Behind Central Banks' Gold Buying: Opinion

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( Bullion Bulls Canada) -- The World Gold Council recently released its own report for the gold market for 2011. It noted that while global demand for gold had hit a new all-time high in (nominal) dollar terms, it was merely reaching its highest level in 15 years in terms of tonnages. Hardly the signs of an "over-heated" market, as is regularly claimed by the flock of mainstream Chicken Littles clucking about a " bubble" in the gold market.

Indeed, investment demand rose by a mere 5% year-over-year. Arguably, even that number overstates the performance of the gold market in 2011, since (in the real world) much of what is mistakenly classified as "jewelry demand" should be classified as investment demand.

The reason for this is that in much of the developing world gold jewelry is considered a form of savings (or investment) rather than mere adornment. In 2011, jewelry demand actually declined, meaning that on a net basis true investment demand was likely essentially flat on the year.

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Of interest, however, there was one group of gold-buyers whose appetite was nothing short of voracious in 2011: the world's central banks. The entities that create the paper confetti in our wallets that they call "money" were busily dumping that paper to buy gold in 2011 -- roughly 500% more than what they purchased in 2010 (from 77 tons to 440 tons). Even 2010 had been considered a very notable year in this respect, as it marked the first year in which the central banks had become net-buyers of gold in decades.

It was only a few years prior to that when many of these same, central bankers were publicly proclaiming that gold was nothing but a "barbarous relic." Western central banks flooded the market with thousands of tons of gold during those years (but don't call it " manipulation"). And now they are buying the gold back. What are we to make of this seller's remorse?

The world's central banks are dumping their own paper -- in ever-increasing quantities -- to buy a "barbarous relic." On a net basis, they are now buying back the gold they sold, except at (nominal) prices 500% to 600% higher than the prices at which they dumped those thousands of tons of gold.

If we saw workers at a Ford plant selling their Fords and buying Toyotas, we would likely conclude one or more of the following:
  1. The product they produce is inherently defective;
  2. the product they produce is significantly overvalued;
  3. the product they swap their own goods to obtain is inherently superior;
  4. the product they swap their own goods to obtain is significantly undervalued (relative to their own product).

Let's start with the first one. Do we have any reason to believe that the bankers' paper currency is inherently defective?

Yes. When these same bankers persuaded our governments to abandon the gold standard in 1971, our paper currencies ceased to be "money." They were no longer backed by any tangible asset, so they instantly ceased to be units of value.

From that moment on they have been nothing but units of debt. Every dollar/euro/yen created (by the trillions) in recent years has been produced as a unit of obligation to these same, central bankers (didn't that work our conveniently?). And now all of these debt-based currencies are being produced by governments in the process of defaulting on those debts. Even if one was to (charitably) assume that our paper currencies once had some pseudo-value, these paper "IOU's" of defaulting-debtors will soon be worthless, if they are not worthless already.

Second, do we have any reason to believe that these paper currencies are significantly overvalued?

Yes. As I explained in a previous commentary, any good which is produced at zero cost, and in near-infinite quantities (like U.S. dollars) must be worthless -- as a matter of definition. With the other paper currencies being produced at slightly greater than zero cost (except for yen), they can currently at least pretend to possess some, slight value.

Third, do we have any reason to believe that gold is inherently superior to these (near-worthless) paper currencies?

Yes. Contrary to the mythology of Western central bankers, far from being a "barbarous relic," gold is an eternal storehouse of value -- or at least it has been for thousands of years, up to and including today. Conversely in less than 100 years the mighty U.S. dollar, King of the Paper Currencies, has lost 98% of its value, with more than 75% of that plunge toward worthlessness occurring in the 40 years since the last remnants of a gold standard were abolished.

There is also a very long list of supply/demand arguments which clearly favor gold over (near-worthless) banker paper, but that would simply be overkill.

Lastly, do we have any reason to believe that gold is significantly undervalued vs. the bankers' paper currencies?

Yes. Even if we embrace naivety and conclude that the thousands of tons of gold dumped onto the market by Western central banks was not intended to suppress the price of gold, as any first-year economics student could tell you it would inevitably have that effect.

With the gold-dumping having not only ceased, but reversed, again the basic dictates of supply and demand tell us that the price of gold has only begun its advance. This is especially true once we factor in how much further the bankers have diluted their paper currencies during this bull market for gold. Indeed, once we also calculate the exponential increase in debts and the equally exponential rate of currency-dilution, in absolute terms gold is clearly more undervalued today than when the bull market began more than a decade earlier.

Big Picture

When we combine the WGC data with the basic fundamentals of the gold market, a clear picture emerges. While Asian markets are strong, gold remains almost a complete mystery to Western investors. Proof of this comes in any historical comparison. Traditionally precious metals assets have constituted between 5% and 10% of financial holdings -- and more than that in times of crisis.

Yet today, with Western economies currently sinking into a combination of economic depression and debt-default, we see Western investors with (on average) only 1% of their portfolios comprising bullion and other precious metals assets (i.e. mining shares). To suggest that gold-ownership (and silver-buying) in the West is likely to increase by a factor of 10 (or more) in the near future would seem to be a conservative estimate.

Meanwhile, central banks are dumping their own paper for gold at a pace which is unprecedented since Nixon assassinated the gold standard in 1971. It is harder to imagine a clearer warning.

For the sake of all regular readers who (proudly) call themselves "silver bulls," I'll take a moment to observe that not only do we have many reasons to believe that silver is even more undervalued today than gold, but as "the peoples' money" it is also much more affordable.

Protect yourselves from the collapse of the paper currencies that even the creators of this paper are trying to dump themselves. Swap your banker-paper for gold and/or silver today -- before this confetti (officially) acquires its actual value.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.