| Image Credit: Bloomberg News A key reason why central banks want to hold onto gold is the instability of their most common reserve asset, the dollar. |
Gold bars Central banks around the globe have joined the gold rush, as the World Gold Council's latest report makes clear. This is especially true of the central banks of rapidly growing emerging countries. Up until the third quarter, the central banks of Russia, China, Thailand and Mexico increased their gold reserves six-fold in comparison with the same period last year, which amounts to a total increase of 148.8 tonnes.
In comparison with the previous quarter, central banks around the world have increased their gold purchases by 114%, with emerging economies in particular looking to sell part of their US dollar reserves. Even though the US dollar registered some gains last week, more investors around the world are becoming dollar-sceptics.
Global investors are increasingly afraid of systemic risks and imbalances affecting economic relations. Many observers fear the outbreak of a global currency war as financially stricken countries try to debase their currencies in order to obtain trading advantages. In this context, markets are focusing on the US. It seems that an increasing number of market participants do not believe that the US is following the necessary strategies to keep a strong currency. The country's economic problems are too big, with the unemployment rate remaining stubbornly high. US president Obama has repeatedly said that from now on the US has to concentrate on creating jobs in the exports sector. In order to do this, it needs a currency that is internationally competitive.
Therefore, many market participants expect the US Federal Reserve (Fed) to start a third round of quantitative easing (QE3). Through renewed bond purchases the Fed would inject more electronically generated money into the financial system. But a large sum of this new money would probably flow into the rapidly expanding markets of the emerging countries, since these regions offer much higher returns to investors than the US or Europe. This could be one of the reasons why central banks in emerging countries such as China, India or Russia are quickly increasing their gold purchases. The communist government of China has been repeatedly warning the US government and the Fed to not extend its bond-purchasing programme if they didn't want China to take protectionist measures against the flood of capital threatening to inundate Asia.
Should the US end up implementing QE3, this would probably lead to the expansion of protectionist measures on a global scale. Both the creation of new money by the Fed and the disruption of international trade relations will probably benefit the gold price in the future. Investors will continue to flee to safe havens such as precious metals or other tangible assets – a point of view also shared by the latest WGC report.
Author: Roman Baudzus
