From pet rock to precious asset

(Kitco News) - This past week, the gold market celebrated an interesting anniversary. On May 7, 1999, the Bank of England announced to the world that it wanted to sell half of its gold reserves. In two months, the BoE sold 395 tonnes of gold and raised $3.5 billion, which it used to buy bonds.

The gold auction pushed prices to their historical low of $252.80 an ounce. Even today, 25 years later, this is referred to as the Brown Bottom, a reference to Gordon Brown, who was the Chancellor of the Exchequer at the time.

As I started writing this article, I didn’t want to get into a right-or-wrong argument about what the Bank of England did. In hindsight, 25 years later, with gold breaching $2,400 an ounce, one could say that the BoE made a huge mistake.

However, at the time, gold was seen as an ancient relic. Western capitalism won the cold war of the 1980s, the global economy was growing, and many economists didn’t see the need to hold a useless pet rock. Bonds were cheap, so one could say that the BoE put its money to good use.

I wanted to focus on how the world has changed in the last 25 years. In 1999, gold was seen as a pet rock, but today, it has reestablished itself as a globally essential monetary metal.

While developed market central banks remain reluctant to embrace the precious metal into their portfolios, emerging markets have an insatiable appetite. Setting a record pace, emerging market central banks have bought more than 2,000 tonnes of gold in the last two years because they need to diversify their sovereign debt holdings and exposure to the U.S. dollar.

China continues to dominate the marketplace as the People’s Bank of China has increased its gold reserves for the last 18 consecutive months.

According to fund managers and market analysts worldwide, this official sector demand could dominate the marketplace for the next 25 years… well, okay, nobody actually said that, but for the foreseeable future. 

But it’s not just central banks getting in on the action. The World Gold Council’s monthly central bank data shows that the State Oil Fund of the Republic of Azerbaijan bought 3 tonnes of gold in the year's first quarter. It was just one sentence in the report, but it was a huge revelation that could have significant repercussions for the gold market.

Gold demand as a monetary metal will only continue to increase if sovereign wealth funds are now starting to see value in holding some precious metal. Interestingly, SWFs don’t have to report their gold holdings to anyone, which means we will have to pay a lot more attention to flows in over-the-counter markets.

However, while we see all this official sector demand, major fund managers and investors are still not paying attention. The gold market continues to see outflows in gold-backed exchange-traded products as investors remain narrowly focused on opportunity costs and ignore the broader value in the marketplace.

Looking back, at least 25 years ago, when people were calling gold an outdated relic, bonds had some value and offered investor protection. The question investors need to ask themselves now is: how much value is there left in the U.S. Treasuries as government debt spirals out of control?

That is it for this week. Have a great weekend.