Central Banks Join a New Gold Rush

The world's central banks are likely to be net buyers of gold in 2009 after two decades of selling, sparking a race among analysts to figure out which country will step in with the next big purchase. Gold Fever

Since 1991, central banks have reduced their gold holdings by 10%. It is a trend that has long been cited as keeping an overhang on gold prices. Developed countries like Switzerland, the U.K. and the Netherlands all sold significant amounts of gold to diversify into other assets in pursuit of higher returns.

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India's $6.7 billion purchase of 200 metric tons of gold from the International Monetary Fund last month, absorbing half the amount the IMF put up for sale, was the largest purchase by a central bank in 30 years. Now the market is engaged in a guessing game about which central bank may buy the rest.

Eugen Weinberg, an analyst with Commerzbank AG, is looking to China. Jeff Christian, managing director of CPM Group, a New York-based precious-metal research firm, says other Asian and Middle East countries may be likely candidates.

Wei Benhua, a former Chinese official, was cited by Chinese-language magazine Caijing on Monday as saying China, Brazil or Russia may follow India in buying IMF gold.

India's purchase has thrown central banks back into the spotlight as a potentially powerful force behind gold. Even relatively small changes in the balance of a central bank's reserves could have a drastic impact on gold prices because of the relatively small size of the market.
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Gold ingots await shipping at the Argor-Heraeus gold producing and refining plant in Switzerland.

This year could mark a "watershed year," Barclays Capital analyst Suki Cooper said in a note to clients. And, even though central banks mightn't be big buyers of the precious metal, the prospect of added demand may provide key support to the market, they say.

China, Russia and Brazil have tiny holdings of gold relative to their overall foreign reserves, placing them among more likely buyers. China, for example, has just 2% of its reserves in gold, compared with the world average of 10.3%., according to the World Gold Council; and Russia is at 4% and Brazil 0.5%.

The most logical buyers are countries that are running current-account surpluses and that don't have their own domestic gold production, Mr. Christian said.

With a net inflow of dollars and euros every month, central bankers in these countries are worried about the growing exposure to these currencies and have the most desire to diversify into other assets. According to the IMF's International Financial Statistics, Malaysia, Singapore, Kuwait, Saudi Arabia and Venezuela are among other biggest surplus countries behind China and Russia.

Typically, central banks hold a basket of foreign currencies, bonds and precious metals in reserve, using it to make international payments or adjust the value of their domestic currency. The U.S. dollar was considered the preferred reserve currency for decades. But the greenback's recent decline has spooked many countries sitting on big dollar assets.

While China has become an obvious buyer, some analysts say the country is likely to buy production from Chinese mines rather than buy from the IMF. China, the world's largest gold producer, has $2.3 trillion in foreign reserve, with the majority in U.S. Treasury securities.

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