Today, I continue my investigation into the gold market. As you may know, I recently released a major report on a little known — but potentially huge — development in the gold space. The report also contains an interesting little way to play it.
On a related note, the following report from Kitco is very interesting…
‘Central banks’ appetite for gold has yet to be sated and continues to provide a strong pillar of support for the market as prices hold around $1,400 an ounce.
‘Official central bank reserve data is starting to filter through financial markets, showing that June was a busy month for gold purchases, and comes after a relatively quiet May, according to the World Gold Council.
‘Monday, the WGC updated central bank gold demand for May; in a statement Krishan Gopaul, analyst with the market intelligence group at the WGC said that reported net gold purchases in May totaled 35.8 tonnes, a drop of 27% from April. However, year-to-date purchase are up 73% compared to 2018.’
Up 73% on 2018 year to date?
In January this year, the World Gold Council reported that:
‘Central banks added 651.5t to official gold reserves in 2018, up 74% on 2017 and the second highest yearly total on record. Net purchases jumped to their highest level since the end of US dollar convertibility into gold in 1971, as a greater pool of central banks turned to gold as a diversifier.’
So 2018 represented the highest level of central bank demand for gold since 1971. And, so far in 2019, central bank purchases are up 73% on last year.
There are two highly relevant questions to ask here
Firstly, why are central banks loading up on gold at a record pace?
And secondly, if central banks are buying at record levels, should you be joining them? I mean, if central banks are buying, isn’t the gold trade kind of obvious?
To answer the first question, the simple fact is many years of quantitative easing by the world’s major central banks, and their inability to raise rates without crashing their economy, has left a huge amount of cash sloshing around the financial system.
This supply of cash is far in excess of investor demand for it. This is why asset prices have gone up so much. Cash is like a hot potato that no one wants to own.
It just keeps getting passed around and around, with each iteration bidding asset prices higher and higher.
Many emerging central banks don’t want to hold too many US dollars or euros as reserves. The obvious non-fiat currency candidate is gold. The Kitco article mentioned above quotes from a World Gold Council report:
‘“Several emerging market central banks — including Russia, China, Turkey and Kazakhstan — have dominated buying for a few years now, and this is still the case in 2019 with those banks [being] the four biggest buyers so far.”’
In the scheme of things, apart from China, these central banks aren’t exactly big hitters on the global stage. But the fact that their purchases can push central bank demand to near record levels is very telling.
It tells you that the amount of cash in the system (potential demand for gold) is huge relative to the potential supply.
And as I reveal in this special report, there are big problems brewing for gold on the supply side. We all know what happens when strong demand meets constrained supply…
What about the second question? Should you be thinking about gold if central banks are loading up? Aren’t they usually a good contrarian indicator?
The short answer is yes, you should still be thinking about gold.
Central banks buy gold for different reasons to investors. It relates to what type of reserves should they hold.
Investors operate differently. They ask, what type of asset class should I be in: stocks, bonds, property, cash, gold etc.
The answer to that question, especially for multi-billion dollar asset managers, is that it’s all relative.
Meaning that capital will eventually flow towards relative value. With the decade-long flood of central bank produced cash pushing up asset values all around the world, this is gold’s biggest selling point.
To illustrate, check out the chart below. It shows gold relative to the S&P 500. What the chart is saying is that an ounce of gold will buy you just 0.47 ‘shares’ of the S&P 500.
At gold’s peak in 2011, an ounce of gold bought you more than 1.6 ‘shares’ of the S&P 500. But it’s been a long period of relative underperformance for gold ever since.
In September last year, gold hit its lowest point relative to the S&P 500 in nearly 13 years. It’s since rallied though, and made a higher low in April. That suggests that gold might now be starting a period of relative outperformance.
This change of trend will get more investors interested, as capital seeks out value and momentum.
So from a relative valuation viewpoint, gold is still very cheap. And it looks to be trending higher. I can assure you, big global investors managing billions of dollars have noticed this too.
In my view, the current pullback in the gold price is a buying opportunity.
Editor, The Rum Rebellion
PS: I recently caught up with US gold expert Jim Rickards to talk about the truth behind the recent rise of the gold price in Australia. Click here to watch.