Central Banks Continue to Buy Gold

Smart money buys what foolish money sells. This is one of the most fundamental laws of trading that every investor needs to know.

Much of the selling in gold as of late has been by the investors who came late to the party—those who jumped in during 2011’s rapid rise to $1900.

But for every seller there is a buyer. So just who has been buying all this gold that those who have lost patience with the metal have been selling?

Central banks. And they are buying with purpose, as Bloomberg yesterday reported, “Central banks added 534.6 tons of gold to reserves in 2012, the most since 1964, the [World Gold] council said last month.”

According to the most recent U.S. Geological Survey gold report, global gold production for all of 2012 is estimated to have been 2,700 tons. Central bank purchases last year ended up taking some 19.8%—nearly a fifth—of newly mined gold off the market, and the banks stored it in their vaults.

And people think the gold market is dead? Take 20% of any product’s annual new supply off the market and you can bet the price will rise considerably when people realize what has been happening.

But why would central banks want so much gold? It doesn’t generate revenue like a company stock or even interest like bonds.

Bloomberg explains the motivation:

“Central banks are increasing purchases of gold, yen and China’s renminbi to reduce their dollar and euro holdings as a percentage of total reserves, the World Gold Council said.”

Central banks interest in gold, then, together with purchases of yen and renminbi, is part of a larger hedging strategy to protect their nations’ reserves against potential drops in the U.S. dollar and Euro. Smart move, given the resolve of both the U.S. and European Union to keep their currencies weak in the interest of stimulating economic growth.

But there is one more reason central banks are buying, as Bloomberg adds, “Currency debasement and inflation concerns will spur metal demand, Morgan Stanley said in a Feb. 25 report.”

Yes, let us not forget gold’s favourite energy drink… ‘inflation’. And for that extra kick, ‘hyper-inflation’. Keep interest rates low enough long enough and that is precisely what you will get… rising prices on everything, including gold.

As the Manager for Government Affairs at the World Gold Council, Ashish Bhatia, summarizes, “Building gold reserves in tandem with new alternatives is an optimal strategy as central banks remain under-allocated to gold.”

So if those ‘in-the-know’—namely central bankers—are hedging their reserves with gold, the question every investor should be asking themselves is: Should my portfolio likewise be adequately hedged with gold or other foreign currency?

If we are concerned about gold’s inability to generate income, perhaps a hybrid investment combining the security of gold with the dividend income of a company would placate us, as can be found in a major gold producer.

The world’s largest producer, Barrick Gold Corp (NYSE:ABX), a large-cap of $28.59 billion, has been consistently paying 20 cents per share per quarter for several quarters now (Dividends for ABX), which represents 2.8% annual yield over its current $28.56 stock price.

Production-wise, Barrick is the king of gold producers. “As of December 31, 2012,” the company informs on its website, “Barrick’s proven and probable mineral reserves were 140.2 million ounces of gold, 1.05 billion ounces of silver contained within gold reserves, and 13.9 billion pounds of copper. We replaced proven and probable gold reserves for the seventh straight year in 2012.”

What is equally impressive is the company’s ability to bring its costs under control at a level well below the current market prices of the commodities it produces. “In 2012,” the company reports, “Barrick produced 7.4 million ounces of gold at all-in sustaining cash costs of $945 per ounce and total cash costs of $584 per ounce. Barrick also produced 468 million pounds of copper in 2012 at cash costs of $2.17 per pound and fully allocated costs of $2.97 per pound.”

By comparison, the current price of gold is hovering around $1585, while copper is in the low $3.50’s. Plenty of mark-up room there.

Another heavy-weight in the gold producer arena is Newmont Mining Corporation (NYSE:NEM), also a large cap at $19.37 billion, paying 35 cents per share for several quarters and 42.5 cents just a few days ago (Dividends for NEM), which represents a hefty 4.26% annual yield over its current $38.99 stock price.

“As of December 31, 2012,” the company shares on its website, “Newmont had proven and probable gold reserves of 99.2 million attributable ounces and an aggregate land position of approximately 29,000 square miles (75,000 square kilometers).”

The company boasts some impressive highlights from 2012, including:

• “Annual revenue of $9.9 billion;

• Record regular dividends paid to shareholders of $695 million, or $1.40 per share, representing a payout ratio of 38% of adjusted net income;

• Gold operating margin of $985 per ounce;

• Operating cash flow of $2.4 billion;

• Attributable gold and copper production of 5.0 million ounces and 143 million pounds, respectively;

• Gold and copper consolidated costs applicable to sales (“CAS”) of $677 per ounce and $2.34 per pound, respectively;

• All-in sustaining cost of $1,149 per ounce; and

• Average realized gold and copper price of $1,662 per ounce and $3.43 per pound, respectively.

• Included in the Dow Jones Sustainability World Index for the sixth year in a row.”

So if you think like a central banker with one half of your brain, but also like a business-owner with the other half, perhaps a hybrid investment in a gold producer might give your portfolio the security of a gold holding with the steady earnings of dividend income.

And if those currency debasement and inflation predictions come to fruition, you could be sitting on a fairly lucrative capital gains gold mine of your own.

Joseph Cafariello

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