World Gold Council: Central Banks’ Influence On Gold Prices A Growing Bullish Force

October 22, 2012



Inflation Risk

The amount of money in the economy is clearly related to the rate of inflation — too much money chasing too few goods equals rising prices. So far, it looks like the policies have increased the monetary base without increasing the monetary supply in most countries. However, the WGC notes that monetary supplies are likely to increase over the long term, possibly leading to higher inflation.

Right now, the WGC notes, “While the inflation needle has yet to move, there appears to be a willingness to tolerate a higher rate of inflation in the future to ensure the sustainability of fragile economic growth.” The WGC points out that this is likely positive for gold investment.

Currency Impact

In the current economic environment, strengthening the economy often means boosting exports, and that, in turn means many countries want a weaker currency. These policies aimed at tweaking currency strength to increase exports also have an impact on gold prices.

Since gold is typically priced with reference to U.S. dollars, investment in the metal can provide a hedge against an investor’s concern about a U.S. “weak dollar” policy.

Looking at the strength of the U.S. dollar itself, it may be in trouble. Peter Schiff said during IndexUniverse’s Inside Commodities conference this month, “The closest thing I know to being a sure thing is that the U.S. dollar is going to depreciate. Faced with a weakening outlook, gold and other precious metals are a perfect hedge against the loss of purchasing power.”

Support Of Asset Prices

One interesting idea from the WGC analysis is that central banks are essentially gold buyers of last resort—if the price of gold halved, they would gobble it up as fast as they could.

By purchasing bonds, central banks have shown that they will also step in, such as they did with buying AIG bonds, to support the price of other assets. (In the case of AIG, the Fed managed quite a tidy profit when the last of the assets were sold off back in August.) The Word Gold Council puts it this way—“The willingness of central banks to engage in protective strategies provides an implicit ‘put’ option—an implied guarantee to prevent precipitous falls in asset prices.”

Given the propensity of emerging markets central banks to continue hoarding gold at current prices, the idea that there’s an implied put here makes a ton (pardon the pun) of sense.

Low Interest Rates

One motivation for unconventional monetary policy is the belief that households will increase spending in times of low interest rates. But, given low interest rates, households will have to save even more money to pay for future expenditures like retirement and college, because their savings are not growing as quickly.

The WGC suggests these low interest rates will likely cause a shift from traditional savings to investment in real assets that will “provide long term and real security.” Additionally, Western investors may look to emerging markets for investment purposes because the relatively higher real rates are attractive and the risk-adjusted returns “appear more favorable.”

This flow of capital from developed markets to emerging markets impacts wealth creation, and wealth creation drives gold demand in those emerging countries, where gold-buying as a store of wealth is often culturally embedded far more strongly than in the industrialized world.

WGC: Gold Is Good

In the end, it is no surprise that the World Gold Council is bullish on gold’s long-term strategic investment picture. “The backdrop of negative real yields, a slow recovery and a likely continuation of expansionary monetary policies—with all the risks these present—provides further support to the long-term strategic investment case for gold.”

(A quick note: The Investment Statistics Commentary replaces the Gold Investment Digest that was released by the World Gold Council until the second quarter of last year. Investment data is published monthly and is now organized by country. It covers price performance, exchange rate effects, correlations and volatility of gold and other assets. All other data on investment (amount and breakdown by type) is covered in the Gold Demand Trends report. The Investment Statistics Commentary is released quarterly and focuses on the economic, financial and gold market influences on gold performance.)

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