Gold Prices: Central Banks See Shine in Yellow Metal

When Federal Reserve Chairman Ben Bernanke failed to hint at more monetary stimulus last week, gold prices took a small hit.

But the picture for gold investors just brightened again thanks to increased activity from central banks.

Central banks are buying the yellow metal in copious amounts, marking the first time since 1965 that bankers have been such steady buyers.

Central banks amplified their gold stores by 400 metric tons, the equivalent of almost 2,205 pounds, in the 12 months through March 31. That was an increase from 156 tons in the same period a year ago, according to data from the World Gold Council.

Barron's reported Saturday that the World Gold Council "is now confident that central banks will continue to buy gold and has added official sector purchases as a new element of gold demand," according to a report from London-based bullion dealer Sharps Pixley.

The fresh facts indicate that central bank purchasing will continue for the foreseeable future.

That is quite a turnaround from the heavy selling the banks made from 1966 through 2007. During that time central bankers engaged in substantial selling, with only short periods of meager buying.

Emerging Markets Lead Gold Purchases

The bulk of the buying has come from Asian and emerging market central banks, which typically hold a lesser share of their currency reserves in bullion than developed economies.

Kazakhstan's central bank announced it will increase the share of gold in its foreign exchange reserves from about 12% to 15%. The country is bulking up on gold while slashing its holdings in the besieged euro by one-sixth.

"World practice shows that holding up to 15% [of gold] is what should be done, depending on the performance of the dollar and the euro," Kazakhstan's central bank deputy chairman Bisengali Tadhiyakov told reporters.

Former Soviet republic Kazakhstan joins Russia, Mexico, Colombia and South Korea as the countries that have bumped up their official gold reserves in recent years.

Following the end of World War II, central banks stockpiled gold, as it was fundamental to the global financial system as set out in the Bretton Woods agreement of 1944.

But when President Richard Nixon took the United States off the gold standard in 1971 (the "Nixon Shock"), it undermined the Bretton Woods system. Banks no longer required so much bullion, and the selling began.

Central banks again took a shine to the yellow metal at the height of the 2008 financial crisis. As the U.S. Federal Reserve attempted to stimulate the economy by printing money, central banks in emerging economies looked for ways to diversify from devalued dollars and other fiat currencies, and began acquiring gold.

Jeff Christian, founder of New York-based commodities consulting firm CPM Group, told Barron's that central banks "will probably be continuous buyers of small volumes of gold for the foreseeable future," accounting for roughly 10% of the gold supply.

Christian noted that central bankers will avoid buying any quantity that dramatically affects the price of gold. Yet steady buying of 10% of annual supply is certain to help buoy gold prices.

Gold Price Volatility

The long-term gold prices outlook is bullish, but price volatility remains.

Gold speculators looking to swiftly trade in and out of the yellow metal have exited. Open interest of managed futures funds, considered a good gauge for all opportunists, has slumped an astounding 28% since the beginning of September, Barron's reported.

I think we'll see more volatility in gold because of the absence of speculators," George Gero, a precious-metals strategist at RBC Capital Markets, told Dow Jones newswires. Speculators often diminish volatility since they add liquidity to markets.

Expect major moves in gold over very short periods, said Gero. The rollercoaster ride in the metal will be too nauseating for short-range speculators to bear.

The new gold environment will be best suited to investors interested in the long haul -- the patient gold bug bunch who buy and hold for years.

Gold prices edged up 0.2% Friday to close at $1,590.10 a troy ounce.

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