Why are these countries buying gold?

Thu, 7 Mar Pre-Open

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What do South Korea, Russia and Kazakhstan have in common? Well, the central banks in each of the countries have been major gold buyers of late. South Korea being the latest to join the club. The Bank of Korea added 20 metric tons to its tally in February, raising its gold reserves by 24% to 104.4 tons. Russia and Kazakhstan expanded their store of bullion for a fourth straight month in January. Russia boosted its holdings to 970 tons in January and Kazakhstan raised its hoard to 117 tons. The World Gold Council expects central banks to continue to be strong buyers of gold in 2013 after increasing purchases in 2012 by the most in almost 50 years.

On the other hand, however, ace investor George Soros has cut his stake in the SPDR Gold Trust, the biggest gold exchange traded product (ETP) by 55% in 4QFY12. In fact ETPs had their worst month in February as strength in the US dollar and US stocks drew investors away from the precious metal.

So why are central banks buying gold even though the precious metal's prices have been volatile this year? As the US economic recovery has gathered momentum, the appetite for gold as a safe haven asset seems to have ebbed.

But these central banks certainly know better. In the midst of a potential currency war, it is gold where they can repose their trust. Plus also hedge their reserve portfolios against runaway inflation. After all, the current scenario is pretty much reminiscent of the 1930s. During that period when certain countries went off the gold standard, they gained a competitive advantage against their rivals in the form of a cheap currency. This put a lot of pressure on the other countries to abandon the gold standard as well. As result, when one country devalued its currency, the other had no option but to follow suit. Now, this forms a self-perpetuating loop of endless currency devaluation exercises.

A similar episode is being played out today in the form of more and more money printing. In such a situation, gold is the only real currency or preserve of value that is safe from the hands of central bankers. You cannot mint excessive gold the way you can print paper money. Similarly, you cannot impose capital controls on it or fix price targets. In the absence of all these factors, there is a strong likelihood that gold will continue to rule the roost. That is the reason we keep on advising our readers to hold a small percentage of their wealth in gold.