Establishment continues to diss gold while central banks buy

Since gold topped in September at $1920, the Establishment has continued to disparage gold, nearly always warning of gold’s volatility.  The warning is valid.  Gold is volatile because its price reflects the emotions of buyers and sellers.

The warnings nearly always highlight gold’s 10% drawback from its September high but rarely notes that gold is up 600% over the last ten years.  And, it needs to be kept in mind that the same people who today diss gold told investors not to buy at $300.

Contrasting the Establishment’s negative position on gold is central bank buying.  And, nothing is more Establishment than central banks.  So, while the Establishment tells the investors not to buy gold, central banks  buy.

In the third quarter central banks, made their largest collectively quarterly gold purchases in four decades, adding 148.4 tons to their holdings, which puts central banks on track to buy more gold this year than in any year since the collapse of the Bretton Woods Agreement in 1971.  Over the last two decades, central banks were net sellers of gold, led by the Bank of England’s now infamous liquidation at the market bottom a decade ago.  Last year central banks became net buyers of gold; this year they are set to buy record amounts.

Central banks do not buy gold impulsively.  They normally set targets early in the year for the percentage of reserves that they want to hold in gold; to achieve those targets, central banks buy dips as they occur.   This, of course, puts an underpinning on the price of gold, and it appears that central bank buying provided the impetus for gold’s strong price action in September, weeks after gold topped.  Now, with gold selling off sharply over the last few days, central banks are looking at another opportunity to buy cheap gold.

Although Russia, Thailand and Bolivia disclosed recent gold purchases, most of the buyers that made it a record quarter have not yet been identified, but many are, according the World Gold Council, emerging nations.   Even the poor want to own gold.

All this begs the question:  Just how much gold are the central banks likely to buy?  One would have to be omniscient to know that.  However, we can look at the central banks’ potential for buying gold.

The most likely buyers are those central banks with large reserves but whose gold holdings make up a low percentage of those reserves, typically Asian nations.  Conversely, the central banks of countries that have high percentages of gold holdings are not likely to be buyers, Western nations.

The unlikely buyers include the United States (75.5%), Germany (72.6%), Italy (72.2%), France (71%) and the Netherlands (61%).  Other countries actually hold higher percentages in gold, but their total gold holdings are small compared with above mentioned countries.  Those include Portugal (88.9%) and Greece (80%).  (Italy, Portugal and Greece are more likely to be sellers than buyers as they are members of the PIIGS group of European counties that are facing serious debt problems.)

The counties with huge reserves but low gold holdings are China (1.7%), Japan (3.3%), Russia (8.6%) and Taiwan (5.7%).  Other notables are Brazil (.5%), which recently added gold reserves, and India (9.0%), which purchased 200 tons from the IMF in 2009. Additionally, Thailand is a recent gold buyer.

China’s total reserves are some $3.2 trillion but gold makes up only 1.7% of its reserves.  Japan’s central bank has more than $1.1 trillion in reserves, of which gold makes up only 3.3%.  Russia has $516 billion in reserves with only 8.6% being held in gold.  (The Russians are important in the gold market because they have shown to be steady buyers of gold albeit it quietly and domestically.  India, also an important player in the gold market, has shown a willingness to buy large in open transactions.)

One of Wall Street’s favorite bullish indicators is “cash on the sidelines,” which measures total cash held by mutual funds and entities that may enter the market.  Large quantities of cash on the sidelines is a significant bullish indicator according the Wall Street.  Nowhere is more cash on the sidelines than in the gold market. This includes not only the cash holdings of central banks but also the cash holdings of individuals.