India Sells Dollars, Buys Gold, What Does it Mean?

There has been a lot of discussion over the last year about central banks and sovereign wealth fund concerns over US dollar weakness, the possible rise in inflation and, in the longer term, the US dollar losing its status as the world’s reserve currency. So far it has been mostly that: discussion. But, in what is arguably the first and most public move by a central bank to diversify its foreign exchange reserves, India purchased 200 metric tons of gold from the IMF last month. The Reserve Bank of India (RBI) bought the gold between Oct. 19 and 30, an IMF statement is reported to have said in the Wall Street Journal. The $6.7 billion in proceeds from the sale indicate an average price of $1,045 a troy ounce. If so, the RBI is up $250 million on their investment as gold has continued to rise.

That isn’t how the RBI is looking at it, of course. This isn’t a short term punt; by their own statements, it is a diversification to avoid anticipated devaluation in the dollar. Sonal Varma, an economist at Nomura Financial Advisory & Securities in Mumbai, is quoted as saying “(The) Dollar will continue to be a significant part of foreign-exchange holdings, as most of India’s external debt is in dollars. The gold buying, as of now, seems just an asset-diversification strategy.”

Needless to say, funds and investors took this as a positive sign for gold, not just because it now looks unlikely that any of the IMF’s physical gold will reach the market, but also because it underlines the logic of a key element in the massive flow of money into ETF gold instruments which is as a hedge against a long-term continuing weakness in the US dollar that is expected to continue. Gold holdings in the SPDR Gold Trust, the world’s largest gold ETF, have reached 1,103.52 tons, making SPDR the seventh-largest gold holder in the world. Illustrating the trend, Aaron Gurwitz, head of global investment strategy at Barclays Wealth, said, “The dollar has been depreciating on a trade-weighted basis on an average rate of 0.75% per year since 1973 and will continue to do so, our currency will command less and less of a premium as the reserve reliable currency.” Barclay’s advice is investors should keep at least 20-25 percent of their allocations in non-U.S. dollar-denominated assets to protect the purchasing power of their wealth, Gurwitz is reported as saying in Reuters.

Does this mean we are going to see the end of the US dollar as the world’s reserve currency anytime soon? No, but it is the beginning of a trend that will build over time. The dollar will no doubt go through periods of strength and weakness over the coming years, as will just about all other national or regional currencies. The Yen has dire problems of massive, near unserviceable debt, an aging population and stagnant economy. The Euro is currently the least bad of the major economies, largely because it has not jumped on the bandwagon of massive stimuli and quantitative easing that the Anglo Saxon currencies have done. But Europe has an aging population and is a society sliding into socialist sclerosis with ever rising levels of bureaucracy and social welfare that will continue to hold the trading bloc back from dynamic growth. As a result, Europe, while remaining a solid anchor in the world economy, will probably gradually lose ground to emerging economies and currencies. We won’t even mention the Renminbi; until it is freely floating and freely convertible, it should and will remain a side show.

So, is this a return to a gold standard by central banks? No, it should be seen for what it is, a realization that we are in for a period of prolonged dollar weakness and unlike most US citizens who cannot hedge against a fall in their country’s currency, central banks can and the historic assumption that reserves will largely be held in dollars is making way for a more actively managed diversification into other currencies and commodities that may provide a degree of protection against devaluation and inflation in the future.

–Stuart Burns