Friday, March 19, 2010

Central Banks Snap Up Gold At Historic Levels

As confidence in fiat currency continues to wane, central banks have been increasing their gold holdings at levels not seen since 1964. The historic significance of 1964 was the shift in monetary policy by the US that resulted in increased money printing that preceded an explosion in gold prices. See the following post from Expected Returns for more on this.

As the fundamental flaws of major currencies become more apparent daily, investors around the world will take on a defensive posture and buy gold. The shift away from a fiat currency system centered around the dollar is well underway, and the window of opportunity to buy gold at reasonable prices is closing. From Bloomberg, Central Bank Gold Holdings Expand at Fastest Clip Since 1964:
Central banks added the most gold to their reserves since 1964 last year amid the longest rally in bullion prices in at least nine decades, data compiled by the World Gold Council show.

Combined holdings rose 425.4 metric tons to 30,116.9 tons, an increase worth $13.3 billion at last year’s average price, according to the data. India, Russia and China said last year they added to reserves. The expansion was the first since 1988, the data from the London-based council show.

Central banks, holding about 18 percent of all gold ever mined, are expanding their holdings for the first time in a generation as investors in exchange-traded funds amass bullion as an alternative to currencies. Holdings in the SPDR Gold Trust, the biggest ETF backed by the metal, are at 1,115.5 tons, more than the holdings of Switzerland.

“There’s clearly been a renaissance of gold in central bankers’ minds,” said Nick Moore, an analyst at Royal Bank of Scotland Group Plc in London. “It’s not just been central banks taking on gold, but a general shift for physical gold in the investment sector.”
In a clear sign of what lies ahead, central banks are adding to their gold reserves at the fastest rate since 1964. In 1964, Charles De Gaulle was calling for a sweeping change in the international monetary system in which the U.S. was allowed to print as many dollars as it wished without affecting its value, at least relative to gold. De Gaulle was, quite justifiably, concerned about the growing trade imbalances between the U.S. and the rest of the world.

Once Charles De Gaulle started exchanging his dollars for gold, central banks around the world started following suit, which led to the eventual breakdown of the Bretton Woods system in 1971. Gold promptly rose from $35 dollars an ounce to $850 dollars.

What's telling about this time period is that economists universally believed that an upward revaluation in gold was unlikely. Remember, most of these economists only understood the de facto gold standard system in which imbalances in trade had no consequences. Most people were caught off guard by the rampant inflation that followed in the next decade.

The same skepticism pervades today as most economists can not fathom a move away from the dollar as global reserve currency. Every economist alive today has only lived through a period when the U.S. was the dominant global player both economically and politically. As such, no one questions the primacy of the dollar, even though gold has already risen from $250 dollars to over $1120 dollars in a stealth debasement of the dollar.

The dollar will eventually be revalued relative to other currencies and gold; there is no other way out of this debt crisis. The only question is how severe this revaluation will be. With Bernanke leading the way, I'm pretty sure there will be a stampede out of the dollar eventually.

This article has been republished from Moses Kim's blog, Expected Returns.

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