Swapping Dollars for Bullion

In Financials, Politics on November 5, 2009 at 13:30

gold4The Central Bank of India’s purchase of 200 tonnes of gold from the IMF yesterday took the market by surprise, sending the gold price sky-high to a record of $1087.45 per troy ounce. This 2.6% price rise on the day can also be attributed to speculation among traders that other central banks would follow suit.

India’s finance minister, Pranab Mukherjee said that the 6.7bn dollars worth gold acquisition underlined the power of an economy that had the resilience to attain 9% economic growth in a year. He contrasted this strength to the weakness of the global stage, especially that of Europe and North America.

The diversification of foreign exchange reserves seems to have become a trend among a large class of emerging economies, aiming to rebalance their holdings of dollar denominated assets. Venezuela, Mexico, Russia and the Philippines are also buying, albeit in small amounts. This seems to be a reversal of the past two decades of anti-gold sentiment amongst central banks, where predominantly Asian countries hoarded US Treasuries as their main reserve asset. China for example, is currently investing a portion of its foreign exchange reserves in commodities trading houses, oil fields and mining companies.

The allure of gold reflects concerns about the health of the US dollar and the Fed’s quantitative easing policy. It is not just central banks buying gold. Hedge funds and institutional investors are too, as a means of diversifying their portfolio risk by investing in assets with a negative correlation to the ‘greenback’. This buying surge has been further accentuated with the financial crisis, sending households to seek refuge in gold.

One cannot help asking, was it the pull of gold or the push of the dollar behind the Reserve Bank of India’s swap? Probably the latter..

by the Undercover Economist

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  1. At this stage A4 recycled paper will be worth more than the Dollar! so OBVIOUSLY no one wants Dollars

  2. One should be careful with such statements.
    India’s swap of dollars for gold reflects its worry about capital losses if the dollar continues its slide but also Asia’s evaporating tolerance with declining US assets. Although this raises the pressure on the Fed, it in no way implies no one wants dollars. The dollar is still the world’s main currency, and a replacement has yet to be found.

    One surely does not expect the US to increase its interest rates and scale down quantitative easing just to boost the dollar. On the contrary, the Fed announced (yesterday) that it intends to maintain interest rates at their “exceptionally low” level for an “extended period”. This announcement clearly underlines the Fed’s focus on economic stability compared to strengthening the dollar, a prioritisation that I definitely agree to. Lastly, a weak dollar could be viewed as aiding the economy, as it boosts exports and reduces imports, thus reducing the trade deficit.

  3. The main point here is that as the dollar is considered the world’s main currency, its price should not be volatile and fluctuate since this provides less dignity and “value” to the currency itself. A currency whose value has been reducing in the past years to a large extent in relation with other currencies, should not be preferred as the main medium of exchange. Probably, in our days, the euro is though to provide more stability to the financial system and especially to the Forex market

  4. Dimitri mou ,
    We’ve seen your blog , navigated through it , learned a lot about the dollar that I did not know .

    Congratulations for a superb presantation; it’s a very useful tool of analysis .

    Warmest regard’s and love from all of us ,
    Alexis, Mariella ,Giorgos ,and Ismene

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