Deficits, Dollar, Federal Reserve, Game Theory, Individual v. Collective, Treasury

Central Banks Stockpiling Gold

Gold, the safe haven investment for those wishing to hedge against inflation and debt, has been maligned by some traders as an emotional investment. Outspoken economists David Rosenberg and Peter Schiff have called for $3,000/oz and $5,000/oz (and possibly $10,000/oz) gold, respectively. David Rosenberg here and Peter Schiff here.

Peter Schiff’s case centers around the print and spend mentality of the United States, and also Europe as they stave off bankruptcy of member countries. Saving and production, he says, will have to be done by somebody other than China eventually. The Chinese simply cannot prop up America and Europe forever as the chief global lender. Schiff also looks for a 1:1 relationship between the Dow and gold, as was hit in 1980 and 1929. With Europe’s stance of printing as many euros as necessary to prevent default of member nations, he says he may have to up his prediction to $10,000/oz. Either way, Schiff says to look for gold and the Dow to converge.

Another reason to be bullish on gold is that Central Banks are upping their reserves. In 2009, central banks were net buyers of gold for the first time since 1997. As currency (see USD and euro) becomes a less desirable reserve asset, gold looks shinier and shinier. It isn’t tied to government monetary and fiscal policy across the globe, and it has tangible value.

Russia has increased their gold reserves by 26.6 metric tonnes in the first quarter 2010, or about $1.2 billion at today’s price, according to World Gold Council data. Russia added 117.63 tonnes in 2009.

Kazakhstan bought 3.1 tonnes, or $137 million, of the precious metal in the first quarter.

The Philippines acquired 9.6 tonnes, or about $424 million, of gold this year.

India increased its reserves by 55% last November in a purchase from the International Monetary Fund, or 200 tonnes.

And then there’s China. It should come to little surprise that China is a stealth buyer of gold. Like Russia, they purchase the precious metal from their own mines, and don’t always report their reserve levels. The largest producer of the metal reported in April 2009 that it had increased it’s reserves by 76% since 2003, or 454 tonnes. Given their exposure to US Treasuries, this seems like a shrewd move.

The gold rushes by central banks probably signal more than just diversification and emotions. There might be some sound thinking here.

We’ve hit many nominal all-time highs for gold as of late, the most recent being today at $1,258.30/oz, which beat yesterday’s record closing high of $1,248.20. Keep in mind, though, once adjusted for inflation, the all-time high was set January 21, 1980 at $2,163.62/oz, in 2009 dollars. Sure enough, if you do the Peter Schiff math, this was the 1980 1:1 relationship with the Dow he speaks of (in nominal terms). Each converged around $825.00. In other words, we’re hitting nominal highs, but we’re not in unprecedented territory.

Whatever your feeling about gold, it’s performance stacks up favorably next to almost any asset. The following 5-year spot price chart beats stocks, real estate, and seems steadier moving forward given its reactionary logic to government policy.

Click for larger image

Source: BullionVault.com

If you had moved your portfolio into gold in March 2008, upon the collapse of Bear Stearns, you would have enjoyed about a 28% gain during this financial crisis, recession, and economic turmoil. I choose this entry point not because it is an ideal price floor, it isn’t. Only because if you were completely clueless about the state of global finance and fiscal and monetary policy up to that point, you could have woken up then, and moved at least a portion of your assets into gold. For the last 5 years, the average annual return on gold is about 37%. As far as buy and holds are concerned, that’s a nice 5-year run.

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