Gold Prices Won't Jump Because of Russia's 100 Tons of Purchase

Russia is planning to buy 100 tons of gold a year to replenish its reserves. There are a lot of hedge fund managers who have invested significant amounts in gold. Should we imitate Russia and hedge fund managers, and buy more gold? Facts first.

Investing in gold isn’t much different from investing in tulips. People buy it because they think they can sell it to other people when they want to. Gold doesn’t pay any dividends or generate any income. It’s just a piece of shiny metal, deriving its value from people’s expectations and its relative scarcity. Russia is planning to buy 100 tons of gold a year. The 5 foot, 8 inch cube would be valued at $4.3 Billion. Incredible.

Unfortunately, this isn’t a significant enough amount of gold to affect gold prices. There are currently more than 160,000 tonnes of gold held by investors and institutions. On top of that, every year 2,300 tons of gold are extracted by miners. So, Russia’s additional demand for gold is really a drop in the bucket. In 2010, Russia bought about 150 tons of gold for its reserves. So their 100 tons of gold purchase plan for 2011 signals a decline from 2010. This might even reduce the gold price rather than increase it.

During the 5 years ending March 2010, there were several countries that actually reduced their gold reserves as gold prices more than doubled. Here are the countries with the highest decline in gold reserves:

1. Spain: 46% decline to 282 tons of gold reserves.

2. European Central Bank: 35% decline to 501 tons of reserves.

3. Sweden: 26% decline to 126 tons of gold reserves.

4. Switzerland: 19% decline to 1040 tons of gold reserves.

5. France: 18% decline to 2435 tons of gold reserves.

Actually, during this five year period, only 4 countries with sizable reserves increased their gold reserves by more than 5%:

1. Saudi Arabia: 126% increase to 323 tons of gold reserves.

2. China: 76% increase to 1054 tons of gold reserves.

3. Russia: 72% increase to 664 tons of gold reserves.

4. India: 56% increase to 558 tons of gold reserves.

Saudi Arabia and Russia have huge foreign currency surpluses because of oil sales. China is the world’s largest gold producer, adding less than half of its production to its reserves. India doesn’t really have any sensible reason to buy gold with the capital it needs to build its infrastructure. Overall, there isn’t any significant official reserve demand for gold. Most of the demand for gold came from traditional consumers who use gold as jewelery. In recent years investors and hedge funds piled on gold with the expectation that inflation will drive prices higher. Insider Monkey doesn’t think this is a good time to imitate hedge funds’ gold trade. After all, we added gold to our portfolio when it was $550.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long physical gold.