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Central Bankers’ Secret Love Affair with Gold
Gold Trading Forecasts & Alerts
“Gold is a means of payment that everyone is always prepared to accept.”
–Mervyn King, former head of the Bank of England
On May 23, we published our view that the Federal Reserve is “the gift that keeps on giving,” in the sense that every time the Fed hints that they might raise rates, gold tends to fall, giving buyers another attractive entry point. By the same token, every time the Fed expresses more caution, gold tends to spike up.
On Friday, June 3, within 15 minutes of the release of a downbeat jobs report for May, gold shot up $30, from $1212 to $1243. Following that and other negative economic statistics released on Friday, Fed officials suddenly advised “caution.” By June 8, gold gained even more ground to $1260, due to more negative economic news releases. As we said here on our May 9 update, “Gold Loves ‘Bad New (and Bad Presidents) and we’re liable to see a lot more of both.” On Tuesday, June 7, gold rose strongly after Donald Trump and Hillary Clinton wrapped up their nominations. Gold shot up $12 the next morning.
One the biggest bullish factors in the price of gold moving forward is the “secret love affair” that many central bankers have with gold. When they see their currencies losing value, savvy central bankers load up on the key metal which has defined the value of money over the centuries, gold. The biggest gold-buying nations are those with a “depreciating currency” problem, like Russia and China. Last year, central banks bought 483 metric tons of gold. In the last five years, central banks have been net buyers of gold. *
*One metric ton is comprised of one million grams, or 1,000 kilograms, or 2,205 pounds, or 32,150 Troy ounces. At $1250 per Troy ounce, one metric ton of gold is currently worth about $40 million; 500 tons are worth $20 billion.
We just learned from the World Gold Council that the central bank of Russia bought 45.84 metric tons of gold in the first quarter of 2016. China was next (at 35.14 tons), followed by Kazakhstan (6.51 tons), a relatively poor nation which has now bought gold for the last 41 months in a row. Some nations are selling gold – Canada via coin sales and Venezuela to pay off some of its debts – but at the end of March 2016, central banks owned a total of 32,754 tons, or nearly 18% of the total amount of gold ever mined.
Over the last five years, central banks have almost fallen over each other in creating plans of quantitative easing (QE), lower interest rates and even negative rates. Currently over $10 trillion of global sovereign debt yields negative interest income – a guaranteed loss, even before inflation. In such an environment, it is no wonder that central banks have almost secretly been loading up on a much more stable asset – gold.
Four major Western nations – the U.S., Germany, Italy and France – are also the four largest holders of central bank gold. What’s more, gold comprises over 60% of their total hoard of foreign exchange.
In addition, The Netherlands is the #9 holder of central bank gold with 612.5 tons in their foreign exchange vault, 61.2% of their total. The Netherlands, like many European nations, has also recently repatriated a large amount of its gold from storage in the U.S. For the first few decades after World War II, many European nations held their gold for safe-keeping at the Federal Reserve Bank of New York, in fear of another European war. Now, after 70 years of peace, European nations are repatriating the gold.
Veteran Central Bankers Reminisce about the “Golden Era”
In 1965, President Lyndon Johnson took silver out of U.S. coins and the Treasury began to hemorrhage gold to foreign creditors who feared the gold window would also be closed. (That eventually happened in August, 1971 under Nixon.) In 1966, future Chairman of the Federal Reserve Alan Greenspan wrote a pro-gold article for Ayn Rand’s “Objectivist newsletter, titled “Gold and Economic Freedom.” He opened that article with these stirring words: “An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense – perhaps more clearly and subtly than many consistent defenders of laissez-faire – that gold and economic freedom are inseparable.”
Before he became Fed Chairman, Greenspan was Chairman of the President’s Council of Economic Advisors (1974-77) under Gerald Ford. In his book “The Map and the Territory 2.0,” Greenspan wrote a segment entitled “Gold is Special” (pages 264-267), describing how he defended America’s gold hoard in 1976 in a dramatic debate with Treasury Secretary William E. Simon and leading free market economist Milton Friedman, both of whom argued that we should sell our central bank gold at the then-depressed prices of $100 to $150 per ounce. As Secretary of the Treasury, Simon had more influence over gold sales than Greenspan, who was merely a staff advisor, but in this case the soft-spoken Greenspan and the even softer-spoken Fed Chairman of the day, Arthur Burns, but Greenspan won the argument. “In the end, Ford chose to do nothing and to this day the U.S. gold hoard is little changed at 261 million ounces.”
Just think what would have happened if Friedman and Simon had carried the day. Gold had fallen from $192 per ounce at the start of 1975, when Americans could finally own gold legally, to $104 in September 1976. If the Treasury had sold over 260 million ounces of gold in the open market, the price would have careened down to maybe $50. In the end, the Treasury would own no gold today instead of our world-leading 8133 metric tons of gold. Greenspan deserves credit for preventing a gold “fire sale” in the 1970s.
As for Mario Draghi, the current Chairman of the European Central Bank (ECB), when asked in 2013 why so many European nations and the ECB owned so much gold, he replied that gold is a “reserve of safety,” providing “fairly good protection against fluctuations of the dollar and risk diversification.”
And now we learn that Mervyn King, former head of the Bank of England, is also a fan of gold. In his new book, “The End of Alchemy,” he compares the machinations of central banks to the alchemists of old – those who tried through some magic formula to create gold out of base metals. Today’s alchemists, he wrote, “have thrown everything at their economies, and yet the results have been disappointing.”
Later, King told the World Gold Council in an interview (in Gold Investor magazine) that investors should own gold as an asset that is “negatively correlated or uncorrelated” to major stock and bond markets, adding “I am very struck by the fact that over many, many years, central banks, governments and individuals have always, despite the protestations of economists, held some gold in their portfolio. Obviously, there is no high running return, but when unexpected things happen, particularly when governments rise and fall, then gold is a means of payment that everyone is always prepared to accept. And I think that’s why even central banks have always had a role in their portfolios for gold.”
It’s important to note that central banks are not always very smart in their short-term timing, even though gold has beaten every paper currency over the long term. For instance, Great Britain sold 395 tons of their gold holdings in 1999, a year in which gold prices reached a two-decade low of $252 per ounce.
As this chart shows, central banks were net sellers of gold in most years from 1965 to 2008. Once central banks started printing more “fiat” (unbacked by gold) paper money, that caused a bout of high inflation, primarily during the 1970s. In the end, however, central banks came to their senses during the global financial crisis of 2008-09 and decided that gold was a good long-term alternative to paper money.
The more currencies depreciate, the more central banks will turn to gold, especially the poor nations seeking a non-inflationary alternative. Currently, China’s gold hoard represents only 2% of its foreign exchange reserves. The figure for Russia is 15%. With the ruble depreciating and the Chinese yuan in danger of devaluation, it’s likely that both those nations will continue adding more gold to their vaults.
As Mervyn King said, gold tends to “zig” when other investments zag. Private investors can also help create their own private “gold standard” by accumulating enough gold to make up 5% to 10% of their portfolio, replacing the depreciating cash and low-interest bonds as a proven source of wealth protection.