EDITORIAL & OPINION — Has gold lost its lustre? — Canada selling again

Gold bugs are nothing if not faithful to their precious metal of choice. Any day now, they say, gold will break out of its below-US$300-per-oz. trading trough and head straight for the stars. Unfortunately, they’ve been saying this for so long that no one bothers to listen anymore. The gloom has turned to doom, and producers have resigned themselves to a “low gold price environment” and written down assets that no longer make the grade.

But gloom and doom are contagions no less infectious than euphoria was a few years ago when the bull market in resource stocks had a full head of steam. They color the thinking of investors, the media, central bankers and political leaders. To hear some tell the tale, gold is out of vogue, a hula hoop relic of an earlier, simpler time — a time when the financial world was less sophisticated, believed in tangible assets and didn’t comprehend the awesome wealth that could be generated from numbers on a computer screen, a time when wealth came from making and selling things, rather than from a powerful arsenal of financial instruments, including (but not limited to) derivatives, hedging programs and currency trading.

And who better to understand the power of these new tools than the bankers and financial wizards who created them from thin air? Central bankers have been downright eager to realize the benefits of gradually replacing gold reserves with interest-bearing assets. It makes sense to monetize gold, they say, rather than allow bullion to collect dust in the basement.

Canada has been a leader of this global selloff. Once a major holder of the yellow metal, the Bank of Canada disposed of 594 tonnes between 1980 and 1996, upsetting most of the country’s gold producers in the process. (Ironically, the Canadian politician who got these gold sales rolling now sits on the advisory board of one of the world’s largest gold producers, but we digress.)

After a 21-month hiatus, the Bank of Canada got back into the game this year, selling 5 tonnes in July, 4 tonnes in August, and 7 tonnes in September. Experts say these sales likely were triggered by recent weakness in the Canadian dollar.

Canadian gold reserves now total a mere 81 tonnes, which means our national paper is backed with little more than, well, paper. Small wonder our currency is buffeted around by speculators; paper is a poor ballast. The United States, on the other hand, has kept a tight grip on its piles of gold in Fort Knox, and its dollar has become the de facto currency of the world.

Not all countries feel, as Canada does, that gold is yesterday’s story. Poland, a nation that has struggled long and hard for its political and economic destiny, bought substantial quantities of the yellow metal this year for “economic and strategic political reasons” and to diversify reserves. It now holds 102.7 tonnes, more than Canada, and is rapidly becoming the economic engine of Eastern Europe.

Across the world in China, politicians are urging the country to raise the percentage of gold reserves in order to shelter the country from the economic financial crisis that has rocked its neighbors. For many decades, gold was a principal component of the country’s foreign exchange reserves. For example, in 1973 (before reforms), China’s gold reserves stood at 9 million oz., then valued at US$1.6 billion, while foreign exchange in the form of American dollars was only US$83 million.

Trade surpluses, combined with market reforms, have enabled China to increase its foreign exchange reserves to its current level of US$141.1 billion, ranked second in the world. But gold reserves of 397 tonnes have remained constant since the early 1980s, which means gold accounts for a mere 3% of China’s current foreign exchange reserves.

Chinese officials are now calling for gold reserves to be increased to around 10%, to bring the quantity of total reserves to between 1,000 and 1,500 tonnes (thereby reducing their exposure to American dollars). This would make China the world’s sixth-largest holder of gold in official reserves.

Chinese politicians are a pragmatic lot and know full well that the devaluation of their currency would be a devastating blow to Asian recovery. Accordingly, they have focused on augmenting their foreign exchange reserves, thereby insulating their country from financial crisis and stabilizing its local currency. But American dollars don’t come cheap anymore. Gold, on the other hand, is a downright bargain. Maybe, just maybe, those gold bugs are on to something this time.