Ten years ago, the western world’s central banks were selling gold from their vaults just as fast as they could… at a rate equivalent to 10% of annual demand, about 442 tons.
They didn’t see any further need for such an ancient symbol of monetary stability in the 21st century. After all, it paid no yield; it just sat there, incurring storage and insurance costs along the way.
So they opted instead to fill their vaults with “safe” sovereign debt, with its yields and interest.
Fast forward to today, and that same investment looks far from reassuring. And central bankers are finally beginning to see the light.
They now understand the value of gold, a store of value for 2,000 years and one free of liability.
Central banks are no longer selling gold; in many cases, they’re buying it. This makes for one of the most important developments in recent history for the gold market.
Even overlooking its psychological boost, it has removed a very real, very large source of supply from the market. In Europe, for example, central banks have all but halted sales of their gold reserves, ending a run of weighty disposals averaging 388 tons every year for over a decade.
From 2004 to 2005, the continent hit its peak selling 497 tons of the shiny metal. Compare that with the 6.2 tons it has sold so far this year, down 96% from 2009′s total.
Gold’s recent spike due to major power shift
Gold’s recent ascent to $1,300 an ounce also comes from a major power shift.
As Asian economies grow, their central banks and sovereign wealth funds have begun stocking up on bullion. This reflects the importance of gold in the region’s culture and history.
China gave the clearest sign of this new trend last year when it almost doubled its gold reserves. With 1,054 tons, the country has become the world’s fifth-largest holder of the metal.
Yet only 1.6% of its $2.5 trillion of reserves is in gold. If China increased the proportion of that gold to the world average of 10.7%, it would need to buy some 7,000 tons more. That equals three times what they mined globally last year.
More recently, other countries – including India, Saudi Arabia, Russia and the Philippines – all announced big additions to their official gold reserves. And even smaller countries like Sri Lanka and Bangladesh have made small purchases.
Precious metal consultancy GFMS says that central banks – led by emerging markets – are, as a whole, buying it up for the first time since 1988 this year.
That emerging market trend will likely continue too. The proportion of bullion as a percentage of official reserves in the BRIC countries, for example, averages just 5%. This compares with over 50% in the U.S. and most European countries.
Some countries like Russia and China may even be buying all of their own domestic gold mine output. That says something, since China now produces the most gold and Russia claims another large chunk.
Put simply, production from their mines will never hit the global market, thus supporting gold prices.
Gold has nowhere to go but up
Investors shouldn’t expect emerging markets’ central banks to make large purchases elsewhere though. In order to keep gold prices low for as long as possible, they have to buy more conservatively.
The global gold market simply cannot support large purchases. The entire global gold supply amounts to less than $200 billion a year, while global foreign exchange reserves come to $8.5 trillion.
So emerging market central bankers will wait for opportunities… like India’s 2009 purchase of 200 tons of gold from the International Monetary Fund.
And with the continuing problems in the periphery of Europe, more opportunities could arise. For instance, Portugal has over 80% of its reserves in gold.
It may have to sell some of that off in order to stay solvent, considering its current financial problems. And that would just shift economic power to the emerging world that much more.
With all those factors at play, gold can easily gain more. Adjusted for inflation, current record prices are far below what they touched in 1980: about $2,300 in today’s money.
Why now is the time to invest in gold
Gold even has famed hedge fund manager Paul Tudor Jones’ attention, who normally doesn’t like gold. He wrote last year: “I have never been a gold bug. It is just an asset that, like everything else in life, has its time and place. And now is that time.”
Investors can join the new gold rush through stocks such as Randgold ADR (NASDAQ: GOLD, Stock Forum), which has risen about 28% so far this year. And there are, of course, ETFs like Market Vectors Gold Miners ETF (NYSE: GDX, Stock Forum) and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ, Stock Forum), which focuses on smaller mining companies.
Or, SPDR Gold Shares ETF (NYSE: GLD, Stock Forum), a so-called paper ETF, claims to hold bullion in storage. But for investors who don’t trust any such thing, physical bullion and/or coins make excellent gold investments as well.
Disclosure: The author does not hold positions in any of the stocks mentioned