Central Bank Buying Means Gold to Rally to $2,000

Oct. 14 (Bloomberg) -- Gold may surpass $2,000 per ounce for the first time by early next year, as central banks in emerging markets add the precious metal to reserves to diversify away from the dollar, according to Mine Life Pty.

The CHART OF THE DAY shows the proportion of gold in the international reserves of India, Russia, China and Mexico is lower than the rates in the U.S., Germany and France, based on data compiled from the World Gold Council. The lower panel tracks central bank holdings in metric tons and the bullion price since March 2008. Central banks last year were net gold purchasers for the first time in two decades.

“I certainly expect international central bank gold buying to continue, especially in emerging economies where foreign reserves are growing,” said Gavin Wendt, founder and senior analyst at Sydney-based Mine Life, which publishes reports on the metals industry. “It’s the safest option for them.”

Immediate-delivery bullion has dropped 13 percent since setting a record $1,921.15 on Sept. 6. The metal is still up 18 percent this year, having outperformed equities and Treasury bonds because investors sought alternatives amid low interest rates and economic-slowdown concerns. The dollar, which mostly moves inversely to gold, was down 2.2 percent this year against a basket of currencies of six major U.S. trading partners by 6:22 p.m. in Shanghai yesterday. Bullion was at $1,671.99 an ounce at the same time.

Central banks, the biggest gold holders, have expanded reserves as bullion is headed for an 11th straight annual gain. Central bank and government-institution buying totaled 192.3 metric tons in the first half of 2011, World Gold Council data show. Gold accounts for 75.4 percent of the U.S.’s reserves and 72.7 percent of Germany’s. The ratio is 1.6 percent for China and 8.2 percent for Russia, WGC data show.

“Governments in many places like Asia and South America are rapidly embracing gold as a security mechanism,” said Wendt, who expects gold at $2,500 in 2013. “The value of their U.S. dollar foreign reserves has drastically fallen over the past decade.” Thailand, Bolivia and Tajikistan raised reserves in August, according to the International Monetary Fund.

Is the global economy facing a global banking crisis?

Posted by MICHAEL SCHUMAN Tuesday, October 11, 2011 at 6:31 am

6 Comments • Related Topics: bailouts, banks, china, europe, greece, politics, sovereign debt, wall street 

(Photo: Michel Gangne / AFP / Getty Images)

So it's official. The French-Belgian specialty bank Dexia is the first financial institution to fall victim to Europe's debt crisis. In a deal hammered out by the governments of France, Belgium and Luxembourg, Dexia will be dismantled, with the Belgian government nationalizing the local operations of the bank. Taxpayers are also on the hook for $120 billion in credit guarantees. I can't imagine that Dexia will be the only bank in Europe to meet this fate as the euro crisis continues to boil. Banks across the region hold festering compost heaps of rotting sovereign debt, spoiling the strength of their balance sheets. Some have holdings bigger than their capital. Greek banks are so exposed to their faltering government that I can't see how they dodge a bailout. French banks have been under pressure as financing has dried up. And with talk of a do-over for the proposed second bailout of Greece, as that nation's financial position continues to deteriorate, banks across Europe could be facing larger losses on their holdings of Greece's sovereign bonds.

And why stop there? Banks all over the world seem to be stumbling. Not only is the global economic recovery faltering under the weight of persistent unemployment, high commodity prices and debt crisis-induced austerity measures, but the global financial system, on which the global economy is built, is also too sick to help us out. And, even worse, the world's banks could need a whole new round of repair.

Of course, ground zero of this renewed banking crisis is Europe. But the shakiness of European banks has raised fears that problems on the continent could spread around the world, much like the Wall Street subprime fiasco of 2008 tanked global markets and ushered in the Great Recession. Eyebrows have been raised over the possible exposure Morgan Stanley has to European banks, for example. And then banks in the U.S. still have troubles of their own, leftover from the housing bust. Our own banking guru Stephen Gandel recently asked if Bank of America has turned into the walking dead.

And something worrying happened in my part of the world on Tuesday as well. Mighty China dipped into its sovereign wealth fund to buy up shares of major Chinese banks, which had been taking a serious beating. Banking experts at Fitch and elsewhere have warned that Chinese banks could be highly vulnerable, despite the nation's lofty economic performance – or should I say, because of it. Few believe the massive credit expansion China undertook to combat the Great Recession will leave banks unscathed. It seems impossible that they, too, could experience a spike in bad loans as a chunk of the debt built up sours.

The Dexia disaster and the problems of France's major banks have woken policymakers to the dangers they face if the world's banks aren't fixed up. At their weekend summit, German Chancellor Angela Merkel and French President Nicolas Sarkozy pledged a euro zone-wide effort to support the region's banks. As usual, we got lots of vague statements and no details, let alone action – this was a meeting of European leaders, after all -- but the bank repair plan is now supposed to be part of yet another grand scheme to finally quell the euro zone debt crisis, to be finalized over the next two weeks. I'll believe it when I see it. But the fact that Merkel and Sarkozy are talking banks at all is encouraging. Europe's policymakers had been in la-la land on the severity of their banking problem, despite warnings from, well, just about everybody.

How costly could a European bank bailout be? That depends on how much worse the European debt crisis gets. If we can stop at merely a Greek default, the burden probably won't be too heavy. But if the euro crisis spirals further downward, undercutting the value of Italian and Spanish bonds even more, then we enter the danger zone. A big bank bailout in Europe could then spread to a big bank bailout in the U.S. That's just one reason why acting sooner rather than later on fixing Europe's banks is so crucial. Look at what happened in Japan. After its property-and-stock bubble burst in the early 1990s, Tokyo refused to admit the country's banks were broken for half a decade. The failure to act quickly is one reason why Japan's post-crash downturn has lasted for two decades.

Will Europe's leaders do enough to fix its banking sector? That remains to be seen. Based on their previous attempts to contain contagion, my guess is that we'll all be disappointed. But to be fair to Merkel & Co., bailing out the banks in 2011 won't prove as easy as in 2008. The world has changed too much since then.

First of all, we have to ask if the governments of the West have the money to undertake a big bank bailout. Well, OK, they have the money, if they are able to use it. With austerity and budget cutting the priorities these days, there is a lot less room for governments to intervene and support banks as they did so aggressively after the 2008 crisis. So we're looking at a possible Catch 22 here. Governments need to shore up banks to protect them from the sovereign debt crisis and rebuild investor confidence. But the process of doing so places an extra financial burden onto governments, which could then intensify the sovereign debt crisis. Remember, Ireland ended up in a bailout mainly due to the costs heaved upon the government by its banking crisis. Belgium will likely see its government debt to GDP ratio increase simply because of the Dexia mess.

Secondly, the political situation in the West isn't as conducive to bank bailouts as it was in 2008. Bailing out Wall Street was less than a popular idea three years ago. Now, with angry protestors cramming Wall Street and the furor over banks escalating, any politician brave enough to spend yet more taxpayer money supporting bankers is taking a serious risk come election time.

So the best hope for everyone involved is that we avert a banking crisis entirely. That again puts all of the pressure on the leaders of the euro zone and their next great bargain. Let's hope it's just that. A bargain, but one that works.