How We Benefit From Central Banks Supercharging Gold

by: Brian Foglia

Nowadays, it seems that every news cycle brings more evidence to bolster the bullish case for gold. The kicker is that most of this evidence comes not from gold bugs or bullion sellers, but from central banks themselves-- the so-called lenders of last resort. Within the past several weeks alone, central banks around the globe have announced tremendous gold purchases. Not only that, but the central banks of the world's richest countries (the Federal Reserve, Bank of Japan, European Central Bank, Bank of Canada, Bank of England, and the Swiss National Bank) launched a coordinated effort to make it easier for foreign banks to borrow dollars. This has the potential to very inflationary for the U.S. Both events are incredibly bullish for commodities in general, and gold in particular.

The price of gold has reacted strongly to this news. From Thanksgiving to December 2nd, its price has shot up about $66 per ounce. Mining stocks have been following suit as well. This makes sense, considering central banks (which have been net sellers of gold over the past several decades until a few years ago) are now scrambling to hoard the shiny metal. "Official net purchases of gold exploded in the third quarter, totaling 148.8 tons, more than double the entire amount of government buying in 2010," the World Gold Council recently reported. And that doesn't include the 19.5 metric tons of gold purchased in October by the Russian central bank. The Russians now possess 871.1 tons according to IMF data. Clearly these central bankers have dwindling confidence in the global financial order.

In summary, central banks are accumulating gold to hedge against future financial turmoil. Instead of central bankers driving down gold markets, as they have traditionally, they are now pushing them upward. I can't stress enough how bullish this is. If gold is not in your portfolio now, I recommend buying and holding as soon and for as long as possible. Let's review some ways to do just that.

The most conservative way to own gold is to buy the actual bullion and take physical possession. This allows you full control over your investment. The downside is it's not as easy to sell this way. It's not difficult, mind you, but you must find a reputable dealer to whom to sell it when the time comes.

An easier way to play gold is to go into the paper markets. GLD is an obvious option. Here are some others: The E-TRACS CMCI Gold ETN (UBG) is an exchange-traded note which seeks to replicate the performance of a basket of gold futures contracts. The futures are distributed among three month to three year contracts, so this product offers safety from purely short or long term moves in the gold paper market. This ETN is issued by UBS.

Next, there's the ProShares Ultra Gold ETF (UGL). This ETF seeks to provide twice the performance results of gold bullion. There's also the PowerShares DB Gold Double Long ETN (DGP). This is another exchange-traded note, but this one provides leveraged exposure to gold futures. It provides twice the performance of a portfolio of gold futures. This note is issued by Deutsche Bank, which means a holder of this ETN is exposed to the credit risk of this bank. On the other hand, unlike ETFs, ETNs have no tracking error. Which one you choose hinges on your personal preference. As with any leveraged financial vehicles, these are only for investors who have a high tolerance for risk and volatility. However, if you are very bullish on gold, these products may look very attractive.

The last way to play the gold markets that I'll mention is going straight to the source. There would be no bullion markets without the miners who dig it up. As one would expect, what's good for gold is great for gold mining companies. Although one could invest in particular companies, I prefer to diversify across the sector by buying mining ETFs. One such fund is the Market Vectors Gold Miners ETF (GDX). This fund replicates the NYSE Arca Gold Miners Index, which provides impressive exposure to some of the world's most established gold miners, small and large. It also boasts a low expense ratio.

Another mining ETF I'll mention is the Market Vectors Junior Gold Miners ETF (GDXJ). Like its sister above, this fund provides exposure to mining stocks from all over the world. Juniors are defined as small and medium cap companies which derive at least half their revenue from gold mining. This fund is riskier and more volatile because the companies are less established, but the most attractive aspect of this fund to me is the dividend yield. This ETF generates very generous dividends. The yield is presently 9.88%.

In closing, the gold markets have receded recently, and may continue to do so in the short-run, but the fundamentals are as strong for gold as ever. More demand from central banks, an ever-rising supply of paper money, and economic uncertainty are all propane on the flames of the gold markets.

Disclosure: I am long GDXJ.