Follow the Money

The following article was written by Mary Anne and Pamela Aden for the August 2010 edition of Peter Schiff’s Gold Letter.

Gold has been rising steadily for the past decade. In recent years, the rise has gained momentum, in large part thanks to the world’s central banks.

“Follow the money” is a secret that smart investors have known about for years. In a nutshell, it just means go where the money goes.

Well, the world’s central banks have a lot of money, and they’ve been buying gold. This is expected to continue, and it’ll keep upward pressure on the gold price.

How Do We Know?

Over the past few years, the world financial system has experienced one crisis after another. This made investors nervous and uncertain – including the central banks. During times of economic or political trouble throughout history, gold has shined as humanity’s preferred safe haven. With that track record, it’s no wonder central banks took refuge in gold.

As the World Gold Council (WGC) reported, central banks around the world added 425 metric tons of gold to their reserves last year. That was the biggest increase in nearly 50 years, and the first increase in more than 10 years.

China Gaining Ground

China was one of the three countries buying the most gold. This isn’t surprising considering that China has seen the most spectacular growth in history and has the largest cash reserves in the world.

Plus, China has a cultural affinity for gold. That goes for the government and the average Chinese citizen. Gold is popular across the board, and the government has actually been encouraging its citizens to buy gold.

Meanwhile, the Chinese middle class has been growing by leaps and bounds. As it does, so does its demand for gold. As the WGC notes, “China has an insatiable appetite for gold, which looks likely to continue.” They also predict that China’s gold consumption will double in the next decade.

As for the government, it has increased its gold reserves 76% over the past six years. Even so, China’s reserves remain well below the global average; unlikely for a fast-growing country that recently took the title of world’s #2 largest economy from Japan.

India Buying Too

The same is true of India, which is already a major market for gold. Last November, for instance, the Indian central bank bought a huge amount of gold from the IMF at $1000 an ounce. This was considered expensive at the time, but we now see that it was a good price.

The Indians know what they’re doing, especially since gold has been culturally important to them for a very long time.

Keep in mind that in the cases of both China and India, we’re talking about hundreds of millions of people who are entering the middle class. Only 25 years ago, 93% of all Indians lived in poverty; now, that number is about 35% – and it’s shrinking rapidly each year.

China is similar. Money and wealth are building in the East, so that’s where the gold is going. But it’s not just the East that is buying. Central banks worldwide now possess nearly 20% of all of the gold ever mined. The central banks know gold is money. It always has been, and it always will be.

The Trend Continues…

This year, the trend has continued. As gold surged to a record all-time high, China’s gold bar sales doubled. Meanwhile, India’s gold demand soared almost 700% in the first quarter.

Europe jumped on the bandwagon too as the Greek crisis spread, triggering a broader flight to gold. Gold sales from the Perth Mint to Europe have soared, surpassing all previous records. This demand boom also pushed production of South African Krugerrands to their highest level in 25 years.

Central banks are clearly concerned about the global markets and this concern is widespread. Russia’s gold purchases in May amounted to its biggest one-month increase ever. Iran and the other oil producers joined in as well, with Saudi Arabia doubling its reported gold holdings.

…And It’s Powerful

These trends are powerful. That’s especially true because the buying is taking place not only by central banks, but by the man on the street too. This has not yet become obvious in the US, but eventually it will be impossible to ignore.

An important sentiment change has occurred, and it’s extremely bullish for gold. If you follow the money, you can see that the outlook remains very positive for gold. Despite normal ups and downs, gold will remain strong by staying above $1080. In fact, all of this action behind the scenes is providing a solid foundation for a higher gold price in the months and years ahead.

Mary Anne and Pamela Aden are authors of The Aden Forecast, an investment newsletter now in its twenty-ninth year. It is one of the longest continually published investment newsletters in the world. They specialize in the precious metals and foreign exchange markets, as well as the US and international equity and credit markets.

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