Central Bankers Trust Gold More Than Money

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October 25, 2013 4:21pm NYSE:GLD NYSE:SLV

india-gold-etfJan Skoyles: Whilst I have argued that when it comes to the gold market this is China’s year, we should also not forget that central banks have played a key role as well.


I don’t mean in terms of leasing, price manipulation etc but instead there are some out there making the case for gold.

Last year when the Goldmans, Morgan Stanleys and UBSs of the world were making their 2013 forecasts many saw further gains in the gold price to be driven by central bank buying.

In the first six months of this year central banks have bought over 180 tonnes of gold, and on average have bought between 70-160 tonnes per quarter for the last couple of years. Q2 of 2013 signalled the tenth consecutive quarter of central bank buying (graph courtesy of WGC).

central bank gold demand

The purchasing of gold by central banks and the repatriation of gold reserves has meant that the role of such assets held by these institutions has come under much scrutiny of late.

Whilst central banks were given credit for their support for gold, this certainly was never in reference to banks in Western countries.

However, something odd has happened in the last couple of months. Not only have central banks been buying gold but those who haven’t have still been forced to defend their right to not just hold gold but to have a say in where it is held.

Western banks have openly discussed their desire to not only hang onto gold but also why it is so important that they do so. And in terms of where to hold gold the most recent campaign to repatriate such reserves has begun in Poland, joining a host of ongoing and previously successful campaigns.

Granted, few (if any) are buying more, but recently both the US Treasury and central bankers speaking at the 2013 LBMA/LPPM Precious Metals Conference reminded us how important central banks view gold to be, whether they’re buying it or holding it.

Fiat currencies of course came about as central banks didn’t like the apparent restrictions offered by a gold-back currency. Some wonder however if some institutions have had a change of heart as they work to protect reserves, in favour of exposure to the US dollar or campaign to return what’s theirs to home-turf.

Of course few expected Western nations to be the ones buying up gold, but we should also pay attention to these as between them they hold the largest gold reserves in the world.

Germany and their repatriated gold

At the beginning of the year the biggest story in the gold market was the repatriation of Germany’s gold reserves. Of course, this isn’t the first time Germany has decided to move some of its gold reserves. Between 2000 and 2001 930 tonnes were moved from London to Frankfurt in order to reduce storage costs.

As the powerhouse of the Eurozone and owner of the largest gold reserves in the region there were many questions surrounding the reasons for the latest decision?

At last week’s LBMA conference Clemens Werner, Deputy Head of the Market Operations Division, at the Bundesbank outlined the plan for the gold reserves’ whereabouts:

bundesbank gold reserve locations

Reasons given for the move were, as expected, nothing to do with currency risks and exposure to a dollar collapse. Instead Werner attributed the decision to the now non-existent Cold War threat and the launch of the Euro.

It is because of gold’s role in a diversified portfolio and its ability to absorb volatility and retain trust that the German central banker confirmed the Bundesbank has no intention to sell any of its 3,390 tonnes of gold.

Italy ignores pressure surrounding gold

Italy of course has a recent relationship with Germany when it comes to gold. In 1974 the country used 500 tonnes to collateralise bonds when it received a bailout from Germany of $2 billion.

More recently Italy’s gold reserves and their use as collateral have been the height of much speculation after the World Gold Council rather abruptly suggested the country use the 2,451.8 tonnes of gold held in reserves to offset high public borrowing costs.

This is not an option however, according to the Banca d’Italia. The top man at the central bank Salvatore Rossi reminded attendants at the LBMA of the “special role that gold plays in central banks’ official reserves.” One wonders if this was a subtle dig.

Rossi acknowledged the importance of value, even though his own currency has depreciated by 69% since 2000 (although the smallest amount of the major currencies assessed), ‘it is unique among safe assets owing to the fact that it is not “issued” by any government or central bank, so its value cannot be influenced by political decisions or by the solvency of any institution.’

Rossi argued that gold is an important component of central bank reserves due to its historical, psychological and political elements. He also appeared to make it clear that above all else the possession of gold reserves allowed central banks to assert their independence ‘As an element that enhances the resilience of reserves to abrupt falls in value in times of stress, gold underpins the independence of central banks and their ability to act as the ultimate guarantor of domestic financial stability.’

As a side note it is worth reminding readers that the ECB are not allowed to get their hands on member banks’ gold thanks to a regulation regarding central bank independence that prohibits the use of gold reserves to prop up an economy.

But like Italy and the WGC, this did not stop Cyprus coming under pressure when in April an assessment of their financing needs led many to suggest the country’s 13.9 tonnes be used to help the country raise the required 400 million euros.

US Treasury appreciates gold more than most

Earlier this month Brett Arends at MarketWatch took the time to ask the US Treasury if they had considered to sell the gold reserves should the budget crisis escalate. The answer was a flat out ‘no’; “Selling gold would undercut confidence in the U.S. both here and abroad,” a spokeswoman said, “and would be destabilizing to the world financial system.”

As Arends points out, the statement provided suggests even the Treasury acknowledges that the trust and faith instilled in gold is greater than that in the US dollar, our global reserve currency.

Now, many are likely to write in the comments below that the reason the US won’t be selling their gold is because they don’t have any to sell, having leased it all over the place. But that is not the point here, the US Treasury acknowledges that a government that holds gold is able to hold the trust of the markets far more than if they were to have none.

The Treasury does not hang onto the gold notion because it wants the markets to think it can use them as a last resort to clear debts, after all the official gold reserves of the US would barely keep the country afloat for a month, but rather because the value of gold is more powerful than anything the US is touting.

The grand plan for gold

When it comes to speculation over gold reserves many automatically head to the argument that there are grand plans to return to the gold standard. You rarely hear a discussion on China’s reserves without such a suggestion. To be honest, looking at the devaluation of sovereign currencies against gold, you can see how the argument certainly has legs.

Spet 13 perc dev of currencies

Ultimately though this graph should be for the individual investor. It’s all very well speculating over the plans of central bankers and whether or not they understand gold. This graph suggests that right now sound money and monetary policy is far from their minds.

What we must draw instead from the aforementioned comments of our central bankers is that it is important to have gold in your portfolio. Whilst its price action may be comparable to other assets you hold, its ability to maintain value and trust is second-to-none.

Central bankers clearly appreciate this. Whilst the gold standard is far from their minds, the option of selling gold is even further.

This article is brought to you courtesy of Jan Skoyles  from The Real Asset Co.


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