Stars align for gold – the world’s ultimate reserve currency
Central banks have been buying up gold in record numbers.
It is never wise for anyone to claim they fully understand what’s driving gold because there are too many competing forces in the market for the metal, but over the past few weeks the stars have been aligning for gold, the world’s ultimate reserve currency.
This week’s upward move, which saw gold reclaim a price above US$1,700 an ounce, was attributed to a decline in the value of the US dollar, as investors fret about the results of the US mid-term election and an upcoming inflation report.
But an equally important factor was covered in a Small Caps story on Tuesday about central banks returning to the gold market.
Central banks scoop up gold
The importance of central banks purchasing a record 399 tonnes of gold in the September quarter for an estimated US$20 billion lies in fact the buyers are also the institutions which control the world’s paper currencies.
It’s going too far to say that some central banks are losing faith in the value of currencies issued by rival central banks, but that’s a thought for investors to consider because most asset purchases by central banks normally consist of buying and holding US dollars, yen, pounds, euros and other paper currencies.
But in one country it could be a case of the central bank making an investment in gold to protect itself from losses on its own currency.
Turkey’s buying-spree
Turkey, the biggest single buyer of gold in the September quarter is also a country with a rapidly declining currency caused by one of the world’s highest inflation rates, an annualised 85%, and rising.
The problem for Turkey is that its government is experimenting with a radical inflation cure – it is lowering interest rates just as the rest of the world raises them.
As cartoon character Homer Simpson might have said when he made a foolish decision “D’oh!”.
The Turkish central bank is countering the inflationary spiral created in part through government action by acquiring gold, 31t in the September quarter, taking its purchases this year to 95t.
According to the World Gold Council, central banks are buying gold at the fastest rate since 1967 which ought to be a reason for investors to think about their position because the institutions which print paper currencies are loading up with something else – the ultimate reserve currency.
Creasy’s rationale
Australia’s most successful prospector and billionaire investor, Mark Creasy, explained the relationship between gold and central banks to me about 20 years ago, shortly after the Bank of England made the world’s worst ever investment decision.
For reasons never fully understood, the bank decided it would be a smart move to sell half of its gold and reinvest the proceeds in the currencies of other countries, particularly the US dollar, the euro, and the yen.
This was based on a belief that it was safer to own a basket of currencies than a single commodity/currency which is gold.
Over a period of four years the bank sold 395t of gold at an average price of US$275 an ounce in a process which was followed by other central banks with a devastating effect on the gold price which remained depressed until the selling ended with a standstill agreement called the Washington Accord.
As Creasy explained, those events were particularly damaging for gold because it meant the biggest owners of an asset (33,000t between them) had decided that it had limited growth with greater prospects and greater safety would be found in the currencies of other countries.
The same argument can be mounted for property ownership. When big property investors start to sell it’s a signal for smaller investors to do the same thing because of a reasonable assumption that they know more about the market than anyone else.
An insurance policy
What the Bank of England did to gold in the 1990s is now being reversed by central bank gold buying, which is an enormously positive signal for the metal.
Another way of looking at gold is its role as an insurance policy, or sheet anchor, in an investment portfolio, something I touched on the last time I wrote about gold.
Back then, gold was trading at US$1,689/oz with its latest price of around US$1,708/oz a modest increase – but also an increase at a time when most other assets have been falling in value.
It’s even better for an Australian gold investors, because of the currency effect with the Aussie gold price up from A$2,514 in mid-September to the latest price of A$2,634, which is a 4.7% increase thanks to the exchange rate slipping from US64.7c to US64.5c.
Central bank gold buying could have a significant effect on the gold price just as Bank of England selling did in the 1990s with one enormous difference – this time the central banks believe gold is more likely to rise than fall.