Why the Rush to Buy? China, Japan,
Russia, and India All Need More Gold

Why the Rush to Buy China, Japan, Russia, and India All Need More GoldIn the current situation in which central banks are scrambling to build up their gold bullion reserves because it’s something they need to fall back on, which central bank has gold bullion and which doesn’t?

There is a disparity between those countries that have gold bullion and those that don’t. Central banks that do not have gold bullion are continuously in pursuit of it—simply because they need it; they realize they can’t rely on fiat currencies anymore.

As of October 2012, there were 31,477 tonnes of gold bullion in reserves at central banks around the world. The euro area, including the European Central Bank (ECB), held more than 34.0% of it. (Source: World Gold Council, last accessed October 5, 2012.)

Looking at the top-four holders of gold, the central banks of the U.S., Germany, France, and Italy combined hold 16,416 tonnes of gold bullion in their reserves—that’s more than 52.0% of the entire world’s gold reserve. If observed individually, these central banks have 25.8%, 10.8%, 7.7%, and 7.8% of the world’s gold bullion reserves, respectively.

The problem? China, Japan, Russia, and India do not hold nearly as much gold bullion as the countries I mentioned above. The U.S., Germany, France, and Italy hold more than 70.0% each of their reserves in gold bullion. China, Japan, Russia, and India each hold 10.0% or less each of their reserves in gold bullion.

What does this mean? The reserves of the central banks of China, Japan, Russia, and India will be affected by the currency fluctuations, and they need more gold bullion to protect themselves from the volatility.

This leads us to the ultimate question: why can’t the central banks of China, Japan, Russia, and India go out in the open market and just buy gold bullion to increase their positions? Fair question, but the issue is that total world mine production is much less than the demand from world central banks. In 2010, there were only 2,560 tonnes of gold bullion produced; in 2011, there were only 2,700 tonnes. (Source: The United States Geological Survey, January 2012.)

At the end of September, the Chinese central bank had foreign exchange reserves of $3.3 trillion. (Source: Market Pulse FX October 19, 2012.) China currently holds 1.7% of its entire reserves in gold bullion. If China bought all the gold that is estimated to be produced this year—86.4 million ounces—the gold it would then own as a percentage of its reserves would only increase to six percent, still well below the 70.0% gold-to-reserves ratio of the U.S., Germany, France, and Italy.

The moral of the story is quite simple: there is not enough gold being produced to satisfy demand. My conclusion is that, due to the Federal Reserve’s unprecedented expansion of U.S. dollars and the downward pressure such an action will place on the value of the greenback, central banks that don’t have a lot of gold bullion will pursue it; those who have it will hoard it.

Again, there isn’t enough gold bullion being produce to meet the demand and, like every other time that there is too much demand and little supply, prices will rise to reflect the imbalance.

Michael’s Personal Notes:

Has all the quantitative easing by the Federal Reserve done more harm to the U.S. economy than good? The initial plan of the quantitative easing was to stimulate the U.S. economy after the most severe recession since the Great Depression—create jobs, increase lending, and get the housing market moving.

On all fronts, for the average American consumer, quantitative easing by the Federal Reserve has been failing. And, in fact, it may be creating more economic issues.

Job Creation: This has been the worst job recovery of any post-recession period since the Great Depression. The underemployment rate in the U.S. economy remains at very high levels—14.7% in September, similar to August. (Source: U.S. Bureau of Labor, last accessed October 5, 2012.) There are more than 12 million Americans unemployed and another eight million who are working part-time only because they can’t find full-time jobs.

Increased Lending: Banks’ “bad assets” were being bought by the Federal Reserve and they continue to be. One would link good money coming into banks with bad assets coming out; the banks would be lending more money to consumers. That isn’t happening. In September, consumer lending by banks in the U.S. economy decreased to 1.3% from 2.3% in August. Commercial and industrial loans were in a similar place—loans only increased by 1.4% in September. (Source: The Federal Reserve, last accessed October 19, 2012.)

Housing Market: I have been harping in these pages for far too long about the U.S. housing market. It is still down more than 30.0% since its 2006 highs. From what I can see, investors have jumped into the U.S. housing market and have bought up distressed properties. A healthy, recovering housing market has actual homeowners buying into it—not investors buying properties to rent them.

So what has the Fed’s quantitative easing done?

For me, the quantitative easing by the Federal Reserve has created more money in the U.S. economy, devalued the U.S. dollar, caused prices of commodities to increase, made big banks more profitable, pushed up the stock market (on liquidity, not fundamentals), and punished savers.

The end result of quantitative easing is now trickling down to the average American. He/she is paying higher prices for food, gas, and other basic necessities, while inflation-adjusted personal incomes are declining.

Big banks are making big money again as old junk assets continue to come off their books and fresh new money comes in. Meanwhile, Main Street is struggling to make ends meet. We have seen three rounds of quantitative easing. And it won’t surprise me if there are more rounds in the pipeline.

Where the Market Stands; Where It’s Headed:

We are near the top of a bear market rally in stocks that started in March of 2009. I’m becoming increasingly convinced this rally (what I refer to as the “bounce” or “sucker’s rally”) is getting very close to its end.

What He Said:

“What group of stocks is next to fall in light of the softening U.S. housing market? The stocks of companies that sell retail products to the American consumer, I believe, are next on the hit list. Many retail stocks are already reporting soft sales. In my opinion, they haven’t seen anything yet in respect to weaker sales.” Michael Lombardi in Profit Confidential, August 30, 2006. According to the Dow Jones Retail Index, retail stocks fell 42% from the fall of 2006 through March, 2009.