Gold Price Supported by Central Banks

By Dave Brown —Exclusive to Gold Investing News

The price of gold has already recently hit an all time high of $1911 per troy ounce and signs of it retracting towards a historical mean appear absent. This meteoric climb in the price of gold and the decade long rally has been supported by a dynamic and evolving series of macro economic concerns, which have impacted the United States dollar, and other traditional safe haven investments. The price of gold and forecasting any future target price has been the subject of numerous public debates and private conversations among investors, traders, speculators, politicians and central bankers.  However, if the level of interest in the price of gold is any indication of what is to happen in the future, perhaps it would be a worthwhile observation to follow the trend of the “smart money.”

Smart money

As a proxy for smart money, the central banks are public institutions that generally issue currency, regulate monetary supply, and control the interest rate for a nation. The executive controls on any capital invested by these institutions have been analyzed and stress tested by a series of financial professionals and could arguably be considered to be the choice of the well-informed, experienced or sophisticated practitioners.

Show me the money

According to the most recent data from the World Gold Council, the central banks have stealthily continued to accumulate positions in gold over the last six months. In March additions to reserves and trading for The Bank of Mexico resulted in a net accumulation of almost 79 tonnes of gold adding to the nearly 15 tonnes it accumulated the previous month. The acquisition of gold by Mexico over two months represented the largest accumulation of gold by a central bank in over a decade.

The second largest reported growth in gold accumulation over the last six months has been the purchase of 25 tonnes of gold from South Korea’s central bank in June. Of significance to investors is that this represents a 17 time increase in the size of their existing gold reserves. South Korea’s central bank currently holds less than 1 percent of its assets in gold and is the seventh biggest foreign exchange reserve holder with 64 percent of its reserves are in United States dollars. The bank also holds euros and other assets; further diversification to mitigate downside currency risk which will be of significant interest for gold investors to monitor.

With the exception of a small net disposition of gold by the Philippines during January and April, every central bank that has reported changes in reserve holdings over the last six months has resulted in a position of net accumulation for each of the institutions.

A medium lens timeframe

In April 2009, China announced very publicly that it had acquired 454 tonnes of gold over the previous six years. India purchased 200 tonnes of gold directly from the International Monetary Fund in October 2009. Russia has bought 280 tonnes over the last 2 years on the open market.  Over the past five years, gold reserves of the Russian central bank have grown by just less than 400 tonnes.

World Gold Council outlook

In the most recent quarterly report, the World Gold Council indicates that central banks’ purchases for the last three months more than quadrupled the comparative levels from the same time period last year.  The press release optimistically contends, “central banks are likely to remain net purchasers of gold.”  Marcus Grubb, Managing Director, Investment at the World Gold Council comments further, “The strength of demand in India and China, coupled with an overall drop in recycling activity this quarter, demonstrates that consumers have adjusted to the current price environment and expect the upward price trend to continue. In addition, ongoing macro economic uncertainty, the continued sovereign debt crisis and widespread inflationary pressures, will result in gold demand remaining strong.”

Investors will note that China only holds 1.6 percent of its assets in gold reserves compared with more than 70 percent by both the United States and Germany. Any mitigation of risk or diversification of the Chinese central bank would have tremendous implications for gold price appreciation and on the overall gold industry.

Cautionary note

Although there is not any documented empirical evidence to support the notion that central banks’ investments or “smart money” investments perform any better than “non-smart money” investments do, some speculation methods are predisposed to utilize the application and consider these transactions very seriously. The objectives, investment horizon and risk tolerance of investors are equally diversified with those of the central banks and should be monitored and regularly evaluated with actions to update on an as required basis.

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