If the global economy is really improving after five years in the sin bin, why are the central banks of the world buying gold?
That is a question which can only have a disturbing answer.
Either the bankers, arguably the best informed bureaucrats in the world, do not believe what their political masters are saying, or investors have been lulled into a false sense of security and conventional asset values, such as property and shares, have further to fall.
Whatever the reason, it seems that a number of the people who should like gold the least are betting a portion of their country’s savings, and their reputations on a metal once famously tagged a “barbarous relic” with no place in a modern economy.
For most investors, reports that the Bank for International Settlements (BIS) had quietly acquired an estimated four-to-six tonnes of gold last Friday represents a clear signal that gold should retain its role as a core component of a well-managed portfolio.
The BIS is yet to confirm how much gold it did acquire, but a number of close observers of international markets, including the Swiss bank, Credit Suisse, have told clients about what they saw as “aggressive central bank buying” of gold.
The buying has lifted the gold price, but only modestly. From around $US1645 an ounce before speculation started about the central banks entering the market the price flicked up to around $US1664/oz.
Australia’s dollar, which is seen as being closely tied to the gold price (and the health of the Chinese economy), has almost moved back up above $US1.06.
Tracking either the day-to-day movement in the gold price, or the value of the Australian currency, is secondary to what it means to have central banks acquiring gold at a time when it might reasonably have been expected that they would sellers.
Since the rescue of Greece from financial oblivion it has been popular to believe that the worst is over for the global financial system.
That’s why share prices in New York have climbed to their highest level in four years, the European currency, the Euro has stabilised, and optimistic projections about future growth have displaced pessimism about continued contraction.
Gold, which plays a sheet anchor role in times of financial turmoil, was seen as having done its job and would now slide back closer to the US$1000/oz mark than again challenge the $US2000/oz barrier.
Perhaps the $US2000/oz remains a target because a number of central banks, though buying on their behalf by the BIS, have locked in a high entry price, which means they are happy with what they paid, but more importantly it means that the most important players in the gold market are buyers, not sellers.
To understand what it means to have central banks buying it is handy to refer back to the thoughts of Perth’s own Mr Gold, Mark Creasy.
Back in September, 2009, the man who made his fortune selling the Bronzewing and Jundee gold discoveries, and continues to fund one of the world’s biggest private gold exploration programs, spelled out the importance of the central banks in these comments to me.
“Scrap gold, and even mine supply, aren’t really the big players in the gold market,” Creasy said.
“There’s about 160,000 tonnes of gold in existence, and the world produces about 2000 tonnes of freshly-mined gold a year, and about 1000 tonnes is generated as scrap.
“The total amount of mined gold is less than 1% of the overall market. The mine supply isn’t all that important in the gold price. It’s all about sentiment.
“The people who will influence the value of that 160,000 tonnes are the biggest shareholders, and they’re the central banks, which own about 30,000 tonnes.
“Gold is a bit like a company which has a dominant shareholder. If everyone believes the dominant shareholder is selling the price will drop like you wouldn’t believe.
“A major influence is how people see the biggest shareholders handling their gold.”
On the day Creasy said that, gold was trading at $US919.75/oz. It doubled over the next three years and even today, after a substantial correction from its all-time high of $US1920/oz is 81% higher than when he made the case for the influence of central banks in the gold market.
It will be interesting to see how the market interprets the latest buying, though one point is clear. There are a number of central bankers who do not believe the global financial crisis has ended with the printing of vast amounts of extra cash in Europe and the U.S.
As Gavyn Davies wrote in The Financial Times last week: “You cannot solve a debt crisis by creating more debt”.