the functioning of the gold market. Over half of the total amount of that sale was bought by the Reserve Bank of India. That India acquired that gold didn’t come as a surprise. Several Asian central banks have expressed similar desires to be willing, if not eager, to increase their gold reserves. Investors should be mindful that sales by any European central banks will therefore not be likely to depress gold prices, but rather provide other central banks with the opportunity to acquire more gold. Timothy Green, author of “The Ages of Gold,” compares this desire to acquire gold by Asian banks to “the U.S.'s steady purchases in the 1930s and 1940s.”
It’s obvious that the European Union is in trouble. The mounting debt problems incurred by a few nations threaten the entire organization. Before anyone suggests that gold sales could help solve the European debt crisis, it wouldn’t. The amounts of gold held, while vast, would barely make a dent that problem. Instead, the concerns should be the way the central banks are attempting to manage that debt; they print money. Not only that, they circumvent their authorization to print money by trading currencies among themselves. That reeks of inflation.
While some observers believe a restructuring of some sort is inevitable, should any nation choose to go out on their own then a sale of gold from that country’s central bank is possible. That is because gold would be considered a viable form of credibility in backing that currency’s launch. That is what happened when the Euro was launched; the ECB backed it with gold.
There are many guesses and numerous ominous predictions on what can happen to the EU regarding a breakup or restructuring. A growing swell believes that it is likely that something extreme may happen, and that an individual country, or perhaps even more than one country, could find it necessary to re-issue their currency among them. Even if that were to transpire, the potential demand not only from fearful investors, but from other central banks could be expected to meet, or exceed any temporary created supply.
Even without the gold standard in force, gold still has retained an important function among central banks. It serves as a desirable backstop of last resort among global monetary reserves. Gold is exchangeable, and that quality keeps it the ultimate reserve currency, even among central banks. Decisions made by central banks influence money supply, relate to interest rates moves, and economic growth. Investors are now seeing financial stresses that make gold a desirable investment, even among other central banks. For now, expect European central banks to hang on to the gold they have. Meanwhile the entire available supplies of gold in the world, including all that is held privately is nothing when compared to the amounts of paper gold and underwritten risk in the global financial derivatives markets. But that’s another story.
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