Central Banks and Gold: Buy High, Sell Low

♠ Posted by Emmanuel in at 10/10/2013 11:24:00 AM
Despite strides made by central banks worldwide in recent years to control inflation, they are hardly infallible. Take the case of gold: With developed country central banks printing money like there's no tomorrow in order to jump-start their moribund economies--especially after the global financial crisis--you would expect that gold would benefit as an inflation hedge. Indeed, gold prices have increased many time over in the new millennium.

However, central bankers have not really benefited from the rising and now falling of gold prices since they are, after all, public financial managers of a sort rather than speculators. Owning nearly a fifth of all bullion extant, they are major market players. Yet, when it comes to trading gold, their timing tends to be off in the sense that they collectively buy high and sell low. Based on central bank gold holdings, Bloomberg calculates that their combined losses amount to $545 billion since the metal hit its peak in 2011:
Policy makers, who are responsible for shielding their economies from inflation, often mistime gold investment decisions, buying high and selling low. They were reducing holdings when bullion reached a 20-year low in 1999 and as prices as much as quadrupled in the next nine years. Central bankers became net buyers just before the peak in 2011.
There's more detail from Bloomberg on the extent of mistiming the markets:
Holdings were little changed from the start of 2008 through early 2009. Then, policy makers increased gold reserves as prices doubled and they have purchased a net 884 tons since the 2011 peak, International Monetary Fund data show. Russia was the biggest buyer, adding about 171 tons. Kazakhstan bought 67.2 tons and South Korea purchased 65 tons. Turkey’s reserves swelled about 371 tons in the past two years as it accepted bullion in reserve requirements from commercial banks.

In addition to buying when prices rose, central banks sold into slumping markets, disposing of about 5,899 tons in the two decades from 1988, equal to about two years of current mine supply. The U.K. auctioned about 395 tons from July 1999, a month before prices reached a two-decade low, through March 2002. Gold averaged about $277 as the country was selling. The Bank of England’s hoard of ingots and coins, including a bar smelted in New York in 1916, now totals 310.3 tons, or 13 percent of the nation’s total reserves.
Gold bugs will of course argue that continued money printing and developing states' inability to transition away from easy money policies will result in massive price rises in the future. If this scenario comes to pass, then seemingly large losses trading gold now will disappear. Again, though, it's more conjecture than fact at the moment.

Bottom line: there are good reasons why central bankers are where they are instead of at commodity trading desks.