Gold remains attractive, despite loss by central banks

08 January, 2014 | Posted By: Oren Laurent

By Oren Laurent
President, Banc De Binary

On Monday, Switzerland’s central bank revealed that it expects to record a loss of around 9 bln francs for 2013 and will be unable to pay its usual dividends to the government and shareholders. This is not because it has traded recklessly this year, nor because the economy is in a dire state, but is largely due to the decline in value of its gold holdings. Gold’s first calendar year loss in 13 years was certainly a dramatic one.
Switzerland is not the only central bank to have taken a hit. Between them, central banks worldwide own a staggering 18% of all the gold ever mined. They purchased 535 tons of gold in 2012, with Russia, the biggest buyer, increasing its reserves by 20% after prices reached a record $1,921.15 an ounce in September 2011.
Yet as policy makers were buying, investors were losing confidence in the metal’s value. The improving economy and strengthening dollar led the U.S. Federal Reserve to slow down its inflation policy in 2013, causing gold prices to drop. The commodity’s value plummeted in the first half of the year, and then seemed to stabilise and even increase slightly in the third quarter, before sinking back down in the remaining months. Did the world’s top economists at the central banks miss all the warning signs? Why were they not rushing to sell?
We must remember that the central banks are playing a longer-term game than many retail investors like you and I. Holding gold for several decades is a reasonable strategy, despite the loses suffered this year. The U.S., Germany and Italy, which together own 44% of all central bank gold holdings, have hardly changed their reserves since 1999. Gold is trading far below its 1980 high on an inflation-adjusted basis, but has still performed better than the dollar in preserving its purchasing power. It is not referred to as a safe-haven asset for no reason: gold has an intrinsic value which makes it attractive even when currencies are not. Hence the surge in demand for the asset when the euro looked like it may collapse in 2008-9.
It is true however that the degree to which central banks invest in gold may be a throw-back to the past and the gold standard, and not simply a result of cautious economics. Such is the view of Bernanke who said in a Congressional hearing two years ago that central banks own bullion as a “long-term tradition” and seemed to be suggesting that too much importance is given to the asset.
Time will reveal whether this dependence on gold will pay off or not in the future. Goldman Sachs has estimated that the price could fall to $1,050 by 2014 as the U.S. economy continues to strengthen, although other analysts argue that it is possible that the price will subsequently rise and settle. Yes, the economy is improving, but there remains wide uncertainty and we still haven’t fully recovered from the 2008 global financial meltdown. Besides, many central banks outside of the U.S. are still engaged in monetary stimulus.
It could well be that gold is considered less as a currency alternative and more as a commodity in the decades ahead. As the global economy steadies, so should gold’s price but it isn’t likely to soar. Yet even if it is not always your first choice investment, it will always be worth investing in, if only to a small degree. Its price simply cannot collapse in the same way that stocks are at risk of doing.
Take advantage of today’s world of instant gratification that extends to our financial investments. Enjoy. Yet, with bankers also willing to take higher risks in the market for the chance to maximise profits, I think it is only good sense for retail traders and the central banks alike to invest in the long-term a certain percentage of their portfolios in a low yielding but relatively secure asset.