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Yes, central
banks are holding more gold. But they're holding very much more wood-pulp on
top...
The gold
price on Wednesday broke up through the downtrend starting at last summer's
record high. Or so a technical analyst studying the price chart would tell
you.
But just as
in late 2007 - from where gold began a 55% run inside 6 months - this week
the price of gold
bullion jumped on news that is fundamental: the price of money,
specifically Dollars, the world's #1 currency for trade and central-bank
reserves.
Back in 2007,
the catalyst came as a baby-step rate cut of 0.25%, signaling the Fed's
switch from raising to destroying the returns paid
on cash savings. Now the Fed's new zero-rate promise "took gold
comfortably clear of the 50, 100 and 200-day moving averages, and opened up
some big targets to the upside," says one London technician. The
previous ceiling of $1700 has become a support level according to bullion
bank Scotia Mocatta, "with further key support at the
200-day moving average at $1645."
Whatever you
make of such numbers, it's worth stepping back to
see the wood for the trees. Because the trend in who's buying gold, and why,
is so plain to spot that you hardly need join the dots.
Gold bullion holdings
amongst the world's central banks, for instance, have risen to a 6-year high,
according to data compiled by the International
Monetary Fund. Emerging and developing nations have swollen their gold
reserves 25% by weight since 2008. The debt-heavy West is a net seller, but
only just.
 
"There's
a perception perhaps that gold is no longer a crucial part of the financial
system in the way that it was under the Gold Standard before 1970,
1971," as Marcus Grubb of the World Gold Council put it in an interview
with Tekoa Da Silva this week. "But in fact that's
not really true.
"Because
even with the ending of the Gold Standard, gold remains as an asset held by
the world's central banks...and you've seen a trend recently for gold to
become more and more a part of the fabric of the financial system."
A good chunk
of this weaving is due to official reserves. But as our chart shows, central
banks control a shrinking proportion of what's been mined from the ground. A
far greater tonnage of gold again is finding its way into private ownership,
and there - as Marcus Grubb notes - it's having a greater still impact on how
money and finance work.
First,
private individuals have led the rediscovery of gold as a financial asset, rather
than the decorative store-of-value it had become by the close of the 20th
century. So now, China's giant bank ICBC for instance is holding gold for the
"accumulation" savings of 2.3 million citizens, a program developed
in partnership with the World Gold Council. Also the WGC partners
with BullionVault, amongst several other
private-investor providers worldwide. But institutional finance is catching
on, and gold is now in front of the Basel Committee
on global banking, proposed as a "core asset" for banks to hold -
and count as a Tier 1 holding - for their liquidity requirements.
After all, turnover
in London's bullion market, center of the world's gold trade,
is greater at $240 billion per day than all but the four most heavily traded
currency pairs worldwide. So its liquidity is barely equaled. Turkey's
regulators already acknowledged physical gold bullion as a Tier 1 asset for
its commercial banks starting in November, with the cap of 10% worth some 5.5
billion Lira ($2.9bn) according to Dow
Jones. And a growing number of investment
exchanges, meantime, as well as prime brokers, now accept gold as
collateral, posted as downpayment by institutions
against their commodity and other leveraged positions.
Gold bullion pays no
interest of course. But in our zero-yielding
world, that only puts it ahead of where the capital markets are being herded
by central-bank policy anyway. Nor does gold have much industrial use (some 11%
of global demand in the 5 years to 2011), a fact which highlights its
unique "store of value" attributes. Being physical property, gold
is no one else's debt to repay or default. Being globally traded, it's deeply
liquid and instantly priced. And being both rare and indestructible, it
couldn't be any less like "money" today.
Scarcely a
lifetime ago, gold underpinned the globe's entire
monetary system. Outside China, which tried sticking with silver, the
compromised and then bastardized Gold Standard
which followed first World War I and then World War II still saw the value of
central-bank gold reserves vastly outweigh the paper obligations which those
banks gave to each other.
Even three
decades ago, 10 years after the collapse of what passed for a Gold Standard
post-war, central-bank gold holdings still totaled some three times central-bank
money reserves by value. But look at the decade just gone - the 10 years in
which gold
investment beat every other store of value hands down. Pretty much every
currency you can name lost 85% of its value in gold. Yet the sheer quantity
of new money pouring into central-bank vaults saw their gold holdings only
just hold their ground.
Gold's rise,
in short, has been buried under wood-pulp. To recover its share of
central-bank holdings as recently as 1995 would now require a further
doubling in value. To get back to the 1980s' average would require a 15-fold
increase. Or, alternatively, a 93% drop in the value of foreign currency
reserves relative to central-bank bullion holdings.
Such a trend
is not yet in train, neither on the charts nor the fundamentals. The US
Dollar remains the biggest reserve currency, weighing in at 62% of stated
reserves according to IMF data,
down from its peak above 71% in 2001 but more than equal to its share in the
mid-1990s. Even so, as former FT columnist and current capital-markets
editor at The Economist Philip Coggan writes in his latest book, Paper
Promises:
"If
Britain set the terms of the Gold Standard [1870-1914], and America set the
terms of Bretton Woods [1944-1971], then the terms of the next financial
system are likely to be set by the world's biggest creditor - China. And that
system may look a lot different to the one we have become used to over the
last 30 years."
Coggan
rightly notes that China isn't the only large creditor, and nor does it hold
anything like the dominance which the US held at the end of World War II. But
whether this switch starts today or only starts to show 10 years from now,
such a change of direction can't be discounted to zero. Repudiation of
government debt - the form which most foreign currency reserves take - will
only begin with the Greek bond agreement, perhaps leading first to a rise in
US Dollar holdings but also highlighting the ultimate risk of paper promises.
That fear, of
having to write off money in default or devalued, is already driving the rise
in central-bank gold purchases.
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