Why the Gold Rush?

Buying by central banks has sent gold prices even higher


Gold prices just hit new all-time highs, and the yellow metal’s surge now is the talk of Wall Street trading floors and Main Street barber shops.  So, why the gold rush?  What’s causing the price of this ne plus ultra safe-haven investment to soar higher than ever before?

One of the common reasons cited for gold’s recent rise is growing concerns over re-ignited global inflation.  Core producer prices in the U.S. rose 0.4% in August, and though the increase was small, the number was larger than economists predicted.  Another reason often cited is fear of a currency market breakdown. 

Recent volatility in the yen and the U.S. dollar could be a harbinger of trouble on the currency front, and it could be one of the reasons for the golden spike.  Former Fed Chairman Alan Greenspan seems to agree with this hypothesis. He’s recently been quoted saying that gold still represents the “ultimate means of payment” and that if there are serious problems in the currency markets gold will be the currency to hold.  In typical Greenspan fashion, he also said a jump in gold prices could be “the canary in the coal mine to keep an eye on.”

Fears over inflation eroding the value of the dollar and other currencies are undoubtedly part of the equation when calculating the causes of the current gold rush, but perhaps the biggest reason why gold prices have jumped nearly 27% over the past year is due to the recent buying of gold by several key central banks.

The International Monetary Fund (IMF), a major holder of gold with estimated reserves of over 3,300 tons, just sold 10 metric tons to the central bank of Bangladesh.  Now, Bangladesh isn’t exactly a powerhouse on the international stage, but the news was significant as it was the first sale of gold by the IMF to a central bank since November 2009, when it sold gold to the Reserve Bank of India, the Bank of Mauritius and the central bank of Sri Lanka.

More significant central bank accumulation of gold comes from the bigger players on the global stage.  Russia has reportedly increased its gold holdings in 2010 by some 2.8 million ounces (approximately $3.6 billion).  Oil-rich Saudi Arabia also has reported increased gold holdings this year.  The big fish in the golden pond, however, could be China.

That nation’s central bank, The Peoples Bank of China, is a big holder of gold reserves.  Considering China holds some $2 trillion in total capital reserves, it makes sense that some of that would be in the form of hard currencies like gold.  In fact, China holds an estimated 1,161 tons of gold reserves.  That’s not as much in gold reserves as countries like France, Germany, Italy or the United States, but there’s another factor at play when considering China’s role in the recent gold rush.

Investment firm UniCredit Group recently cited the Chinese government’s encouragement of consumers to invest in gold.  Over the past 12 months, China’s total demand for gold amounted to 532 tons, according to UniCredit.  Gold market purchases (as opposed to jewelry purchases) went from 17 tons in 2008 to 73 tons in 2009.  Over the past 12 months, that number rose to 143 tons.  UniCredit also cited new gold market reforms in China for the recent unleashing of demand.

So, the bottom line on gold is that the world wants more and more of it.  Central banks want it, hedgers want it, currency traders want it — and everyone from Wall Street to Main Street wants it.  For individual investors wanting to get in on the gold rush, two of the best ways to do so are via the SPDR Gold Trust Shares (NYSE: GLD) and the iShares COMEX Gold Trust (NYSE: IAU).  Both of these exchange-traded funds are pegged to the price of gold, and both offer easy investor access at a low expense ration to the current gold rush.

Article printed from InvestorPlace Media, http://investorplace.com/2010/09/why-the-gold-rush/.

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