Until recently, an entire class of investors that control a huge pool of money – more than $27 trillion worldwide – have almost entirely ignored gold.
But lately, this group has begun to show more interest in the yellow metal, a trend that ultimately will exert massive upward pressure on gold prices.
We're talking about pension funds, which typically have had little interest in gold.
But with more traditional investments like bonds at historic lows, many pension funds aren't getting the returns they need to fund future obligations.
And with central banks debasing most major currencies and risking higher inflation, pension fund managers almost have no choice but to consider adding gold.
It's already started in Japan, which has about $3.4 trillion in pension funds – second only to the U.S., which has about $20 trillion.
In response to Prime Minister Shinzo Abe's pledge to spur inflation by printing more yen, Japanese hedge fund managers plan to double their gold holdings from about $500 million to $1.1 billion over the next two years, primarily by investing in gold exchange-traded funds (ETFs).
Itsuo Toshima, who represented the Tokyo office of World Gold Council for 23 years through 2011 and now advises Japanese pension fund managers, sees gold becoming a standard asset as inflation becomes more of a threat – with major consequences for gold prices.
"Pension money invested in bullion is "peanuts' at the moment," Toshima told Bloomberg News. "If 1% of their total assets shift to the metal, the gold market would explode."
How Pension Funds Could Make Gold Prices Soar
Shayne McGuire, managing director and head of Global Research at the Texas Teacher Retirement System pension fund, estimates that gold only makes up about 0.15% of pension fund portfolios now.
In his 2010 book, "Hard Money: Taking Gold to a Higher Investment Level," McGuire argues that it makes sense for pension funds to invest in gold.
Like the pension fund managers in Japan, McGuire sees gold as a way to diversify a portfolio while increasing returns and gaining some protection against inflation.
And as more pension fund managers realize this, gold prices can only go up – and up.
Consider this: According to the World Gold Council, global gold sales reached a record $236 billion in 2012, with purchases by gold-backed ETFs rising 51%. The biggest is the SPDR Gold Trust (NYSE ARCA:GLD), with almost $70 billion worth of the yellow metal.
But using Toshima's formula, if pension funds around the world shifted just 1% of their assets to gold, it would create $270 billion of demand – more than the entire existing gold market. U.S. pension funds alone would account for $200 billion of demand.
"The effect of suddenly moving a substantial amount of investment money into the precious metals market was best described in a telephone conversation I had with an expert in the industry: It would be like shoving an elephant into a mailbox," McGuire wrote in his book.
He noted that only about $80 billion worth of new gold is mined every year, and half of that goes to jewelry and industry. A surge in pension fund buying would have to drive gold prices up, as demand would far outstrip supply.
"If gold rose from the minuscule part it represents in the world's largest portfolios today to just 1 or 2% of global assets under management, the effect would be substantial," McGuire wrote. "That it could rise to $10,000 an ounce is not out of the question."
Pension Funds Buying Gold Now
One Japanese bank, Mitsubishi UFJ Trust, told Bloomberg that some local pension funds in Japan already have made gold 2%-3% of their portfolios and the bank is talking to other fund managers.
In the U.S., McGuire's Texas Teacher Retirement fund – with over $100 billion in assets, the eighth-largest pension fund in the world – has tried to lead by example.
As of Dec. 31, 2012, the Texas Teachers fund held 2.4% of its portfolio in the SPDR Gold ETF, while adding new positions in gold miners Gold Fields Ltd. (NYSE ADR: GFI), 0.15% of the portfolio; and Harmony Gold Mining Co. Ltd. (NYSE ADR: HMY), 0.11% of portfolio.
Among its top 100 holdings, the fund also has 0.39% of its portfolio in Goldcorp Inc. (NYSE: GG) as well as 1% of its portfolio in the iShares Silver Trust ETF (NYSE: SLV), and 0.28% in Silver Wheaton Corp. (NYSE: SLW).
Separately, McGuire launched and created Texas Teachers pension fund, the $560 million GBI Gold Fund, entirely focused on precious metal investing in gold and silver.
Some other U.S. pension funds have shown interest.
The State of New Jersey Pension Fund E, which focuses on alternative investments, had 15.16% of its portfolio in gold, though the $577 million Fund E makes up just 2.5% of the total assets of New Jersey's four major state pension funds.
And the Commonwealth of Pennsylvania Public School Retirement System holds 0.36% of its portfolio in the SPDR Gold ETF.
Given the uncertain economy, the frustrating bond market and rampant money printing across the globe, pension fund gold buying could turn from experiment to policy in a hurry, with rising gold prices perhaps even encouraging the trend.
"A significant move into the metal could happen by default, as even the most die-hard gold opponents might soon be forced to consider it," McGuire wrote.
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- Shayne McGuire:
Hard Money: Taking Gold to a Higher Investment Level