As gold tanks, don't expect central banks to come to the rescue
Dec 4th 2009 1:20PM
Updated Dec 5th 2009 9:47PM
Everyone agreeing that an asset can only go up in value -- take tech stocks at the end of the last decade, or real estate prices more recently -- should be a warning sign in itself to potential investors. But the latest argument for buying gold advanced by some of its staunchest proponents -- that prices will skyrocket as central banks load up -- is strikingly shoddy and investors would be wise to steer clear of the famously volatile metal.
Noted gold bug David Rosenberg, an analyst with Gluskin Sheff, concedes that a gold play isn't really about hedging against inflation or deflation. But he urges investors to pile in nonetheless because China's central bank, terrified about a falling dollar and looking to diversify, could be poised for a big move into the precious metal.
Rather than any fundamentals, in other words, the gold trade is really about the Greater Fool Theory where investors prepare to flip an asset to a bigger sucker down the road. But the problem is that the marks in this case -- the world's central banks -- are no fools and already wary of the price of gold.
Even at current levels, China sees gold prices as very high and is concerned about bubble assets, press reports cited Hi Xiaolian, the deputy governor at the People's Bank of China as saying earlier this week.
And Chinese officials are likely well aware of what even a slight move of their massive $2 trillion reserves would mean for the tiny gold market.
"It would be like a sumo wrestler jumping into a kiddy pool," Peter Zeihan, vice president of strategic analysis at global intelligence company Stratfor told DailyFinance in an interview.
Indeed, while the purchase of gold by the central banks of India and Sri Lanka have fueled the euphoria surrounding gold since November, investors should note how trivial those sums are in proportion to the holdings of major central banks. India picked up a mere $7 billion worth, about half the amount the IMF recently put on the block, and Sri Lanka bought $375 million. Stratfor estimates that the amount of gold available for purchase is only $83 billion worldwide.
Central banks in Japan and South Korea, meanwhile, hold a $1 trillion and $270 billion respectively, in mostly dollar reserves. There simply isn't enough gold available to allow central banks like China's to meaningfully diversify by buying it up. "They would buy it up in a matter of days and there would be no gold market," Zeihan says.
Selling any gold reserves down the road, meanwhile, would be an even bigger nightmare for the heavyweight central banks. Unwinding a relatively small position would weigh down the market. And while piling into gold "may expose them to the potential upside of the investment, it would definitely expose them to any downside danger."
And if Friday's jobs report is a sign of things to come, there could be plenty of danger down the line for gold investors. A faster than expected labor market recovery would trigger the U.S. Federal Reserve to raise interest rates sooner than investors anticipate. That could strengthen the dollar and pummel gold prices, as recent moves have indicated.
Of course, the Chinese central bank is likely already aware of those dangers, too.