Gold Befuddles Bernanke as Central Banks’ Losses at $545 BillionNicholas Larkin and Debarati Roy
Ben S. Bernanke, the world’s most-powerful central banker, says he doesn’t understand gold prices. If his peers had paid attention, they might have stopped expanding reserves that lost $545 billion in value since bullion peaked in 2011.
Bernanke, who holds economics degrees from Harvard College and the Massachusetts Institute of Technology and led the Federal Reserve through the biggest financial disaster since the Great Depression, told the Senate Banking Committee in July that “nobody really understands gold prices and I don’t pretend to really understand them either.”
Central banks, which own 18 percent of all the gold ever mined, will add as much as 350 tons valued at about $15 billion this year, the London-based World Gold Council estimates. They purchased 535 tons in 2012, the most since 1964. Russia is the biggest buyer, expanding reserves by 20 percent since prices reached a record $1,921.15 an ounce in September 2011. Gold slumped 31 percent since then.
As policy makers were buying, investors were losing faith in the metal as a store of value. The value of exchange-traded products dropped by $60.4 billion, or 43 percent, this year, saddling hedge fund manager John Paulson with losses, according to data compiled by Bloomberg. Billionaire investor George Soros sold his holdings in the biggest gold-backed ETP this year and mining companies wrote down the values of their assets by at least $26 billion.
Gold, which entered a bear market in April, slid 21 percent to $1,316.28 in London this year on Oct. 4, set for the biggest drop since 1981. It rose sixfold as it rallied for 12 successive years through 2012, beating a 17 percent gain in the MSCI All-Country World Index of equities as the Standard & Poor’s GSCI gauge of commodities more than doubled. It’s this year’s third-worst performing raw material, after corn and silver. Gold today settled at $1,323.23 an ounce.
Policy makers, who are responsible for shielding their economies from inflation, often mistime gold investment decisions, buying high and selling low. They were reducing holdings when bullion reached a 20-year low in 1999 and as prices as much as quadrupled in the next nine years. Central bankers became net buyers just before the peak in 2011.
“Central bankers have typically bought when you probably should be selling and selling when you probably should be buying,” said Michael Strauss, who helps oversee about $25 billion of assets as chief investment strategist and chief economist at Commonfund Group in Wilton, Connecticut. “It’s going to be a difficult market and sometimes the price of gold is driven by emotions rather than fundamental factors. Central banks have been bad traders of gold.”
Holdings were little changed from the start of 2008 through early 2009. Then, policy makers increased gold reserves as prices doubled and they have purchased a net 884 tons since the 2011 peak, International Monetary Fund data show. Russia was the biggest buyer, adding about 171 tons. Kazakhstan bought 67.2 tons and South Korea purchased 65 tons. Turkey’s reserves swelled about 371 tons in the past two years as it accepted bullion in reserve requirements from commercial banks.
In addition to buying when prices rose, central banks sold into slumping markets, disposing of about 5,899 tons in the two decades from 1988, equal to about two years of current mine supply.
The U.K. auctioned about 395 tons from July 1999, a month before prices reached a two-decade low, through March 2002. Gold averaged about $277 as the country was selling. The Bank of England’s hoard of ingots and coins, including a bar smelted in New York in 1916, now totals 310.3 tons, or 13 percent of the nation’s total reserves.
Warren Buffett, the fourth-richest person in the Bloomberg Billionaires Index and the world’s most successful investor, has said the metal has no utility because it moves to vaults once mined. While countries from the U.S. to the U.K. adopted a gold standard by the 19th century to limit inflation, no central bank or government institution links currencies directly to the metal anymore. The Fed, created a century ago, cut the dollar’s ties to gold four decades ago.
Bernanke, when asked to explain gold’s volatility and the long-term impact of reducing economic stimulus, told the Senate Banking Committee July 18 that investors see a reduced need for “disaster insurance.” In a Congressional hearing two years ago, he described the commodity as an asset rather than money and said central banks own bullion as a “long-term tradition.”
Following that tradition has proved a poor investment decision. Kazakhstan almost doubled reserves the past two years and South Korea expanded them sevenfold since mid-2011.
“Bernanke was suggesting in his own way that too much importance is given to gold, it’s too hyped,” said Nouriel Roubini, professor of economics and international business at New York University. “Gold is not a currency.”
Bullion rose 70 percent from December 2008 to June 2011 as the Fed debased the dollar by pumping more than $2 trillion into the financial system, spurring demand for a hedge against inflation. That protection hasn’t been needed, because U.S. consumer prices have risen at an average annual pace of 1.7 percent in the past five years, compared with a four-decade average of 4.3 percent, Bureau of Labor Statistics data show.
After taking inflation into account, gold is worth almost half of what it was in 1980. It reached a then-record $850 that year after U.S. political and financial turmoil in the late 1970s caused a surge in consumer prices. The metal is valued at $464 in 1980 dollars, according to a calculator on the website of the Fed Bank of Minneapolis.
The most accurate analysts say the bear market will deepen. Goldman Sachs Group Inc. and Societe Generale SA correctly forecast this year’s rout. New York-based Goldman says prices will drop to $1,110 in 12 months and Societe Generale, in Paris, sees an average of $1,125 in 2014. Prices will average $1,300 in the fourth quarter, the lowest in three years, according to the median of 12 analyst estimates compiled by Bloomberg.
Central banks bought metal as the Fed’s balance sheet swelled fourfold since 2008 and policy makers around the world lowered interest rates to record low levels. Greece, Ireland, Portugal, Spain and Cyprus needed bailouts since the European debt crisis erupted four years ago, sparking concern that nations would be forced out of the euro.
“There was a widely-circulated belief that the euro as a currency will cease existing,” said Michael Aronstein, the president of Marketfield Asset Management LLC in New York, whose MainStay Marketfield Fund beat 97 percent of its peers in the past five years. “A lot of foreign central banks thought they cannot keep the euro and did not want to increase dollars. It was desperation and fear that drove the surge in demand.”
While gold is trading below the 1980 high on an inflation-adjusted basis, it has still been better than the dollar in preserving its purchasing power. A dollar bought about three quarters of a gallon of milk in 1970, a year before the peg to gold ended, and an ounce of gold 28 gallons. By the end of 2011, a dollar got you about a quarter of a gallon and an ounce of bullion 420 gallons.
Holding gold is a reasonable, prudent strategy and central bankers probably build reserves with a one- to two-decade view rather than one to two years, Nathan Sheets, the former head of the Fed’s international-finance division and now the global head of international economics at Citigroup Inc., said in an interview in August. The U.S., Germany and Italy, which together own 44 percent of all central-bank holdings, changed gold reserves by less than 3 percent since the start of 1999.
U.S. holdings of 8,133.5 tons, valued at $344.2 billion and accounting for 72 percent of total reserves, are the world’s largest. Most is stored at the U.S. Bullion Depository at Fort Knox in Kentucky and has been held at a book value of $42.22 an ounce since 1973, the U.S. Mint’s and Fed’s websites show. The hoard contracted by about 450 tons, or 5 percent, since then.
Former Texas Representative Ron Paul, the Republican who pushed for an independent count of U.S. gold holdings to prove they exist, also urged that a commission consider “a metallic basis for U.S. currency.” Utah recognizes precious metals as currency and lawmakers in at least six other states have or are considering bills to accept bullion coins as legal tender.
“The gold standard era, at least from an academic view and I think from people that were contemporaries in the 19th century, were that it didn’t work very well,” St. Louis Fed President James Bullard said Aug. 23 in Jackson Hole, Wyoming. “It seems like it would be very problematic to tie the dollar to gold in an environment where gold is fluctuating like crazy.”
Returning to a gold standard, a monetary system in which currencies are converted into fixed amounts of metal, wouldn’t be feasible because there’s not enough available and it would prevent governments loosening monetary policy, Bernanke said at George Washington University in March 2012.
Central banks’ gold holdings are valued at $1.35 trillion now and totaled $1.9 trillion in September 2011 at prices then. Nations will buy more than another 500 tons by 2018, Morgan Stanley says. Their appetite contrasts with investors who cut the value of holdings in ETPs by 43 percent this year to $81.4 billion, data compiled by Bloomberg show.
The most recent central-bank buying began less than a year before Soros called bullion the “ultimate asset bubble” in January 2010. The 83-year-old sold his entire stake in the SPDR Gold Trust, the biggest gold-backed ETP, in the second quarter. Paulson cut his company’s stake by 53 percent in the period.
Venezuela holds 67 percent of its reserves in gold, the most among emerging-market countries, compared with less than 9 percent for Russia. While Russia’s central bank will continue buying, the pace may vary, former First Deputy Chairman Alexei Ulyukayev said in January. Bullion’s fluctuations failed to change the bank’s view on the role of gold in reserves, former Bank Rossii Chairman Sergey Ignatiev said in June.
“There’s been a perception that they are a contrary indicator when they buy and sell, but they’re not traders,” said Quincy Krosby, a market strategist for Newark, New Jersey-based Prudential Financial Inc., which oversees more than $1 trillion of assets. “Some central bankers have come to see gold as an alternative currency, certainly as a defense against potential inflationary pressures from the historical deployment of quantitative easing and low rates by global central banks.”