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Reply #41: Time for Gulf economies to increase gold reserves [View All]

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54anickel Donating Member (1000+ posts) Send PM | Profile | Ignore Fri Mar-31-06 08:51 AM
Response to Reply #19
41. Time for Gulf economies to increase gold reserves
Dr. Eckart Woertz is the Economics Program Manager at the Gulf Research Center in Dubai.

There is no doubt that gold is regaining its luster as an asset class. After it has been in a bear market for two decades, with prices plummeting nearly as low as $250 in 2001, its dollar price has more than doubled within four years and stays now well above $500. The women of India and the Middle East, who represent the two most important demand factors in the world gold market, have thus outperformed the sophisticated hedge funds of Wall Street with a very basic "gold, buy and hold" strategy. The performance of gold-mining stocks is even more impressive: The HUI index of gold mining stocks rose from 35 to more than 300 in the same period.

There are ample reasons for this price hike: The U.S. trade deficit has spiraled out of control. Compared to its economic base, the accumulated debt in U.S. dollars has become too high to be effectively repaid; it will either default or will more likely be inflated to such an extent that it won't hurt to "pay" it back. Alan Greenspan's successor as governor of the Federal Reserve Bank, Ben Bernanke, has made this sufficiently clear when he said that the Fed would rather start the "electronic printing press" and let rain down free "helicopter money" on the people than face deflationary shocks. Additionally, the market has become increasingly aware of the huge supply deficit in the gold market. According to Frank Veneroso (2001), who challenges the official statistics of the World Gold Council, mine production only accounts for roughly half of the annual demand and is declining. Apart from scrap supplies, the most important filling of the gap comes from the central banks, which sell and lease gold into the market. The latter activity is especially tricky and has led to a huge derivative short position in the gold market: Western central banks mainly lease gold to commercial banks, which sell it into the market, the central banks earn a lease rate and the commercial banks invest the proceedings of the sales in higher-yielding assets like bonds, for example. Everybody could be happy, but there is one problem: the gold still exists as an asset on the books of the central banks and as a liability on the books of commercial banks or hedge funds, while the actual physical gold has left the vaults a long time ago and now hangs around the necks of the women of the world, who are the "ultimate longs" in the market without even knowing it. It is inconceivable that this short position can be covered at current prices and the market seems to reckon that at some point the central banks won't be able to cover the supply gap because they will run out of gold or won't be willing to sell more of one of their most valuable assets. First signs in that direction are already discernible: An increasing number of central banks like Russia, China and Argentina are actually buyers of gold in order to diversify their currency reserves and Western central banks appear to be increasingly reluctant to enact further sales (e.g. Germany) or have sold or leased out most of their gold (e.g. England and Portugal). Thus, apart from the inflation fears and the dollar weakness, the supply gap and the derivative short position is the third main driver of the gold price rally of recent years. These underpinning fundamentals are so strong that one can safely assume that we are still at the beginning of a secular price rise rather than at its end. In fact, the accompanying boom in commodity and oil prices and unstable political developments remind one of the gold price rally of the 1970s, when gold prices rose more than twenty-fold from $35 to $850.

Individuals in the Gulf countries seem to be well-prepared for these developments, as they are the second-most important buyers of gold in the world after India, but the central banks of the region have not shown the same amount of foresight yet. Their gold reserves are very low, both on an absolute and a relative level. Four countries - the U.A.E., Oman, Qatar and Bahrain - have sold out nearly all of their gold while Kuwait has leased out its complete reserves with uneasy prospects of return, should third parties default. This is all the more astonishing as gold constitutes a superb hedge against inflation and dollar weakness and could thus mitigate the danger of being short-changed by selling precious oil for rapidly devaluing paper dollar receipts. A minimum rate of gold reserves like the European Central Bank (ECB) stipulates for its members (15 percent) and an increase of gold reserves like Russia recently announced (from five to 10 percent) certainly would be an advisable policy for the Gulf countries. But so far they seem to have unshakable trust in the U.S. dollar. After initial attempts at currency diversification, OPEC countries increased their dollar holdings in 2005 again from 61 percent to 69 percent and the skyrocketing amount of U.S. treasury buying out of London has been attributed to Arab investors. This is in striking contrast to Japan and China, which have partially backed out of the dollar supporting scheme as they have kept their treasury holdings stable and refrained from buying as much as they did earlier.


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