Gold Befuddles Bernanke As Central Banks' Lose $545 Billion on the Precious Metal

Gold has been going down quite a bit this year with the precious metal trading in the mid 12 hundreds down from about $1.900 an ounce last year.

But investors aren't the only ones to be losing money. As a matter of fact, Central banks across the world own about 18% of all mined or above ground gold in the world, and collectively bought 535 tons of gold bullion in 2012... with Russia, the biggest buyer in 2012, expanding reserves by 20%. But at about $1,300, gold prices are down 31% from their $1,895 level in October 2011 and central banks have lost about $545 billion in book value on their gold investments.

By the way, I picked up some of this data from an article titled Gold Befuddles Bernanke as Central Banks' on Bloomberg.com.

While central banks were busily adding gold to their vaults, investors were losing faith in gold... as a safe haven, as a hedge against inflation and as a store of value. As a result, 2013 became a rather dark year for gold with gold ETFs losing about $60 billion or about 43% in value, severely impacting many well known hedge funds. This year, we've seen the biggest drop in gold prices since 1981, of course after rallying for 12 successive years through 2012... so I guess something had to give.

The chairman of our central bank, Ben Bernanke, openly admits that he does not understand movements in the price of gold... this from a man who holds economics degrees from Harvard and MIT and has led the Federal Reserve Bank through its biggest financial disaster in recent years.

And Warren Buffett sees no utility in gold because it moves to vaults once it's mined and has no tangible producing power, unlike say steel.

Yet, our government holds about 8,100 tons of gold valued at about $344 billion with most of this gold stored at Fort Knox in Kentucky. And since 1973, America's gold holdings have only contracted by 5%... so despite Bernanke's befuddlement with gold price movements, we continue to hold large reserves of bullion... because it continues to hold value in human minds and the U.S. is better off holding this precious metal than having none at all. I guess it's also sort of a doomsday backup.

So what is it about gold that makes it such a favorite???

I believe it is gold's allure as a lasting store of value. While policymakers such as Fed Chairman Bernanke may not completely understand gold price volatility, they still find value in preemptively holding it to shield their economies from inflation and continue to buy it despite a history of buying high and selling low. For example, central bankers reduced their holdings when the bullion reached a 20-year low in 1999 but became net buyers just before prices peaked in 2011... but these guys aren't stupid... their gold buying and selling decisions are based less on price but more on gold's strategic value in helping them manage the economy - so their purchases ignore near-term price volatility and focus on significantly long-term holding horizons, and these spurts of buying by central banks significantly impact gold supply and prices in the near term.

For example, the U.S., Germany and Italy hold about 44% of all central bank gold and have only changed their reserves by less than 3% since 1999. So they are long-term holders of gold and near-term prices matter little to them.

Gold investors see it as a hedge against inflation. So gold rose 70% from December 2008 to June 2011... because the Federal Reserve went wild printing money for its various bailout and quantitative easing programs... and spooked investors who thought this excessive money printing would weaken the dollar, increase money supply and trigger runaway inflation... But, fortunately, that inflation never came and consumer prices rose only 1.7% annually from 2008 through 2013, well below historical inflation of about 4.3%. So when various gloom-and-doom scenarios did not play out as expected, gold started losing its allure and prices started to correct, with gold down 22% in 2013 alone.

But gold bulls fervently believe gold is still undervalued... partly because current gold price levels are almost half of what they were in 1980 when you adjust for inflation. Gold was at $850 in 1980 after the financial and political turmoil in the late 1970s... but adjusted for inflation, today's price is merely $464 in 1980 dollars according to the Federal Reserve Bank of Minneapolis.

Gold bulls argue that while gold is below its 1980 level after adjusting for inflation, it has still outperformed the U.S. dollar in purchasing power. For example, a dollar bought about 3 quarts of milk in 1970 while an ounce of gold bought 28 gallons. At the end of 2011, a dollar bought just about one quart while an ounce of gold bought 420 gallons. So on a purchasing parity basis gold has handily outperformed the dollar. And this is partly why many think that holding gold is a reasonable and prudent strategy.

On the flip side, analysts who have been relatively correct about predicting gold prices see a deepening bear market in gold and believe prices could drop to the $1,100 level in about 12 months, down from their current levels of around $1,300.

For all of gold's opponents, there are many who fiercely believe in its value. In fact, frustrated with the uncontrolled printing of dollars, many are pushing to get the U.S. back on the gold standard - and pegging dollars in circulation to a fixed % of the amount of gold we hold. Utah already recognizes precious metals as currency and lawmakers in six other states are looking at accepting bullion coins as legal tender.

But one of the challenges with tying our currency to gold is the volatility of gold on geopolitical events and global supply and demand - and this volatility could really bog down exports and imports with currency uncertainties. Other problems with the gold standard are that there just isn't enough gold available to meet expanding global economies and a dependence on gold would make it very difficult to use financial tools such as quantitative leasing to manage the economy. So the real question is why would we peg our incredibly dynamic economy to the amount of some metal that we sitting in our vaults, it just doesn't make sense. I said this to Congressman Rand Paul on this show a few years back. He said that if we couldn't print dollars, we wouldn't have the money to wage war. I responded by saying that it never stopped countries from waging war before and they would just go to war over the gold.

So for the foreseeable future, I don't see our dollar getting pegged to gold but I think central bankers will continue to add to their reserves as their own form of insurance, partly to also prevent gold from getting into the wrong hands, and will continue to hold it for the long run while investment and commercial supply and demand will continue to dictate near-term gold prices.

at 6:35 PM
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