CENTRAL BANKS POLISH GOLD´S SHINE / THE FINANCIAL TIMES ( A MUST READ )

Note from the editor

Central banks polish gold’s shine

By Jack Farchy

The system of fiat money is 40 years old today. And quite frankly, it is looking its age.


The Bretton Woods system under which fixed exchange rates were linked to the gold price gave way to the current monetary system, in which currencies are backed by fiat, or trust, four decades ago.


For the gold market, it has been a tumultuous time. When Bretton Woods collapsed on August 15, 1971 – the Nixon Shock – gold lost its long-held role as the anchor for the global financial system.


But after a period in the wilderness, the yellow metal has come almost full circle. As currency markets become ever more volatile and global imbalances more entrenched, gold is once again in favour.


A return of any form of gold standard – by which the value of currencies is directly linked to gold – is unlikely. But make no mistake: gold is reclaiming is place at the heart of the financial system.

The most striking evidence of its return is the approach of central banks to the bullion market. After two decades in which central banks, mainly in Europe, were queueing up to dump their gold, central banks are now significant buyers.


The most recent figures from the World Gold Council show that as a group, on a net basis, central banks bought about 208 tonnes of gold in the first half of this year.


That is huge: since Bretton Woods ended in 1971, the largest annual net gold purchase by central banks was 276 tonnes in 1981. At the start of this year, only a few analysts expected full-year net purchases of even 200 tonnes.


But bankers – some of whom helped organise the gold sales of European central banks only a few years ago – are now falling over one another to buy gold on behalf of emerging market central banks. Following significant purchases by Thailand, Mexico and South Korea in recent months, bullion bankers are now setting off to Brasília, Buenos Aires and Riyadh to pitch gold as a reserve asset.


The gold buying comes as the sovereign debt crisis in the eurozone, the debt ceiling debacle in the US, and the general willingness of the world’s central banks to fire up the printing presses have demonstrated the precariousness of a global monetary system that puts just one or two currencies at its centre.


Instead, the growing orthodoxy among policymakers and economists is for a multipolar currency system. A recent survey of 80 central bank and sovereign wealth reserve managers by UBS found that more than half believed that a “portfolio of currencies” would supplant the dollar as the most important reserve currency within 25 years.


The good news for gold bulls is that bullion is also seen as part of this system. Articulating the new orthodoxy in an opinion piece in the Financial Times last year, Robert Zoellick, president of the World Bank, wrote that a new monetary system involving a basket of currencies “should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values”.


“Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today,” he added.


It may be easy to forget with prices hitting a record almost every day, but the return of gold as a prominent financial asset is without doubt the most important development in the bullion market today.


These days, it is not uncommon to hear from traders that one of the factors supporting the gold price on any one day is “central bank buying” – usually meaning that the Bank for International Settlements, through which many central banks like to conduct their gold dealing, has been seen bidding in the market. Indeed, while the latest data on gold purchases run only to the end of June, traders tell me there has been plenty of additional buying since then.

The sea change is a challenge to the view among some commentators – including some of my FT colleagues – that the gold market is primed for a collapse. Given that most emerging market central banks are only now embarking on their gold buying, the “official sector” is likely to underpin gold prices for some time yet.