Central Banks Join the Ranks Of Investors Who Like Gold

Is the world going back to a gold standard?

Not really. But with central banks around the globe holding more gold in reserve, it certainly has people talking.

Gold coins and bar
Gazimal | Iconica | Getty Images
Gold coins and bar

“We will see some derivation of a gold standard in the next 5 to 10 years," said Brian Hicks, U.S. Global Investors money manager, in a conference call this week with financial advisors and consultants.

A true gold standard would mean you could exchange paper notes for a fixed amount of bullion. While Hicks isn't suggesting that, he expects there will be “some percentage, perhaps 20%” of reserves will be in a “basket of currencies”.

When asked to clarify this comment after the call he added: “We have been seeing baby steps in the direction of countries holding more gold in their official reserves, and that this gold in effect is backing their currency.”

America gradually moved away from a gold standard beginning with World War 1. Then, in 1971, President Nixon closed the gold window, ending the ability of Americans to convert US dollars into gold at a fixed price gold of $35 an ounce.

"A handful of central banks are buying gold as a small portion of their monetary reserves," Jeff Christian, founder of CPM Group said. "There is a gigantic difference between that and governments collectively using gold as the basis for currency valuations—which is what a gold standard is."

Because the US is the biggest holder of gold in the world—with about 8,133 tons—the dollar is in some sense backed by gold, but not in the traditional sense of a gold standard.

"Dollar value is not backed by gold but by the sum of the U.S. government's assets, of which the military is our primary asset," Christian said.

When asked if we could return to a gold standard, Christian replied: "Only gold bugs are talking about this."

Still, Hicks' comment on a gold standard was just part of the bullish tone on the U.S. Global Investors conference call.

U.S. Global Investors’ Ralph Aldis led much of the call – he is Sr. Research Analyst and co-manager of U.S. Global Investors Gold & Precious Metals and U.S. Global Investors World Precious Minerals Fund.

Aldis gave a synopsis of some of the fundamental reasons for whygold has been rising starting with the basics: more demand, less supply.

About 3000 metric tons of gold are “consumed” each year—by the jewelry industry, investors and industrial users—while only about 2,200 tons are being mined. While the gold market has been more or less in that situation for years, sales by central bankers usually made up the difference. That is no longer true. In fact, central banks have become net buyers.

Hicks added some details after the call. “You are seeing central banks buying more gold," he said. (According to the World Gold Council, Saudi Arabia has more than doubled its official gold reserves, and Russia bought more than 25 metric tons in the first quarter of 2010).

"At the same time, European central banks are selling far less gold than in recent years,” he added. “Gold sales under the Central Bank Gold Agreement—the year for them ends in September, and so far only 41 metric tons have been sold—about one-tenth of the allowable amount.”

Aldis also discussed how China has become not just the biggest producer of gold in the world (325k tons/year) but also, how it is quickly turning into its biggest consumer.

None of the gold being produced in China, leaves China. It is all sold on the Shanghai exchange and purchased by the Chinese government - which takes an awful lot of production out of circulation.

In addition, Chinese consumers are being encouraged to diversify their assets and are buying gold for both jewelry and investment. And that gold is generally being imported into China.

Historically, there have been periods where gold stocks have outperformed bullion, and vice versa. But Aldis expects stocks to outperform the physical asset in part, because of differing tax treatments—especially relevant if you’re shopping for commodity ETFs.

Aldis said interest rates will need to go up and debt to go down before you see a headwind to gold. And with central banks here and in Europe fighting deflation, you may not see that for some time.

Finally, seasonal demand usually picks up in the August, September time period when the jewelry buyers step into the market.

“People have been waiting for the price to correct, but we have unusually high amounts of debt and we are not seeing the usual summer sell-off,” Aldis said. He suggested that investors watch for dips to get long during the summer lull and notes, “17 of the past 18 years we have had a seasonal rally.”