The Secret Return to the "Gold Standard"

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Although it happened more than 40 years ago, many Americans still rue the day back in 1971 when U.S. President Richard M. Nixon effectively took this country off the so-called "gold standard."

Under a true gold standard, paper notes are "convertible" into pre-determined, fixed quantities of the "yellow metal."

What actually happened back in 1971 was that President Nixon - facing huge budget and trade deficits, and a plunging dollar - enacted a series of economic moves, including the unilateral cancellation of the direct convertibility of the U.S. dollar into gold.

By slamming the "gold window" shut, Nixon also brought down the curtain on the existing Bretton Woods system of global financial exchange.

The fallout was immediate, creating a situation that financial historians still refer to as the "Nixon Shock."

Proponents of the gold standard say the real damage is still being wrought: That decision four decades ago led directly to the uncertainty, volatility and irresponsibility that we see in the U.S. economy and global financial markets today.

Whether you agree or not is a topic for another time.

But what I'm here to tell you today is that the world's central banks have quietly - almost secretly - returned the world to a new version of the gold standard.

Back in 2010, the world's central banks became net buyers of gold for the first time since 1988. Buying ramped last year and net purchases exceeded 455 metric tons (tonnes). That was the largest net purchase since 1964.

But the world's central bankers will handily eclipse the 2011 totals here in 2012: They will purchase a projected 493 metric tons this year as they expand reserves to diversify away from the U.S. dollar and protect their countries' economies against inflation, Thomson Reuters GFMS said.

And GFMS said you can expect central banks "to remain a significant gold buyer for some time to come."

Real Asset Returns Editor Peter Krauth told me he completely agrees with that assessment.

As Peter explained: "You can see their thinking, Bill ... you can see them saying: "We have enough of all these fiat currencies in our bank reserves - now we want something that's going to counter those holdings, that's a valuable asset and that has all the right fundamentals in place.' And that asset is gold."

We're seeing the results of this "new gold standard" in the marketplace...

For instance, gold had its biggest day in three weeks on Thursday after reports surfaced that central banks in Brazil and Turkey boosted their holdings.

Turkey purchased 6.8 tons in September, and Brazil added 1.7 tons - its first purchase in nearly four years.

The countries that are most-aggressively adding to their yellow-metal reserves include South Korea, The Philippines, Kazakhstan, Russia, Mexico, Turkey, Argentina and the Ukraine.

Gold has risen 11.1% so far in the third quarter and was up 16% on a year-to-date basis. It has outperformed virtually all of the world's top stock markets so far in 2012, according to a report by the World Gold Council.

And here's a key point: Central bankers aren't day-traders. So when they make a move like this, there's generally a long-term time view.

"All the fundamentals are in place for this to continue," Peter told me. "These guys tend to have a long time frame in mind. So when you see a shift like this, it's a big deal. And the chances are that this could last for a very long time."

In a recent report, 24/7 Wall Street did a nifty job ranking and analyzing the Top 10 global gold holders. To understand just how committed the world's central bankers are to this "new gold standard," let's look at a modified version of the news service's rankings and notes.

We'll rate which countries will be buyers, holders or sellers of gold (we're including the International Monetary Fund, or IMF, here as well, which brings our list to 11). And that will give us a big hint about the future direction of gold prices.

And we get to start here at home, with the USA:

1. United States

  • Gold Reserves (in metric tons, or tonnes): 8,133.5 tonnes.
  • Percentage of Total Foreign Reserves: 75.4%.
  • Gross Domestic Product (and Global Ranking): $15 trillion (No. 1 economy).
Buy, Sell or Hold (BSH) Gold: Washington keeps telling us inflation is no problem. And with the mountain of debt we've now taken on thanks to Wall Street's latest shenanigans, we may not be a buyer. But because of the way Team Bernanke keeps running its monetary printing press, we also can't be a seller. There's one wild card: America's massive New Energy reserves (natural gas and oil shale). If those reserves are fully exploited, untold wealth will be created - enough to turn the country from an over-extended creditor back into a true superpower. But that's a longshot right now. Hold.

2. Germany

  • Gold Reserves: 3,395.5 tonnes.
  • Foreign Reserves Pct: 72.4%.
  • GDP (Rank): $3.6 trillion (No. 4).
BSH Gold: The Central Bank Gold Agreement calls for Germany to be a gold seller. But as the captain of Team Euro - and to keep its own economic future from getting chewed up by the Eurozone Contagion - Germany has to maintain its underlying asset base. So even if it's not a buyer, you can bet it won't be a major seller. Hold.

2a. International Monetary Fund (IMF)

  • Gold Reserves: 2,814 tonnes.
BSH Gold: Although not a country with a central bank, the IMF is a powerful banker, with reserves hefty enough to take note of. It adopted a new income model and sold gold in the 2009-2010 timeframe as part of its plan to shore up its own finances - and brought in about $3.8 billion more than expected because of higher-than-anticipated gold prices. In late September, the IMF said it agreed to distribute $2.7 billion in windfall profits from the sales to subsidize loans to poor countries. To maintain its relevance, the IMF is supposed to keep a specific portion of gold in reserve. And sales are made slowly - over an extended stretch - to keep from hammering prices. Hold.

3. Italy

  • Gold Reserves: 2,451.8 tonnes.
  • Foreign Reserves Pct: 72%.
  • GDP (Rank): $2.2 trillion (No. 8).
BSH Gold: An economy so troubled that it's ranked as one of the "PIIGS" nations (Portugal, Ireland, Italy, Greece and Spain), Italy was also part of the Central Bank Gold Agreement. If it sells gold to raise money, it will lose the financial cushion it and other Eurozone countries will need if the EU disintegrates. But it also probably can't afford to be a buyer. Hold/Sell.

4. France

  • Gold Reserves: 2,435.4 tonnes.
  • Foreign Reserves Pct: 71.6%.
  • GDP (Rank): $2.2 trillion (No. 5).
BSH Gold: Like other Eurozone countries, France faces a quandary. It wants to remain a powerful economy, but has to navigate the EU crisis. It's part of the gold agreement. And new French President Francois Hollande rails against the austerity policies of his predecessor, and has economic initiatives he wants to implement. Those might force France to be a seller. However, like other EU countries, it will need a cushion in the case of a breakup or long malaise. Hold/Sell.

5. China

  • Gold Reserves: 1,054.1 tonnes.
  • Foreign Reserves Pct: 1.7%.
  • GDP (Rank): $7.3 trillion (No. 2).
BSH Gold: China added 454 metric tons of gold between 2003 and 2009. And all its plans and objectives - which include being the world's largest economy - will require it to inspire confidence, eradicate uncertainty and opacity, and become "transparent" to foreign investors. Adding hard assets like gold is a great way to do all that. It'll be a big buyer of gold going forward. Buy.

6. Switzerland

  • Gold Reserves: 1,040.1 tonnes.
  • Foreign Reserves Pct: 11.5%.
  • GDP (Rank): $660 billion (No. 19).
BSH Gold: Tiny Switzerland ranks 95th in the world for population and 19th for GDP, but is ranked No. 6 as a holder of gold for one simple reason: Tiny Switzerland is the world's private banker. Switzerland sold gold from 2003 to 2008. But as long as its private-banking cachet remains, this country will always be a big holder of gold. Hold.

7. Russia

  • Gold Reserves: 936.7 tonnes.
  • Foreign Reserves Pct: 9.6%.
  • GDP: $1.85 trillion (No. 9).
BSH Gold: Like China, Russia has some big-time global-economic ambitions. And like China, Russia will create a huge foreign reserves cache as it does so. Massive gold purchases will be a part of that formula - and already have been. A 24/7 Wall St. analysis demonstrated how Russia's gold reserves reached 784 metric tons by the first part of 2011: It added to existing reserves by purchasing 70 metric tons in 2007, more than 100 in 2009 and 120 more in early 2011. And while the numbers have yet to be released, the World Gold Council already has said that Russia added more gold, meaning the 937 metric tons figure we reported above is already outdated. Just like China, count Russia in as a big buyer going forward. Buy.

8. Japan

  • Gold Reserves: 765.2 tonnes.
  • Foreign Reserves Pct: 3.2%
  • GDP (Rank): $5.86 trillion (No. 3).
BSH Gold: Japan is trapped in an infinite loop of price declines that discourage investment and make consumers put off spending, which in turn weighs on demand and output. The government is planning a $2.5 billion stimulus infusion which 24/7 Wall Street reports is funded by gold sales. But an analysis done by another researcher back in April concluded that Japan, India and China were making big gold purchases. In the long-run, thanks to its aging population, Japan will need to be a buyer to support its massive monetary base. Hold/Buy

9. The Netherlands

  • Gold Reserves: 612.5 tonnes.
  • Foreign Reserves Pct: 59.8%.
  • GDP (Rank): $838 billion (No. 17).
BSH Gold: If you recall our July 2 report about "Tulip Mania" ("The Flowering Inferno"), then you understand that The Netherlands has a long history of wealth. That helps explain why such a small country has so much gold. Also worth noting is the fact that, despite being part of the gold-sales agreement, The Netherlands did not sell all that it could have. That probably means it's not going to be a big seller going forward - instead keeping much of what it has as a protective safety net as the Eurozone continues to bleed, or collapses completely. Hold.

10. India

  • Gold Reserves: 557.7 tonnes.
  • Foreign Reserves Pct: 10%.
  • GDP (Rank): $1.82 trillion (No. 10).
BSH Gold: India has been a steady buyer of gold for a long time, and now is a big buyer of the yellow metal. In fact, when the IMF sold its gold back in 2009, India muscled up and spent $7 billion to acquire 200 metric tons of the metal. You can bank on that aggressiveness continuing - for one very good reason: It's one of the easiest and most-effective ways for the government to support its currency in the face of a whipsaw economy. Buy.

Conclusion: If you're a true "gold bug," or are just an investor who's bullish on gold, you have to like what this list of the world's biggest holders of gold says about the direction of gold prices for the next few years. It's highly bullish.

Here's why. Even with the problems we see in Europe, none of the biggest holders look to be really huge sellers. And the buyers on this list look to be big buyers.

Remember, too, that the lion's share of the most-aggressive buyers - South Korea, Turkey, some nations in Africa, and the many others - aren't even on this list.

And here's one other great point that Peter made as we talked late last week: These secular trends tend to be pretty steady, on both the downside and the upside.

The fact that central banks were out of the gold market from 1988 to 2010 - 22 years - says that they'll be in the market for a long stretch, too.

"Even if you look at this conservatively, it's clear that we're just at the start of this - meaning the central bankers are going to be buyers for an extended period," Peter said. "Even if this upturn in buying only lasts half of [the 22 year downturn], we're talking 11 years - meaning we're only two years into this."

And that tells us there's plenty of money to be made from this no-longer-secret global return to the "gold standard."

"Some investors look at the current price of gold, and view it as expensive because it's more than doubled in the last few years alone," Peter said with an audible chuckle. "But given what I see coming at us, I can say this with a high degree of confidence: Three or four years from now, we're going to look back on this as a period when gold was still cheap, and where the profit potential was vast, because of where prices are going to go from here."

To how Peter is playing this bullish trend in gold, silver and other metals, click here.

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish… and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.

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