Central banks are buying gold bullion

The increased interest of monetary authorities in gold is sending a strong signal to investors to buy gold bullion. As central banks of many nations—most notably of India, China, Qatar, and Russia—diversify their official reserves by accumulating gold, bullion prices are likely to continue their move higher. Individual investors can buy gold bullion to approximate this investment strategy of the central banks so as to diversify their risks and capture a share of gains from a continued increase in gold prices.

Central banks are currently holding some 29,600 tons of gold, or 18% of all gold ever mined. This is still a smaller percentage than in the 1960s, when governments had some 38,000 tons of gold in their monetary reserves. When prices were low (and the U.S. currency as the anchor currency and a store of value was strong), central banks sold over 141.5 million ounces (4,400 tons) of gold. However, this year, for the first time since 1988, they are increasing their gold holdings by an additional 429 metric tons. This partly reflects an increased demand for gold by central banks in support of the IMF plan to sell 403.3 tons of gold in order to raise the funds that will be used to subsidize lending at lower rates to developing nations. However, a more important reason is the long-term strategy of many monetary authorities to diversify their dollar-denominated holdings into safer investment vehicles, such as gold.

For instance, since the beginning of 2008, the central bank of Qatar has been buying at least a ton of gold every month in an attempt to diversify some of its dollar proceeds from the sale of oil and natural gas. On the other hand, in October, in the single largest central-bank purchase in at least three decades, the Reserve Bank of India purchased 200 tons of gold from the IMF.  In the same month, the Russian central bank also purchased 15.6 tons of gold produced by its own mines. Russia's central bank will buy additional 30 tons of gold from the state repository, which should bring the country’s total gold stock to 5% of the gold reserve. Furthermore, the Bank of Mauritius added 2 tons of gold in November to its total reserves, while Sri Lanka purchased 10 tons. Kazakhstan, Venezuela and the Philippines will also add to their gold reserves this year. The dollar-rich Middle Eastern nations are likewise expected to buy gold bullion in order to diversify their excess exposure to the weakening U.S. currency. China, currently the sixth largest gold holder, also plans to increase its official gold holdings six-fold (to 6,000 tons) in the next three-to-five years.

It is relevant to note that past trends suggest that an increased demand for gold by the monetary authorities is followed by the bullion price increases. For instance, the surge in gold prices in the 1970s was partly caused by the surging demand for gold by the world’s central banks. The current lack of confidence in the U.S. economy and the long-term viability of the dollar as an anchor currency will likely boost demand for bullion by the central banks, thereby boosting bullion prices.

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GoldBuzzer,
Newsletter of the 31st December 2009