goldheaven.com

Is the People’s Bank of China Buying Gold for itself and silver for its citizens…?

IN THE LAST MONTH’S U.S. Treasury report, it was announced that China had sold $34.2 billion of Washington’s debt in December – or allowed short-term bonds to run off – making Japan once again the largest holder of US Treasuries, writes Martin Hutchinson for Money Morning.

That battle between China and Japan is not very interesting. But the question of where China is opting to invest instead certainly is.

After all, $34.2 billion is a fair chunk of change, and China’s overall reserves are growing – not shrinking – now totaling $2.4 trillion.

The People’s Bank of China usually keeps its holdings a carefully guarded secret, much more so than for most central banks. Our knowledge of its holdings of Treasuries comes from US data, not from China.  We do, however, have some evidence about the Chinese government’s investment thinking, thanks to the holdings of China Investment Corp., the country’s $200 billion sovereign wealth fund.

CIC got heavily involved in the U.S. financial business in 2007, buying a $3 billion stake in the Blackstone Group (NYSE: BX) and a $5 billion stake in Morgan Stanley (NYSE: MS) – in both cases, 9.9% of the outstanding common stock. Neither of those investments turned out particularly well, however. Blackstone is down about 60% from CIC’s buy price while Morgan Stanley is down about 40%.

More recently, CIC has turned toward natural resources, in 2009 buying 17% of Teck Resources Ltd. (NYSE: TCK) and 13% of Singapore-based Noble Group. Teck Resources is a major diversified mining company, while Noble is a global commodities trading/supply-chain manager with $36 billion in sales.

For CIC, the bad news is that because commodities companies have wimpy market valuations compared with the overstuffed titans of Wall Street, its investments in Teck and Noble were much smaller – some $1.7 billion and $1.1 billion respectively. Still, those investments have turned out a lot better. CIC’s Teck investment is worth about 110% more than it cost and its Noble investment has risen about 60%, with both increases coming in less than a year.

So which do you think the Chinese government is motivated to invest in – the staggering titans of US financial services…or rapidly growing commodity producers? That’s without taking into consideration the fact that China has an ever-increasing thirst for commodities, because of its rapid growth, whereas it has perfectly competent banks of its own.

Let’s not get carried away. The People’s Bank of China is a central bank, not a sovereign wealth fund, and it couldn’t invest $2.4 trillion in Teck Resources shares if it wanted to (though the other Teck shareholders would doubtless enjoy the ride if it wanted to try!).

Still, look at the alternatives:

• The People’s Bank could buy more Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) bonds. However, those are effectively guaranteed by the U.S. government and are subject to the risk of U.S. inflation and rising rates. Probably not;
• It could buy Euro bonds and bills. It already has a fair chunk of these, and probably doesn’t want to increase its exposure while it’s still not clear what will happen to Greece. One possible solution to the Greek problem would be Bernanke-esque money printing by the European Central Bank (ECB), which would zap the value of Euro bonds; alternatively, if no solution was found, further countries could follow Greece into default;
• It could buy British gilts. If it doesn’t like the US risks, it will really hate the British ones, which are the same, but worse;
• It could buy Japan government bonds. With Japan running deflation at 2%-3%, the 2% yield on 10-year JGB represents a real yield of 4%-5%. So if you think Japan will sort itself out before defaulting, this is about the best deal in the market. But China is not big buddies with Japan;
• It could buy Australian, Canadian or Swiss government bonds. All three are good deals in sound economies, but deploying $34.2 billion into any of them within a month is probably impossible.

So given that central banks don’t generally buy stocks (that’s what sovereign wealth funds are for), or dabble in commodity futures, there are really only two decent alternatives into which China could sink that amount of money: Gold and silver.

China already owns some Gold Bullion, but not much, compared to the size of its reserves – 1,054 tons at March 2009, worth about $37 billion at today’s prices.

At 1.5% of its reserves, that’s pathetic, though it’s up 76% since 2003. On average, international central banks hold 10.2% of their reserves in gold. To get to that level, China would have to buy more than $200 billion worth – about two years’ global mine output.

Nevertheless, it seems unlikely that China will be willing to retain above average confidence in the eternal value of Western fiat currencies, and so it’s probable that considerable Chinese gold buying is taking place on a confidential basis.

Silver is not is a significant part of most countries’ reserves, but China is historically an exception, since in Imperial times it was on a silver standard rather a Gold Standard, and so retained substantial reserves. Early in the 2000s it was a major seller, selling 50 million ounces in each of 2001 and 2002, at the then-prevailing prices of below $5 an ounce. After that it stopped selling.

Then, in September 2009, the Chinese government passed a decree encouraging Chinese savers to buy silver, issuing publicity explaining that buying silver was a good deal since the Gold/Silver Ratio at 70-to-1 was historically very high, offering them convenient small-value ingots with which to buy it, and prohibiting the export of silver from China.

This was almost certainly a move designed to dampen stock-market speculation and reduce money supply growth, since bank deposits converted into silver would effectively be sterilized. What’s more, if the long-awaited Chinese banking crisis ever happened, the effect on the long-suffering Chinese public would be mitigated if people held substantial wealth in the form of readily negotiable silver ingots.

In any case, it’s likely that China as a whole – whether the government or its people – is now a very substantial buyer of silver, indeed, possibly to a greater extent than gold. Thus, a rundown in People’s Bank of China holdings of US Treasuries could be readily accounted for by purchases of gold for its own account and of silver to supply to the Chinese public.

China is not a universal fount of investment wisdom. But with this information, I know which way I’m betting.

Looking to Buy Gold and silver for your personal reserves today? Make it simple, secure and low-cost by using BullionVault…

Source:China Buying Gold…and Silver?

Gold, Greece and the Euro currency’s "irreparable exchange rate"…

PRICING YOUR money in gold – in a world where everyone else did the same, and at fixed exchange rates, too – made for a big problem when the welfare state began gobbling up more wealth, year after year, than it could earn in taxation.

"No [social] safety nets were allowed," wrote Peter Bernstein of the Gold Standard in his Power of Gold (Wiley, 2001).

"If the gold stock was flowing outward [thanks to the currency falling on the international exchanges], interest rates had to rise to attract foreign funds and the domestic economy had to be suppressed to curtail imports."

Glued back together after the cataclysm of World War I put an end to cross-border capital flows, this informal yet tightly rule-bound system cracked and finally shattered for good when the 1930s saw world trade collapse in turn. But "even when countries went off gold," as Princeton professor Paul Krugman wrote in late 2009, "the prevailing mentality made them reluctant to cut [interest] rates."

Or rather, it made central banks reluctant to cut the cost of money below zero, as Krugman would advise. Because with the monthly in- and out-flow of Gold Bullion from the foreign exchanges for so long measuring the credit extended by foreign and domestic wealth, government policy naturally leant towards deflation.

Defending the value of cash, rather than inflating it away, gives creditors confidence. And that, paradoxically, is the only way to finance deficit spending long term.

The alternative, at least to the mind of 1931 policy-makers, was Germany’s 2.7 million per cent Weimar inflation of 10 years before. Whereas the solution, 10 years ago, was for higher-spending Euro nations to piggyback on Germany’s unparalleled credit rating with a single, pan-sovereign currency.

"Whether we returned to the Gold Standard [after WWI] too early or not is debatable, but it is no longer a matter of more than academic interest," wrote Edward Peacock, King George V’s own financial advisor, a director of Baring Bank, and a likely-looking successor as Bank of England governor, on 1st August.

"To go off the Gold Standard, for a nation that depends so much upon its credit, would be a major disaster."

Hence the deflationary measures – such as slashing the dole by ten if not twenty per cent – argued over in cabinet. Great Britain couldn’t support both its gold reserves and its growing state-spending commitments, a fact made livid by the apparent "bankers’ ramp" that bet against the Pound on one side, trying to force a cut in state wages…and the near-mutiny of a thousand Royal Navy sailors from the Atlantic fleet at Invergordon, Scotland on the other, after those wage cuts were imposed.

The news sent to the Admiralty on August 19th sparked a fresh run on the Pound, finally forcing the crisis in London. Something must give, and in a world of gold-fixed exchange rates, that something was Sterling – its gold backing, and thus its international exchange-rate value.

Great Britain, long "the conductor of the international orchestra" in John Maynard Keynes’ phrase, abdicated its role with the ultimate default five weeks later.

"Two lessons were taught by Invergordon and the withdrawal from the gold commitment," reckoned William Rees-Mogg, former editor of The Times and advisor to Margaret Thatcher, as the ugliest financial crisis since the Thirties hit the global exchanges in late 2009.

"Governments should not try to balance the budget by cutting the pay of essential public servants; and they should not defend at all costs an overvalued fixed exchange rate."

Athens today, of course, is a long way from balancing its budget, and it rarely tried to defend the pre-Euro Drachma, let alone at all costs. But did it enter the fixed currency union at too high an exchange rate…over-valuing its money and thus itself…thereby dooming Greece to a date with deflation, if not default, sooner or later?

Pricing yourself out of the market, and thus out of Gold Bullion, was what France (at first) avoided but Britain fell for when the pre-WWI Gold Standard was revived – only to gasp its last a decade later – in the mid-1920s. Thanks to what became known as the 1925 "Norman Conquest of $4.86" in honor of the Bank of England’s eccentric, neurotic and frankly unhinged governor, Montagu Norman, Sterling was priced at its 1914 valuation in terms of both gold and the Dollar. Whereas Paris, instead of nailing itself to some pre-war ideal of honor or virtue, watched the Franc lose two-thirds of its Dollar value, before cutting income tax and raising consumption levies in 1926, inviting a flood of French wealth back into its coffers.

"From a position of approximate equality with the gold reserve of the Bank of England in 1926, the Bank of France’s gold holdings were double [that] by 1929," writes Peter Bernstein in his Power of Gold. "Two years later, the French gold hoard would be approaching five times the size of Britain’s."

Hence Britain’s failure to devalue Sterling against bullion, rather than quit gold entirely, in Sept. 1931. It couldn’t risk a final flight from the Pound, sucking out what little remained of its hoard – a phantom that would haunt the US when it ran the world’s Gold Exchange system post-WWII (and only exorcised by Richard Nixon also "closing the Gold Window" four decades later). Not with France, the US, Russia and even post-Weimar Germany all hoarding ever-more gold in what proved a scramble for the ultimate money as Japan annexed Korea, Spain fell to Franco, and the Wehrmacht then marched into Prague.

Devaluation today – a policy so often used to rescue the short-term political and economic fortunes of what City analysts cannot now call the PIIGS – also remains shut to the Greeks, but for another reason entirely: Revaluation within the Euro is impossible.

Joining the European single currency, and consigning sovereign notes and coins to history, meant swapping those notes and coins for a certain, agreed quantity of Euros. Once set and enacted, that exchange rate could never again be revised. Because the exchange…once you were holding Euros…could never again be replayed.

"There is no wiggle room here," as two English academics – both smirking and gasping at the Eurozone strait jacket – wrote in a 2004 tome.

"Greece has to live with this conversion rate no matter what happens to its level of productivity or inflation relative to its Euroland partners, or its level of internal unemployment.

"If it becomes politically unacceptable to live with this rate, Greece has only one realistic option, and that is abandoning the Euro."

Hence the name – "irrevocable exchange rate"…although "irreparable" would seem a better name with hindsight, and after the domestic inflation which continued regardless.

Set 12 months in advance of each member state’s last sovereign trade, this fixed, irrevocable and now historic rate offers no second-chance to price the Euro again. To inflate (i.e. devalue) its way out of this fiscal crisis, Greece only has the nuclear monetary option of quitting the Euro. And just as in 1931 London, the forecasts for what will come after – a "major disaster" indeed – are dire.

Civil protests had long since rattled Great Britain; the General Strike and its flirtation with revolution came within 12 months of the 1925 return to gold. British civil servants then fretted over ten, twenty, even fifty per cent overnight hikes in the cost of living. But the loss of credibility – and even with Sterling dropping from $4.86 to $3.25 between mid-Sept. and end-Dec. 1931 – never quite destroyed Britain’s credit. Because the entire British Empire also went off gold together, taking nearly one-quarter of the world’s land mass and population with them. London thus remained the centre of world finance, including the global Gold Bullion trade, regardless.

Quitting Euroland, on the other hand, would leave Greece – or Spain, Ireland or Portugal, or all of them together – horribly alone. Gold Standard historian and former IMF advisor Barry Eichengreen posited an Italian exit back in late-2007. Only the names have been changed:

"The very motivation for leaving would be to change the parity [between Greece's new domestic currency and the now-neighboring Euro]…Market participants would be aware of this fact. Households and firms would shift their deposits to other Euro-area banks. A system-wide bank run would follow. Investors anticipating that their claims on the [Greek] government would be redenominated into [the Euro's devalued replacement] would shift into claims on other Euro-area governments, leading to a bond-market crisis…

"It would be unlikely that the ECB would provide extensive lender-of-last-resort support. And if the government was already in a weak fiscal position, it would not be able to borrow to bail out the banks and buy back its debt."

In short, "This would be the mother of all financial crises," guesses Eichengreen. But no matter, he says; it can’t happen. "The decision to join…is effectively irreversible. Exit is effectively impossible."

How come? "The insurmountable obstacle to exit is neither economic nor political, but procedural," says the professor. Short of a coup, revolution or state failure, you have to agree.

First, all contracts – both domestic and cross-border – would either be void (which again means revolution, state failure, coup or all three), or they’d be subject to a sweeping redenomination law. That would require long, detailed, co-operative discussion, both internally and with governments, business and private individuals across the European Union and beyond. So no dice there, then.

Then there’s the logistical nightmare of re-pricing all goods and services, replacing all those vending machines, and reprogramming all Greece’s bank and till systems – a fun project when Euro accession approached, but hardly a laugh as hyperinflation looms. So again, we’re back to revolution…if not a coup or failed state…and you don’t need to be Helmut Kohl or Jacques Chirac to wince at the irony of Europe’s greatest unifying dream (to date) ending with chaos and bloodshed west of the Balkans.

Greece’s problem, therefore, really is "a Eurozone problem" as finance minister George Papaconstantinou has repeated throughout this crisis. Since it cannot devalue or exit, something else has to give. And that something, we guess, is the Euro – or rather, its historical backing of post-war German-style strength, built on the living memory of Weimar inflation and so coveted by those very Eurozone states now making it untenable.

"The Europeans would be silly to let this blow up," says Credit Suisse’s head of interest-rate strategy, speaking to Bloomberg. "The ECB will have to be relatively dovish and relent a bit on their plan to withdraw [banking] liquidity."

Relenting "a bit" is precisely what the Euro was supposed to avoid, however, and precisely what got it into this mess. Sticking to the Growth & Stability Pact’s budget deficit rules may (or may not) have kept the Euro’s 16 members aligned economically (a balance of payments limit would have helped, too) but it’s too late now to pretend 3% and 60% hold more than totemic value. The ECB’s half-trillion in ultra-cheap liquidity, meantime, went against all the European Central Bank claimed to stand for when it opened in 1998, setting the aim – long since denied and disdained – of keeping money-supply growth at 4.5% per year for fear of the price-inflation or deflationary collapse that might otherwise follow.

"Public commitment", "inflation vigilance", "price stability"…these are just words. The Eurozone union is fact. And while promises, like stability pacts – or the commitment to honor a gold-exchange at a certain weight of metal – can be over-looked, the world’s most heavily issued money cannot.

Not by those 317 million people for whom it’s now their domestic currency. Right now, it would seem their only-possible currency, too – whether strong, weak, or devalued to all-time record lows against gold, as it has been already in 2010.

Got Euros to exchange for Gold…? Want out of Sterling or Dollars as well? Make Buying Gold simple, secure and cost-effective like nowhere else by using BullionVault today…

Source:1931 for the Euro, Part II

India bought 200 tonnes of IMF gold. Now the Fund is selling another 191.3 tonnes…

WHEN INDIA announced its purchase of 200 tonnes of IMF gold in November, it added a statement that it might buy more of the International Monetary Fund’s gold as well, writes Julian Phillips at Gold Forecaster.

This implied that it was limited by the IMF to the 200 tonnes it bought. But the IMF never said that. Rather it said it would announce the sale of any other portion of their gold to the public.

It has been several months since another sale took place, leaving the IMF with 191.3 tonnes of the 403 tonnes slated for sale still up for grabs. Now with last week’s announcement, we are given the impression that central banks have not come forward to buy and are therefore not buyers.

Talk about "spin"!

China for sure would not buy if an announcement were to be made. It would rather Buy Gold once it had been sold in the open market, for it could then buy through its chosen bullion bank or bullion banks – and do so "under the radar". In fairness to the IMF, they have said they are open to central banks buying direct from them still, and will announce such sales. But you must realize that any further sales through the ‘open’ market will be done anonymously. This levels the playing field. However, all we will now hear is the completion of such sales.

If the IMF decides to sell 4 tonnes a week, we will hear about it through the ECB website in tonnage terms but with no further details. Will we hear of a 100 tonne sale done this way? Unlikely, but possible!

The gold market first reacted by fearing a dumping of this amount of gold, but once it gathered itself together, the market realized that the IMF’s open-market sales could be bullish for the Gold Price.

After all, 191 tonnes is an amount that the gold market does not see often, so a big buyer in the wings, finding that much gold for one price, might well come and bid for it. But will the IMF offer the amount to the market in one go or drip feed it? No one knows. They can now play the game as they choose.

If the IMF wants to sell its gold quickly, it is incumbent upon the Fund to accept a bid for the entire amount. But rarely is life so straightforward, these days. The reality is that there is the demand for such amounts in one sale. But the real question is, "Do the IMF want to sell it in one go?"

Looking to Buy Gold at live market prices? Sidestep the middleman and go to the wholesale market direct – starting with 1 gram of free gold right now – only at BullionVault…

Source:Spinning the IMF Gold Sales

Could Japan’s record-breaking deflation end with hyperinflation in prices…?

LAST AUGUST, Japan reported that deflation had reached a new record, writes Bill Bonner in his Daily Reckoning. Consumer prices were dropping at the fastest pace 38 years.

Come November, and it was duration, rather than depth, that got the press’s attention. Prices had been going down for 10 months in a row. And then, last week, an update:

"Japan Deflation Hits a Record Pace," reported the BBC…

Prices in Japan were falling faster than they ever had since they began keeping track in 1970. The tide has gone out so far, beachcombers can’t remember when there was so much beach to comb.

What follows is not offered as a prediction, but only out of curiosity. We don’t know how this will turn out. Could it end in hyperinflation? Maybe.

Prices fall in Japan. The Yen rises. And the government uses every trick in the book – and some as yet unpublished – to knock it down. If you are in a position to borrow money from the central bank, the bankers will give it to you at practically zero interest. And if your neighborhood wants a bridge or a community center, that too will be forthcoming from the Japanese government.

No government has ever been so generous. At least, not without going broke. For every ¥1 the government squeezes from its taxpayers, it returns more than ¥2 in public spending. Investors must think the trend is eternal. Or perhaps they don’t think at all. They lend money to the world’s most spendthrift major government for 10 years in exchange for a yield of only 1.310%.

The drama of this story is an old and familiar one. Deeply flawed heroes at the world’s central banks and treasury departments think they can do a better job of guiding the economy than the markets themselves. It is they who set the price for short-term money, for example, not willing borrowers and lenders. They are the ones who fight the correction every inch of the way. They are also the ones you don’t want to stand behind; every shot they take backfires.

In France, the savings rate, as percentage of revenue, has gone up for the last 16 months, to 17% – the highest rate in 27 years. This comes as the Sarkozy government follows the lead of the US and Japan, with a deficit of about 8%…compared to 10% in the US and even higher in Japan.

This is not the first time this has happened in France. The previous savings rate peak came when the Mitterrand government was trying to stimulate the economy out of the slump of the early ’80s. The more the government tries to stimulate spending by running deficits, the more people try to protect themselves by saving.

While the drama continues throughout the world, the story is most advanced in Japan. Which is to say, the central bankers have gotten themselves into deeper trouble. Martin Wolf of the Financial Times and Richard Koo of Nomura Securities applaud their performance. But by trying to suppress a correction in the private sector, Japan’s central bankers have stretched out a slump over two decades and set up the nation for a bigger crisis in the public sector. And there is nothing they can do about it. Their fiscal stimulus no longer stimulates. Their monetary inflation no longer inflates. And every quack cure they offer brings the patient closer to the grave. You might think they’d give up. Instead, they increase the dosage. Fiscal stimulus hits a new record, right along with deflation.

But it’s the final act that interests us. And with public debt at nearly 200% of GDP and 700% of tax revenues, we shouldn’t have to wait much longer.

Given the track record, we have to assume that it will be the exact opposite of what central bankers expect. They are aiming for the whimper of newborn growth. More likely, they will get the bang of hyperinflation.

The Japanese were recently among the champion savers of the world. Directly or indirectly, these savings financed the government’s stimulus efforts. Banks, pension plans, insurance companies – all bought government bonds as a safe way to store wealth. The government then drew upon this stored up wealth to finance its bridges to nowhere and its other boondoggles. The result is a misunderstanding on its way to becoming a disaster. The typical Japanese person looks forward to his retirement with a mountain of savings in his backyard. He believes he still has his cake.

The government, however, has eaten it.

Higher savings rates typically produce lower prices, for a while. Currencies rise. Even in Weimar Germany, there was a period in 1920 when the mark rose. Falling prices would seem to be proof that the money is still there. But the real money is gone. Then, suddenly, people notice that their savings are nothing but paper. The tide turns. Confidence disappears. The big wave of accumulated savings hits the marketplace like a tsunami. Desperate people try to get rid of paper. They want something solid to hold onto. Long-term bonds, the most vulnerable to inflation, are exchanged for cash. Cash and government securities flood the market. Prices soar. Middle-class savers drown. Meek debtors, relieved of their burdens in the flood, inherit the world. So do the arrogant debtors in the government. And the shrewd speculators.

And then the central bankers return to their desks…and come up with a new plan.

Looking to Buy Gold today…?

Source:Tide of Deflation

Turning paper into Gold Bullion at the emerging-world’s central banks…

CENTRAL BANKS are becoming modern-day alchemists, says Christopher K. Potter, principal of Canadian-focused hedge fund Northern Border Capital Management Inc., which he founded in 2002.

India’s big gold purchase late last year was a game-changer, Potter here tells the Gold Report, and more and more central banks will follow suit – he believes – successfully managing to turn the paper money their countries accumulate into Gold Bullion…

The Gold Report: Just after the Reserve Bank of India (RBI) bought 200 tonnes of gold last November, you wrote an article entitled Game Changer, highlighting previous transactions such as China’s Central Bank 99-tonne purchase gold in ‘02 and Argentina’s 55 tonnes in ‘09. Since no other central bank has stepped forward in the months since India’s announcement, was that really a game changer?

Chris Potter: I think so. For as long as I can remember, gold bears have warned that central bank gold is a massive source of supply that is capable of overwhelming any conceivable demand scenario. They said that this would make it very difficult for the Gold Price to rise significantly. It’s been an easy argument to make because one fifth of all the gold ever mined is sitting in central banks’ vaults.

But what we’ve seen over the last nine years is that argument being steadily dismantled, piece by piece. Year after year, signatories to the Washington Agreement have sold less than their quota of gold. We’ve also seen various central banks add and talk about adding to their gold reserves. Then when the world became aware that the International Monetary Fund – which I think is the third largest holder of gold – was a potential seller of 400 tons, there was all kinds of speculation that this would have a very detrimental effect on the Gold Price.

Well guess what, the opposite happened when the Reserve Bank of India announced that it not only bought 50% of what was for sale but bought it at market prices! All of a sudden people realized that central banks might be net buyers rather than net sellers of gold. This was a big development. We still haven’t heard about who is going to buy the other 200 tonnes but the market no longer seems concerned that a buyer will be found. You mentioned that no other central bank has bought gold since the Reserve Bank of India announcement – well, we don’t know that that is the case. If you were a central bank interested in increasing your gold reserves, you would not likely telegraph to the market that you were doing that until you were finished buying.

TGR: Is the IMF actively trying to sell the other 200 tons?

Chris Potter: They reported that they planned to sell 400 tonnes so I see no reason to believe that they have changed their minds about the remaining 200 tons. It had been rumored that the central bank of China was going to buy the whole piece and that is why the Indian announcement was such a surprise. Perhaps China buys what’s left.

We’ve heard that the Chinese Central Bank has been a consistent buyer of gold over the last several years, but we haven’t heard anything officially. I suspect that they do not want to signal that they have a lot of gold to buy, because that would just drive the price up. If they are negotiating with the IMF for the remaining 200 tonnes, we won’t hear about it until the deal is done.

TGR: Could China just be buying it in such small increments that it might take them a year to buy it but they wouldn’t have to report it?

Chris Potter: I’m pretty sure that the US Federal Reserve is required to report purchases and sales of gold and other assets. I’m not familiar with the reporting requirements in other countries, but I would take any lack of disclosure about Chinese purchases of gold with a large grain of salt. In other words, just because they have not announced that they have been Buying Gold does not mean that they have not been.

TGR: Jon Nadler, Kitco’s senior investment products analyst, suggests that central banks’ acquiring gold is no more than re-balancing their portfolios. It’s part of a natural course of events since their portfolios are growing, and in that case, it shouldn’t affect the price of gold one way or another. What do you think of that view?

Chris Potter: By purchasing 200 tonnes of gold, the Reserve Bank of India increased its gold holdings by 50% – I would hardly call that rebalancing. But what is even more important than the amount of gold that central banks are buying is the realization that they are buying and not selling. This is a brand new idea and completely alters market perception about supply and demand. This kind of change in perception can have a very meaningful impact on price. So no, I do not agree with Jon Nadler’s suggestion.

TGR: So how do you look at it?

Chris Potter: If I were running a central bank and I had the ability to create money at virtually no cost and I could then exchange that costless money for one of the earth’s scarcest resources, why wouldn’t I do that all day long? Why not exchange something that costs me nothing for something that is incredibly rare and incredibly valuable?

TGR: It’s not a central bank’s role to print money for the purpose of Buying Gold, though. Creating more money creates other negative trends in the economy.

Chris Potter: Sure, it’s inflationary. But take the example of India buying 200 tonnes of gold. That’s a very large amount of gold, but relative to the amount of money that they are creating for other purposes, it has a very minor inflationary effect.

TGR: I’ve always had the impression that central banks were held to a higher standard to do what’s best for the economy.

Chris Potter: Well, maybe what they’re doing is best for their economies. If you’re a central bank and you’re observing that around the world vast amounts, unprecedented amounts, of new money is being created, you have to realize that somewhere down the road every one of those currencies is going to take a big hit. So, how do you distinguish you currency and your economy from your neighbors’?

Well, one thing you can do is Buy Gold. So maybe the Reserve Bank of India is being proactive about their economy. They are saying, "Look, we can Buy Gold now for $1000 an ounce and five years from now, when we are all swimming in newly printed money, gold might be $5000 an ounce. We can increase our wealth without inflating our currency to the same extent as other nations." Essentially they are hedging against a decline in their currency and that is good for their economy.

TGR: A lot of financial advisors tell investors they should have assets that include 10% to 15% precious metals as "insurance." Are the central banks looking at this as an insurance policy, too, or in some other way?

Chris Potter: I suppose you could call it an insurance policy and that is the way a lot of people think about gold. But that is not the way I think about it. I view gold simply as a currency whose supply and demand characteristics are vastly superior to other currencies. Perhaps that is a more accurate explanation for why central banks are exchanging their paper for gold.

TGR: Gold’s been trading around $1100 for the past few weeks. There seems to be some resistance at that level. Some gold bugs say gold will be at $2000 before the end of the year. Where do you project as a trend for the physical Gold Price through 2010?

Chris Potter: I have a much stronger view of where the Gold Price will be in two or three years than I do over the next few months. It’s had a good run so I am not surprised that it is taking a breather here. If I had to guess I’d say we’ll see new highs before the end of the year. I just think that the path of least resistance is up because the amount of debt that continues to mount around the world is staggering – a lot of that has to be monetized.

Everyone talks about deleveraging but the US ran a budget deficit of $1.4 trillion or $1.5 trillion last year, and it looks like we’re going to do something similar this year. I think I just read we’re trying to increase the debt ceiling here by $1.5 trillion Dollars to $14 trillion. These numbers would have been unheard of a couple of years ago. I think back to a speech that Bernanke gave in January of 2007, in which he worried that the US budget deficit would approach 9% of GDP by the year 2030.

TGR: Oh, we’re way beyond that already, and 2030 is still 20 years away!

Chris Potter: Absolutely. Last year at $1.5 trillion, our budget deficit was more than 10% of GDP. Bernanke’s great fear about what the budget deficit might do occurred 20 years early and it happened not because of our unfunded Social Security and Medicare liabilities that he worried about but because of the global financial meltdown. When we layer on the unfunded liability issues we have a really gigantic problem that will be extremely difficult to grow our way out of, despite what Washington tells us. That is why I say that the path of least resistance – the solution to this – is to inflate these liabilities away.

That requires printing money. It requires a lot of new Dollars, a lot of new Renminbi, a lot of new Yen, a lot of new Euros, a lot of new Roubles. I think you’re going to see all of those currencies depreciate against other assets, and probably most against gold. I imagine that will continue this year, but anyone who has been involved in the gold market over the last seven to nine years knows to expect some scary rides up and down.

TGR: You’ve laid out a compelling argument about all governments increasing their money supplies and we’ll have inflation worldwide. How much higher do you think gold can go?

Chris Potter: It’s always difficult to put a number on it, but the inflation-adjusted Gold Price, depending on your assumptions and in which year you start, is somewhere between $2200 and $3100 per ounce. I’ve run a number of different models to see where the Gold Price could go and have come up with anything from $1500 to $3500 an ounce. In the end it’s anyone’s guess as to what the ultimate high will be, but as I said, the path of least resistance seems to be up.

TGR: If you follow the gold patterns, the summer months have historically been relatively low, with prices picking up again for the holiday seasons, particularly in India. Given that more gold is being bought as an investment or as insurance now, do you see that seasonality coming into play over the next two to three years?

Chris Potter: As you point out, more often than not we’ve seen a rise in the Gold Price in October and November, which coincides with the Indian wedding season. I have no particular expertise here, but I’ll guess that that seasonal pattern will continue. Ultimately though it is not a primary driver of the Gold Price If you look at a nine-year price chart, those seasonal moves are just blips.

TGR: Should investors be looking at physical gold, the majors, the juniors? How should they play what you see as upward trends in Gold Prices over the next several years?

Chris Potter: My strategy is to own both physical gold and mining stocks. I focus on the smaller capitalization gold companies, the exploration companies, the early-stage producers just because if you get those right, they have a lot more leverage to a rising price for the metal.

The problem with owning only Gold Mining equities, and no bullion, is that in a market sell-off, they can go down with everything else. I know people who were managing gold funds who had a very difficult time in 2008 despite the fact that the Gold Price was up. As we saw, gold mining companies were decimated. Many of those equities were down by 50% to 90% in 2008, and the Gold Price was actually up.

TGR: So is the combination of physical and equities a kind of a hedge against each other?

Chris Potter: I wouldn’t characterize it as a hedge. I would just say that it gives you a greater chance of participating in a rising gold market under various market scenarios.

TGR: As I understand it, you consider the Canadian market somewhat less efficient than the US market, thus making it easier to uncover attractively valued companies. What do you think accounts for the discrepancy, and is it specific to small caps or also true of large caps?

Chris Potter: It’s really true of both large caps and small but it’s not a permanent discrepancy. It’s more of a lag. What I mean is that US investors take a lot longer to recognize and buy high quality Canadian companies than US listed ones. I used to be concerned that this lag would somehow be arbitraged away, but I’ve been doing this now for 12 or 13 years, and it has not.

There are a lot of reasons behind that. For one thing, there seems to be an apathy or ignorance on the part of US investors about almost everything Canadian. There’s also a perception that the Canadian securities laws are lax, that its investment community is run by mining promoters, and that US investors won’t get a fair shake up there. While there are certainly landmines to look out for when investing in Canada, they are no more dangerous than those in the US

To characterize the entire Canadian investment scene as corrupt because of the Vancouver mining community and the Bre-X Scandal in the late ’90s ignores the fact that the US has had plenty of its own investment scandals such as Enron and a banking system that perpetrated the greatest financial fraud in history this past decade.

But I can’t tell you all of the reasons for the valuation lag that I continue to see between US and Canadian companies.

TGR: Thanks so much for your time, Chris. This has been great.

How best to Buy Physical Gold today? Go to BullionVault, and slash your costs "dramatically" (Financial Times), using the "most secure way to invest in Physical Gold" (Daily Telegraph)…

Source:21st Century Alchemy