HardAssetsInvestor

Written by Adrian Ash  |

January 30, 2012

Central-Bank Gold: Connecting The Dots

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While central banks are holding more gold, they’re holding very much more debt.

[This article previously appeared on Bullion Vault and is republished here with permission.]

The gold price last week 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 percent run inside 6 months – this week the price of gold bullion jumped on news that is fundamental: the price of money, specifically U.S. dollars, the world's No. 1 currency for trade and central-bank reserves.

Back in 2007, the catalyst came as a baby-step rate cut of 0.25 percent, 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 connect 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 percent 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, which is the 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 percent 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.