Hey, Did Someone Say Central Banks Are Buying Gold?

Includes: GLD
by: Market Blog

By David Berman

One of the key takeaways in The World Gold Council’s report on gold demand trends in the third quarter is that central banks are ramping up their purchases in a big way. The headlines alone are enough to make gold bugs weep with delight: “Central banks catch gold fever,” said the Wall Street Journal.

The numbers are certainly intriguing at first glance. According to the WGC, central banks loaded up on a net 148.4 metric tons of gold last quarter, more than double the amount purchased in the second quarter and about seven-times the amount purchased in the third quarter of last year, when banks bought just 22.6 tons of gold.

"Central-bank buying was a highlight of the quarter,” Marcus Grubb, a managing director at the WGC, told Dow Jones Newswires. “Statistics this year have been remarkable."

This is certainly the sort of news that gold enthusiasts have been expecting to hear. Europe’s sovereign-debt crisis has weakened the euro and called into question its future as a currency, the U.S. dollar remains fundamentally challenged and Japan has been doing everything it can to suppress the value of the yen. As currencies lose their allure, gold gains as an alternative.

However, this might not be as bullish as the World Gold Council would have you believe. For one thing, check out the reaction in the market: After the WGC’s report was released, the price of gold promptly fell to $1,737 (U.S.) an ounce, down $37. The market seems unimpressed, at least in the near term.

For another, details are a little weak. The WGC didn’t mention which central banks are doing most of the buying, but in the past it has been those of relatively small economies. It is hard to get excited about central bank gold-buying activity when such activity is being dominated by places like Bolivia.

As well, the WGC numbers show that purchases by central banks are relatively modest when compared with the overall totals. Overall demand – which takes into account jewellery demand, industrial demand and investment demand – rose a far more modest 6 per cent in the third quarter, over last year, to 1,053.9 tons. Therefore, central bank purchases represented just 14 per cent of the total demand. Is that enough to get excited about?

The thing is, gold is still dominated by investors, where demand surged 33 per cent in the third quarter over last year, even as jewellery demand slumped 10 per cent. Demand among gold-themed exchange-traded funds was particularly strong, jumping 58 per cent.

There is nothing wrong with investment demand, of course. However, as any gold skeptic will tell you, it can be fickle.