Gold Befuddles Bernanke As Central Banks' Lose $545
Billion on the Precious Metal
By Steven
Pomeranz | Submitted On October 18, 2013
Gold has been going down quite a bit
this year with the precious metal trading in the mid 12 hundreds down from
about $1.900 an ounce last year.
But investors aren't the only ones
to be losing money. As a matter of fact, Central banks across the world own
about 18% of all mined or above ground gold in the world, and collectively bought
535 tons of gold bullion in 2012... with Russia, the biggest buyer in 2012,
expanding reserves by 20%. But at about $1,300, gold prices are down 31% from
their $1,895 level in October 2011 and central banks have lost about $545
billion in book value on their gold investments.
By the way, I picked up some of this
data from an article titled Gold Befuddles Bernanke as Central Banks' on
Bloomberg.com.
While central banks were busily
adding gold to their vaults, investors were losing faith in gold... as a safe
haven, as a hedge against inflation and as a store of value. As a result, 2013
became a rather dark year for gold with gold ETFs losing about $60 billion or
about 43% in value, severely impacting many well known hedge funds. This year,
we've seen the biggest drop in gold prices since 1981, of course after rallying
for 12 successive years through 2012... so I guess something had to give.
The chairman of our central bank, Ben
Bernanke, openly admits that he does not understand movements in the price of gold...
this from a man who holds economics degrees from Harvard and MIT and has led
the Federal Reserve Bank through its biggest financial disaster in recent
years.
And Warren Buffett sees no utility
in gold because it moves to vaults once it's mined and has no tangible
producing power, unlike say steel.
Yet, our government holds about
8,100 tons of gold valued at about $344 billion with most of this gold stored
at Fort Knox in Kentucky. And since 1973, America's gold holdings have only
contracted by 5%... so despite Bernanke's befuddlement with gold price
movements, we continue to hold large reserves of bullion... because it
continues to hold value in human minds and the U.S. is better off holding this precious
metal than having none at all. I guess it's also sort of a doomsday backup.
So what is it about gold that makes
it such a favorite???
I believe it is gold's allure as a
lasting store of value. While policymakers such as Fed Chairman Bernanke may
not completely understand gold price volatility, they still find value in
preemptively holding it to shield their economies from inflation and continue
to buy it despite a history of buying high and selling low. For example,
central bankers reduced their holdings when the bullion reached a 20-year low
in 1999 but became net buyers just before prices peaked in 2011... but these
guys aren't stupid... their gold buying and selling decisions are based less on
price but more on gold's strategic value in helping them manage the economy -
so their purchases ignore near-term price volatility and focus on significantly
long-term holding horizons, and these spurts of buying by central banks
significantly impact gold supply and prices in the near term.
For example, the U.S., Germany and
Italy hold about 44% of all central bank gold and have only changed their
reserves by less than 3% since 1999. So they are long-term holders of gold and
near-term prices matter little to them.
Gold investors see it as a hedge
against inflation. So gold rose 70% from December 2008 to June 2011... because
the Federal Reserve went wild printing money for its various bailout and
quantitative easing programs... and spooked investors who thought this
excessive money printing would weaken the dollar, increase money supply and
trigger runaway inflation... But, fortunately, that inflation never came and consumer
prices rose only 1.7% annually from 2008 through 2013, well below historical
inflation of about 4.3%. So when various gloom-and-doom scenarios did not play
out as expected, gold started losing its allure and prices started to correct,
with gold down 22% in 2013 alone.
But gold bulls fervently believe
gold is still undervalued... partly because current gold price levels are
almost half of what they were in 1980 when you adjust for inflation. Gold was
at $850 in 1980 after the financial and political turmoil in the late 1970s...
but adjusted for inflation, today's price is merely $464 in 1980 dollars
according to the Federal Reserve Bank of Minneapolis.
Gold bulls argue that while gold is
below its 1980 level after adjusting for inflation, it has still outperformed
the U.S. dollar in purchasing power. For example, a dollar bought about 3
quarts of milk in 1970 while an ounce of gold bought 28 gallons. At the end of
2011, a dollar bought just about one quart while an ounce of gold bought 420
gallons. So on a purchasing parity basis gold has handily outperformed the
dollar. And this is partly why many think that holding gold is a reasonable and
prudent strategy.
On the flip side, analysts who have
been relatively correct about predicting gold prices see a deepening bear
market in gold and believe prices could drop to the $1,100 level in about 12
months, down from their current levels of around $1,300.
For all of gold's opponents, there
are many who fiercely believe in its value. In fact, frustrated with the
uncontrolled printing of dollars, many are pushing to get the U.S. back on the
gold standard - and pegging dollars in circulation to a fixed % of the amount
of gold we hold. Utah already recognizes precious metals as currency and
lawmakers in six other states are looking at accepting bullion coins as legal
tender.
But one of the challenges with tying
our currency to gold is the volatility of gold on geopolitical events and global
supply and demand - and this volatility could really bog down exports and
imports with currency uncertainties. Other problems with the gold standard are
that there just isn't enough gold available to meet expanding global economies
and a dependence on gold would make it very difficult to use financial tools
such as quantitative leasing to manage the economy. So the real question is why
would we peg our incredibly dynamic economy to the amount of some metal that we
sitting in our vaults, it just doesn't make sense. I said this to Congressman
Rand Paul on this show a few years back. He said that if we couldn't print
dollars, we wouldn't have the money to wage war. I responded by saying that it
never stopped countries from waging war before and they would just go to war
over the gold.
So for the foreseeable future, I
don't see our dollar getting pegged to gold but I think central bankers will
continue to add to their reserves as their own form of insurance, partly to
also prevent gold from getting into the wrong hands, and will continue to hold
it for the long run while investment and commercial supply and demand will
continue to dictate near-term gold prices.
