World Gold Holdings - As of September 2009

The World Gold Council recently updated the gold holdings for every major country, including the IMF. While little has changed since the Lumpy Investor last published the Council’s findings on May 21st (see post for comparison), it is important to emphasize how underinvested the US’s largest creditors remain in gold. Specifically, China and Japan, which collectively hold $1.5 trillion of US Treasuries, have only 1.9% and 2.3%, of their respective foreign reserves in gold. Conversely, the leading Western economies, including the US, Germany, Italy, and France have between 65-80% of their reserves in gold. Across the 107 countries surveyed by the World Council, the average country has approximately 10% of their reserves in gold.



China has publicly expressed its concern over the US dollar and demonstrated its unease by purchasing 400 metric tonnes of gold earlier this year. While unlikely in the near-term, I see no reason why China wouldn’t seek to bring its holdings in-line with the world average of 10%. Assuming such an outcome, China would have to increase its gold holdings by approximately 4500 metric tons. With mine production at approximately 2500 tons per year and declining (see chart below), this would represent 1.8 years of annual supply just to get China on par with the rest of the world. Applying similar logic to other reserve rich/gold poor countries, including Japan (2.3% of reserves in gold), India (~6% after its recent 200 metric ton gold purchase from the IMF), Singapore (2.2%), and Russia (4.3%) could have a massively distortive impact on the price of gold.

While I doubt the conclusion of some analysts that such a scenario would drive gold in excess of $5,000, I see no reason why the yellow metal will not surpass its previous inflation-adjusted price of approximately $2,200/ounce hit in 1980. Given the unprecedented money printing and fiscal imprudence demonstrated by elected officials across the globe, such an outcome becomes more likely with each passing day.

The Lumpy Investor remains bullish on gold over the next several years, and while I am increasingly concerned by the growing consensus around that view (particularly with hedge funds and individual investors clamoring into the trade), the glaring underinvestment in gold by the world’s largest creditor nations, provides strong fundamental support for my thesis. Does that necessarily preclude us from seeing a short-term pullback in the price of gold? Most certainly not. There has been a massive shift out of the dollar and into risky assets, with gold an obvious beneficiary of this migration. Should the Fed begin to tighten, we will likely see a near-term snapback in the price of gold as the dollar-carry-trade gets unwound en masse. However, last week’s policy statement provides minimal evidence that the Fed views inflation as a risk, which would in turn lead to them raising short-term interest rates.

With the Fed's stamp of approval, investors have a license to speculate in risky assets, with gold being the most obvious currency. Until the Fed begins to show some backbone and/or foreign central banks reduce their negative rhetoric on the dollar, the Lumpy Investor will remain bullish on gold.