Gold’s Old Enemies: Allies in 2010

By Marc Davis, BNWnews.ca

Central banks – the long-time nemesis of the gold sector – are doing an about-face to become its biggest supporters. And this quantum shift promises to gather momentum in 2010 with the prospect of a new era of net buying continuing to fuel robust demand for bullion.

So say several of the world’s most prominent gold fund managers and investment industry gurus. They include John Embry, a renowned, long-time gold advocate and the chief investment strategist at Toronto-based Sprott Asset Management, which runs the Sprott Gold and Precious Metals Fund.

“I think central banks will most certainly underpin the price of gold next year,” Embry says.

In fact, he believes the advent of net central bank purchases of gold is “virtually assured” in 2010 and beyond. Most notably, next year promises to be the first in over two decades that central banks opt to buy more gold than they sell.

Embry’s prescient predictions in recent years about gold’s inevitable ascendancy are not just being validated by jittery central bankers. Since last year’s financial crisis, there has also been a buying frenzy among many of the world’s multi-billion dollar hedge funds, as well as plenty of other institutional investors and of course legions of individual speculators. All have been buying in record amounts. And most are venturing into the gold sector for the very first time.
Similarly, gold-backed Exchange Traded Funds (ETF’s) are attracting ever-increasing numbers of rattled investors, who view gold as the ultimate hedge against a weakening US dollar and continued instability in the US economy. The prospect of a continuation of low interest rates for some time to come is also adding to the yellow metal’s universal appeal.  
Among the various other movers and shakers in the investment industry who are boldly endorsing this new Gold Rush is London-based Evy Hambro, who runs two of the world's largest commodities funds, BlackRock World Mining Fund and the Gold & General Fund. 

He too is also forecasting a paradigm shift in central bank gold transactions in 2010, which he argues will provide bullion’s spot price with continued support in its current lofty trading range – in excess of the $1,000-mark. 

"Gold's role is gathering a lot more attention in terms of risk diversification," he adds with a quintessentially British penchant for understatement. .

Another gold advocate who has his finger on the pulse of Europe’s largest financial marketplace is Nick Brooks, head of research and investment strategy at ETF Securities in London. He agrees that we are witnessing a global paradigm shift. One where major sovereign investors (state-owned investment funds), in particular, are increasingly hedging against an ailing dollar in favor of bullion.

"India is likely just the tip of the iceberg with China, Russia and other major emerging market central banks indicating their interest in building their holdings of gold as part of their diversification away from the U.S. dollar," Brooks says. "This appears to be a structural change that may support the gold price on a medium to longer term basis."

That said, there still remains one big seller that continues to cast a shadow over gold’s increasing luster – the International Monetary Fund (IMF). It is still committed to its well-publicized goal of unloading a remaining 201.3 tonnes of gold to raise money for its lending activities. Originally, it had over 400 tonnes to sell.

However, an announcement that India’s central bank bought 200 tonnes (6.43 million ounces) from the IMF at an average price of $1,045 an ounce in late October was a defining moment for the gold market. It represents the first overt move by a major central bank to aggressively diversify out of its foreign-exchange currency reserves, especially US dollars.

It also gave gold a huge psychological boost by alleviating concerns that the IMF would gradually ease its holdings onto the market and cap gold’s price upside as the Bank of England did a decade ago. (Net sales by the Bank of England and other European central banks were instrumental in depressing bullion’s price in the late 1990s).

Now there is considerable speculation that other major buyers will emerge among the world’s largest central banks to soak up the balance of the IMF’s overhang on the market. Certainly China is among them. Its official policy is to exchange a larger percentage of its $2.7 trillion in mostly US dollar-denominated currency reserves for hard assets. China is already the world's leading hoarder of gold, having revealed in April that it held 1,054 tonnes – a jump of 76% from its last official tally six years earlier.

Embry, who has been following the gold sector for over 30 years, believes that Chinese officials must be keenly eyeing the remaining 200-plus tonnes of gold that the IMF has up for grabs. Yet, he notes that Beijing has to date proven to be a shrewd and “very clandestine” buyer that prefers not to over-excite the gold market by signaling its intentions to speculators.

In fact, China’s central bank was positioning itself to try to buy, at a discount, all of the gold that the IMF originally had for sale before “India stole a march on everyone” with its brazen buying spree, Embry says.

He believes that the Chinese are therefore probably loathe to paying a premium to India’s $1,045 average purchase price, especially since the headline-grabbing trade fueled a parabolic rise in gold prices (around $170) in November and early December before a pronounced pullback ensued.

Yet, there are plenty of other much smaller gold-hungry central banks elsewhere in the world, especially in Eastern Europe, that may not wait to see if gold drops much further before they act, Embry says.

“I think the rest of the IMF’s gold will be spoken for without any difficulty…I expect somebody to come out of the woodwork, including the Russians, who are continually adding to their reserves,” he adds.

Indeed, central bank officials the world over are waking up to the fact that their predecessors acquired gold reserves in the first place to stave off currency devaluations. And that impetus is once again taking on a heightened importance against a backdrop of “continued economic and currency uncertainty, and inflation concerns.” This is the conclusion of a recent report by the London-based World Gold Council.

“In the official sector, we expect to see a continuing trend of central banks diversifying their dollar exposure in favor of the proven store of value represented by gold," the report adds.