The debt-ceiling drama and government shutdown that has been playing out in the U.S. for the past few weeks is an absolute embarrassment. Americans, regardless of political persuasion, are shaking their heads in shame at the three-ring circus going on in Washington.
Overseas investors holding U.S. assets are also watching this nonsense, and they are voting with their wallets. Needless to say, it’s a vote of no-confidence. However, one asset class stands to benefit in the long term: gold.
But gold continues to be one of the worst-performing asset classes in 2013. And as my colleague Larry Edelson pointed out recently: Gold’s interim bear market is not over yet.
But as Larry also concedes: “There will soon come a time when it is prudent to load up on gold, but we’re not there yet.” Global investors who tend to take a longer-term view of gold see it as the ultimate asset class of choice to own in an era of lost confidence in paper currencies.
Dollar Assets in Jeopardy
Emerging markets investors, in particular, are losing confidence in dollar-denominated assets, especially bonds, as a direct result of Washington’s dysfunction. While some are sanguine about the debt-ceiling standoff, saying it won’t have a lasting impact, one of the largest holders of dollar-denominated assets, China, disagrees.
|China is on pace to import a record amount of gold this year.|
Just days ago, China’s official Xinhua News Agency said the threat of default is putting China’s dollar assets in “jeopardy” and called for a new international reserve currency to replace the dollar so international investors could avoid “intensifying domestic political turmoil” from the U.S.
China held $1.3 trillion worth of U.S. Treasury bonds at the end of July, so they’re right to be concerned about a potential default, or even deferred interest payments from the Treasury.
Who can blame them for diversifying their massive $3.5 trillion in foreign exchange reserves away from the dollar and into alternative assets? And China’s alternative of choice is gold.
The nation is already on pace this year to import a record amount of the yellow metal, partly due to increased consumer demand. But another reason is central bank buying. China imported 861.4 metric tons of gold through August 2013. That’s more than double the 361 tons it imported at the same time last year.
Jewelry demand in China remains strong, as is the case throughout Asia. But with the price of gold reaching a three-year low in June, the People’s Bank of China is also likely taking advantage of lower prices to exchange U.S. dollar debt for gold. And it’s not just China. This is a trend among central banks around the world, as you can see in the chart below.
Emerging market central banks have boosted their gold holdings steadily in recent years. Central banks globally are on track to add $15 billion to their gold reserves this year alone, according to World Gold Council data. That’s the biggest central bank gold buying binge since 1964.
Since 2011, Russia has been the biggest buyer, expanding reserves 20 percent by adding 171 tons of gold. South Korea expanded its gold reserves seven-fold in two years, buying 65 tons. Turkey bought an additional 371 tons, while Kazakhstan nearly doubled its reserves by acquiring another 67.2 tons.
To put this seismic shift in central bank demand for gold in proper context, consider that gold accounts for an average of nearly 25 percent of international reserves among advanced economies.
For the U.S., gold accounts for 73 percent of reserves.
Germany keeps 69.8 percent of its reserves in gold.
France holds 67.6 of reserves in gold, and the European Central Bank, 29.2 percent.
Now let’s look at the leading emerging market central banks, and you’ll see a different story. Although they have had the biggest appetite for gold in recent years, emerging markets have a lot more buying to do to pull even with central banks in Europe and the U.S. And Washington is providing plenty of extra motivation to diversify their reserves away from paper assets as fast as possible.
China, in spite of aggressive buying, holds only 1.3 percent of total reserves in gold.
Russia, the largest buyer since 2012, still has just 8.9 percent of reserves in gold.
India keeps 8.8 percent of reserves in gold, and for Brazil, it’s just 0.2 percent.
In fact, most emerging markets have a lot more gold buying (and dollar, euro, yen selling) to do before catching up with the BRICs.
On average, emerging market central banks hold less than 5 percent of total reserve assets in gold, compared with nearly 25 percent for developed economies. The majority of their reserves are instead held in more conventional assets such as dollar-denominated Treasury bonds. But times are changing.
While it may not be time for “gold to shine again” just yet, the yellow metal certainly hasn’t lost any of its luster as a long-term store of wealth for investors outside the U.S.
And as Washington’s fiscal folly delivers yet another blow to investor confidence in the U.S., it provides one more reason to diversify into gold.