Commodity Trade Mantra

Central Banks are Buying Gold and Hedging Against their Own Policies

Central Banks are Buying Gold and Hedging Against their Own Policies

Central Banks are Buying Gold and Hedging Against their Own Policies

So far, 2016 has been a good year for gold investors. The last few months have given renewed hope for the gold bulls.

2015 was a different story. There were certain moments that looked promising, but overall it marked a continuation of the bear market in metals that began somewhere around 2011.

But if there was a softening demand for gold in 2015, it apparently did not come from the central banks of the world. In fact, recent reports say that central banks added 483 metric tons of gold in net purchases. That is the second-largest accumulation of gold by central banks in a year since the end of the gold standard era.

Russia accounted for almost half of the net purchases, with China coming in a distant second. It is not surprising that Russia would be seeking gold in order to shore up its own currency. In addition, U.S. sanctions have given Russian officials incentive to diversify out of the U.S. dollar.

Not all central banks were net buyers of gold. The Canadian central bank has essentially sold off all of its reserves, although it was not a big amount to begin with. Venezuela also sold off large amounts, as the politicians there are in desperation mode. Venezuela is in a dire situation as a result of years of socialist policies.

It is not surprising that central banks were adding to their gold reserves in 2015, but it is interesting given the fact that gold fell below $1,100 per ounce last year, reaching levels last seen in 2009. So while many investors were apparently not enthusiastic about gold, central bankers saw a need.

In the first quarter of 2016, gold went up almost 15%, making it the biggest quarterly gain in a quarter of a century. We don’t know yet if this is primarily due to investor demand, or if central bank demand is the biggest reason.

2015 was not a quiet year globally, although there always seems to be some kind of turmoil and chaos. There has been war and terrorism, which could account for some buying, but that is sadly almost becoming the norm.

Are Central Bankers Hedging Against Their Own Policies?

It is also interesting that central banks have been on an unprecedented spree of creating money out of thin air. The big ones are the central banks of China, Japan, and Europe (the ECB). The Federal Reserve is really the one major central bank that is in a tight monetary mode right now. The Fed may not be hiking interest rates as expected, but the Fed stopped its last round of quantitative easing near the end of 2014.

So aside from the U.S., the other economic powerhouses of the world are in loose money mode. This really should be bullish for gold. But despite the loose money and negative interest rates in some places, price inflation has stayed relatively low. There is so much fear in these places that people are not spending their money. Who can blame them?

Right now, the economic fear of recession/ depression is overwhelming any fear of currency depreciation. This can change rather quickly, but people are preferring to hold on to the little money they have. This increased demand for cash and cash equivalents keeps a lid on consumer price inflation.

Some central bankers are not seeing things the same way. Then again, central banks are in a different position. They don’t have to worry about paying bills. They can print up more money if they need to.

It almost seems that the central bankers who are buying gold are hedging against their very own policies. You could especially accuse Chinese officials of this.

They likely realize that their policies of massive monetary inflation will lead to some bad consequences in the future that are more evident than now. Central bankers are getting away with their inflationary policies right now because prices aren’t rising at a fast pace. Still, these policies are distorting economic activity and misallocating resources.

Perhaps these central bankers realize that their currencies largely depend on the faith of the people to keep using them. If the central bankers cross a certain line – not knowing where exactly that line is – faith in the currency can quickly evaporate.

Gold is not only a hedge against currency depreciation; it is also a way to maintain some faith in the currency.

Even though there is no longer any gold standard in any country, a country with a large supply of gold reserves will be in a better position than a country without significant gold reserves.

If two countries are equally as bad in engaging in monetary inflation, perhaps the country with the higher gold reserves may hold up longer in terms of keeping some faith in the currency. Even though the gold doesn’t come close to fully backing the currency, at least it is something.

So while China is probably the biggest bubble in the history of the world right now, at least they are getting something right in accumulating gold reserves to soften a potential blow.

And Russia has had trouble with its currency. The central bankers there likely realize that, aside from a tight monetary policy, adding gold reserves is one of the other ways to strengthen the currency in the long run.

Over the last decade or so, we have really turned a corner, as central bankers have once again become net buyers of gold. This is likely to continue, and it is only going to benefit gold investors.

Some central bankers are hedging with gold. Now it is time for more investors to do the same.

 

 

 

Courtesy: Geoffrey Pike – Wealth Daily

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