Monday, September 27, 2010

Central Bankers Go for the Gold

In recent posts on gold, I have been emphasising the shift in the demand curve as a result of new players entering the gold market. The buyers are major global players and the shift in the demand curve is likely huge. Put another way, this is not your grandfather's goldbug market anymore.

The new players don't buy quantities of gold coins and bury them in the backyard. They buy quantities of bars and store them in well protected vaults. Most forecasts on gold are likely to not be taking the buying from these sources in to account. Thus, the potential gold price climb is likely to be much higher than current forecasts.  Who are these new players? How about central banks.

FT has an important article out about central bank gold buying (I note that among the countries FT is reporting as gold buyers are countries, whose United Nations representatives spoke to me enthusiastically about gold last week.)

FT writes:

Evy Hambro, manager of BlackRock’s Gold & General fund, says the change in central banks’ behaviour is “one major factor supporting” prices. John Levin, head of precious metals sales at HSBC, simply calls the shift a “game changer”. It has propelled gold prices to an all-time high of $1,300 a troy ounce, touched last Friday. Adjusted for inflation, however, the yellow metal is a long way from its 1980 peak of more than $2,300.

The change – which today will be a main topic of discussion at the London Bullion Market Association annual conference in Berlin, the industry’s main gathering – is partly the result of a natural end to European sales after all the years of large disposals. But it also reflects the shifting global power map: as Asian economies’ might grows, their central banks and sovereign wealth funds are stocking up on bullion.

The clearest sign of the new trend is Beijing’s announcement last year that it had almost doubled its gold reserves: with 1,054 tonnes, it has become the world’s fifth-biggest holder of the metal. More recently, India, Saudi Arabia, Russia and the Philippines have announced big additions to their official gold reserves, while others, from Sri Lanka to Bangladesh, have made smaller purchases. Traders and bankers say further countries and their sovereign wealth funds are also quietly buying gold.

GFMS, a consultancy, estimates that central banks as a group will be buyers of gold this year for the first time since 1988... The proportion of bullion as a percentage of official reserves in the Bric countries – Brazil, Russia, India and China – averages just 5 per cent, compared with more than 50 per cent in the US and most European countries. That means developing nations are thought likely to buy gold to diversify the risk in their reserves. Recent buying by India and Russia, which is purchasing its entire domestic mine output, and suspected purchases by China in its domestic market indicate that the theory could be proved right.
Bottom line: You don't get buyers that are bigger than central banks. No one can move a demand curve like central banks can. The long term prospects for gold are very bullish. (However, gold buyers must be cautious of short-term pullbacks and be prepared to hold through such downdrafts.)

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