Monetary Mess, the Dollar, Gold—and You, Part VII

(For previous parts in this series, scroll down and click on the links in the righthand column.)

Private investors have been seeking a store of value in the same way as the nations' central banks. Alarmed by Greece's monetary problems, Europeans have led an exodus out of the euro and into gold coins, bars and exchanged-traded gold funds (ETFs). In scarcely two weeks in May 2010, the Austrian mint sold 243,500 ounces of gold, compared to 205,000 for the entire first quarter. Adrian Ash, head of research at Bullion Vault, an online gold trading service, said, “We saw very strong flows of money from European customers,” a demand he attributed to “anxiety over the euro.” In May, 39% of Bullion Vault's new customers came from the euro zone, compared to an average of 21% since the start of 2009. The South African Mint increased Krugerrand production by 50% in May on brisk European demand.

European concerns have spread to the U.S., as well as other countries. The U.S. Mint is running short of gold coins. Sales of American Eagle one-ounce gold coins tripled in May from the previous month. Sales of American Eagles totaled 449,000 ounces in 2005 but 922,500 by September 2010. Buffalo coins, which the U. S. Mint makes of pure gold, were sold out in September. Other gold coins such as Krugerrands have also been selling well in the U.S. and elsewhere.

But the real gold-buying story is the ETFs. These are a relatively new development, with the first one, SPDR Gold Shares (GLD), appearing in November 2004. When people buy shares of stock in such a fund, the fund buys an equivalent amount of gold, which is stored in vaults. When shares are sold, the fund sells an equivalent amount of gold. The ease and simplicity of the process has resulted in investors pouring billions of dollars into these funds on stock exchanges in the U.S., Paris, London, Australia, South Africa, Mexico, Singapore, and some other countries. As of October 6, 2010, SPDR alone held well over 41 million ounces of gold, valued at $56,357,447,760.40. Collectively, the ETFs hold about $83 billion in gold. This graph shows the phenomenal growth of a dozen major funds: 

In October, 2010, gold ETFs held over 2,000 tons of gold. This is nearly double that of the central bank of China and more than most of the central banks of the ten largest gold-holding countries, according to the World Gold Council:

RANK      COUNTRY       HOLDINGS, JUNE, 2010

                                            in tonnes (metric tons) 
1               U.S.                      8,133.5

2               Germany               3,406.8

3               Italy                      2,451.8

4               France                  2,435.4

5               China                    1,054.1

6               Switzerland           1,040.1

7               Japan                       765.1

8               Russia                      668.6

9               Netherlands              612.5

10              India                       557.7

In addition to the above, the International Monetary Fund holds 2,966.8 metric tons and the European Central Bank 501.4 metric tons. You might easily assume these two institutions plus all the nations' central banks must control most of the world's gold. You'd be wrong. They control only 18% of the gold in human hands. Jewelry, with 51%, accounts for more above-ground gold than all other uses combined. Industrial use, mainly dental, biomedical, and electronic, accounts for 12%. That leaves about 17% taken up by investment.

Overall, investment demand doubled in 2009. According to Gold Fields Mineral Services, this was the first time in three decades that investment demand exceeded jewelry demand. In 1998 investors accounted for less than 7% of demand. In 2009 they accounted for 39%. In the second quarter of 2010, they bought more than 50% of all gold sold.

An extremely significant development is that buyers increasingly want to take possession of physical gold, whether they are dealing in the futures market or buying coins or bars from dealers. They are not buying and selling for paper profits. At the CME Group's Comex, the world's largest metals futures exchange, investors took delivery of 39% more gold so far this year compared to last year.

The demand for storage facilities for gold coins and bars has led to a scramble for vault space by banks and private vault services. First State Depository Co. says it has increased storage capacity three times this year and is considering buying property next door so it can provide even more. Responding to increased demand, the World Gold Council in June announced a $9 million investment in Bullion Vault, the world's leading gold ownership service, which stores 21 tons of gold for 20,000 customers in vaults in Switzerland, London and New York. Vaulting firms Via Mat International of Switzerland and Ocasa of Argentina are expanding. J.P. Morgan Chase will open a new vault in Singapore, and Barclays Capital is seeking to expand its space in London.

The shortage of secure storage for gold investors was compounded last November when the large British bank HSBC required small investors to take possession of their gold stored in the bank's 4.2 million-ounce storage facility in New York City. It said it needed the space to meet the demands of large institutional investors. This was upsetting not only to the small-account owners but to dealers who sent their customers to HSBC. Goldstar Trust Co., of Canyon, Texas, had been an HSBC customer for 15 years and was sending more than 1,000 new accounts each month to them. But HSBC no longer wanted their business because the big investors piling into gold were more lucrative.

“We are receiving steady inquiries for storage from high-net-worth individuals,” said Barry Wainstein, global head of foreign exchange for Scotia Capital. Its precious metal division, Scotia Mocatta, has a 4.8 million-ounce storage facility in New York and has been expanding its vault in Toronto.

Hedge fund manager John Paulson, whose fund made $3.7 billion by betting on the collapse of the subprime mortgage market, is now a big investor in gold. In a speech to the New York University Club in September 2010, he said 80% of his assets are in gold, spread between ETFs, physical bullion and shares in gold mining stocks. Billionaire George Soros has also become a big investor in gold. Since people do not accumulate great wealth by being stupid, maybe their current investments deserve our attention.

Investors often choose geographic diversity in storing their gold. Countries such as Switzerland and Canada are seen as posing fewer geopolitical risks than most others, and their banking systems did not require the massive bailouts that accompanied banking failures in the U.S. Also, many U.S. citizens, remembering that Franklin Roosevelt confiscated most privately held gold in the 1930s, are leery of storing gold in regulated banks in the U.S., fearing such a policy might be repeated. They may also be leery of disclosure agreements between the U.S. and foreign governments regarding foreign banks, hence an interest in non-bank storage facilities even for legitimate holdings. Sprott Asset Management in Toronto recently added storage for about 250,000 ounces at the Canadian Mint. Owners of its ETF may redeem their shares at the mint and take possession of bullion. SPDR and other gold ETFs sold in the U.S. commonly store their gold in London, Zurich and in the U.S., but they do not allow shareholders to redeem their shares for bullion.

Why is there so much interest in owning physical gold? Because it is a store of value. There is no longer any currency in the world that is a reliable store of value. As further evidence of this, look what has happened with the currency markets. Trading has become vastly larger, more volatile and riskier as people try to escape the effects of monetary instability and governments' efforts to manipulate currencies in the absence of a sound international monetary system. Currency trading volume is now $4 trillion per day, according to the Bank for International Settlements, which makes a survey every three years in April. By comparison, stock trading in the U.S. in April averaged $134 billion. Even the giant market in U.S. Treasuries averaged only $465 billion per day in April. Previous surveys by the BIS showed daily currency volumes of $3.3 trillion in 2007 and $1.9 trillion in 2004. There are now 44 currency ETFs, compared to only one in 2004.

Globalization, of course, causes an increase in currency trading, but that in itself does not create instability. With reliable currencies of a gold-based international monetary system, currency trading would grow in an orderly manner as commerce expands, rather than from attempts to offset or profit from currency fluctuations with quick in-and-out trading.

For Part VIII,  the concluding article of this series click link