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Summary

  • At the end of 2013, central banks around the world held roughly 30,500 tonnes of gold, which translates into roughly one-fifth of all the gold ever mined.
  • To combat the demise of the U.S. economy, the Federal Reserve started to print dollars by the trillions. It has also kept the interest rate artificially low, near zero.
  • China's central bank increased its gold reserves 75% to 1,054 tonnes.

By John Whitefoot

Do the economic powerhouses think the global economy is getting better? Not if you look at the amount of gold they're hoarding. Over the last few years, central banks around the world have been on a buying spree; they are now the largest single purchasers of gold.

At the end of 2013, central banks around the world held roughly 30,500 tonnes of gold, which translates into roughly one-fifth of all the gold ever mined. Most of these holdings (last accessed July 9, 2014) are found in advanced economies in Western Europe and North America.

This seems odd when you consider most people/institutions only like to hold gold as a hedge against economic uncertainty. It's also odd when you consider how conservative central banks are when it comes to investing; after all, central banks are charged with maintaining the economy. The last thing you want to see is the central bank risking your country's financial security on penny stocks.

Economic Uncertainty & Geopolitical Tensions

Central banks started to increase their gold reserves back in 2008, amidst the financial crisis on Wall Street and collapse of the U.S. housing market. To combat the demise of the U.S. economy, the Federal Reserve started to print dollars by the trillions. It has also kept the interest rate artificially low, near zero.

The best way to protect your country's wealth against volatility as the world's reserve currency goes into a tailspin is to buy gold. And buy they did: between the first quarter of 2009 and the first quarter of 2014, China's central bank increased its gold reserves 75% to 1,054 tonnes. During the same time frame, Russia's gold reserve almost doubled (98%) to 1,040.71 tonnes, while India's central bank increased its gold reserves 56% to 557 tonnes (last accessed July 9, 2014).

During the so-called global recovery, the central banks in Turkey and Mexico bolstered their holdings in gold. Since the fourth quarter of 2010, Turkey has seen its gold reserves increase more than 315% to 483 tonnes. Mexico's central bank has seen its gold bullion reserves soar 1,640% to 122.75 tonnes over the same time frame.

Most recently, 2013 was a very strong year when it came to central banks and physical gold. Of the 3,756.1 tonnes of gold purchased in 2013, roughly 369 tonnes can be attributed to central banks. Aside from Russia and Turkey snapping up more gold, the central banks in Venezuela, the Philippines, Kazakhstan, South Korea, and Indonesia were the biggest buyers of physical gold in 2013.

The year 2013 marked the fourth consecutive year of net demand from central banks; before the collapse of Lehman Brothers, central banks had been net sellers of gold. So while gold prices were tumbling in 2013 and Wall Street was telling investors to dump gold, the central banks were fortifying their holdings. This was even after 2012 was the strongest year of central bank gold buying in nearly half a century.

Conservative central banks around the world remain interested in gold bullion even as the U.S. champions its economic recovery and record stock market run. In March of this year, the central bank of Iraq purchased 36 tonnes of gold to stabilize its economy. In just one month, Iraq's total gold holdings soared by 82.7%.

In May, Ukraine said it would take $1.0 billion out of the first portion ($3.12 billion) of its $17.0 billion loan from the IMF to buy gold. The remaining $2.0 billion will be used to pay bills.

Granted, gold bullion prices rally swiftly on the outset of geopolitical tension, but tend to spring back in the short term after the air seemingly clears. When the tension is prolonged, however…

The fact of the matter is that all is not well in the world, and the central banks know it. It's not that they're just buying gold - they're not selling it.

In 1999, major European central banks signed the Central Bank Gold Agreement, limiting the amount of gold its members could collectively sell in any one year. Since 2009, just after the U.S. economy tanked, major European central banks have essentially put a halt to selling their gold reserves. In fact, collectively, the European central banks have parted with less than 25 tonnes of gold, against a limit of 2,000 tonnes. And the limited sales that did take place were used mainly to purchase gold coins for collectors.

While the U.S. is championing its economic rebound, central banks around the world are viewing its economic data with a discerning, critical eye. So while the Federal Reserve is hinting it will raise its interest rates to cool inflation, the European Central Bank is working at keeping its interest rate low, even going negative.

What does global economic uncertainty (the U.S., Europe, China) and the ever-charged geopolitical landscape (Ukraine/Russia, Israel/Palestine) mean for gold bugs? Central banks are hedging their bets with gold. Do they know something we don't?

Yes, gold has retraced from its lofty 2012 highs, but after a spectacular 12-year bull run, a correction is in order. Even after a dismal 2013, gold prices remain resilient. With gold currently trading above $1,300, investors seeking a safe haven against economic and political uncertainty have sent gold prices up more than nine percent since the beginning of January.

Why are central banks snapping up gold bullion? Because they don't trust what's going on… anywhere.

Gold Bullion Bulls & Bears

Long-term gold bulls who want to capitalize on rising share prices and ongoing uncertainty might want to look into gold exchange-traded funds like SPDR Gold Trust ETF (NYSEARCA:GLD), iShares Gold Trust ETF (NYSEARCA:IAU), or Market Vectors Gold Miners ETF (NYSEARCA:GDX). Of course, there's always individual gold mining companies and physical gold.

More active investors will want to focus on futures and options.

Gold bullion bears might want to strengthen their portfolio with an ETF that shorts gold, such as ProShares UltraShort Gold ETF (NYSEARCA:GLL) or PowerShares DB Gold Short ETN (NYSEARCA:DGZ). Or even an ETF that shorts gold mining companies, such as Direxion Daily Gold Miners Bear 3X Shares ETF (NYSEARCA:DUST).

In the grand scheme of things, the 30% correction in gold bullion prices in 2013 isn't entirely abnormal. After all, nothing on Wall Street can go up in a straight trajectory forever - something investors should consider as they watch the S&P 500 and Dow Jones march into uncharted territory with reckless abandon.

The ongoing popularity of gold as a safe haven investment isn't all that odd when you consider the state of the U.S. and global economies and geopolitical tensions. If investors truly believe the best time to buy gold bullion is when there's blood on the street, now is clearly a great time.

Source: Is This Why Central Banks Are Snapping Up Gold?