There are 3 main reasons why so many are still investing in gold and will continue to do so. These reasons include central banks now buying, instead of selling their gold, gold having more purchasing power than the dollar and gold starting to become apart of monetary policy.
September 14, 2011
NEW YORK (TheStreet) -- Gold is being taken more seriously as a legitimate form of money as currencies flail and prices hit new records.
Gold's last gasp of monetary fame came between World War II and 1971, when the world pegged their currencies to the U.S. dollar and the dollar was fixed to gold at $35 an ounce. This wasn't a pure gold standard but it forced some kind of fiscal discipline into monetary systems. President Nixon abandoned this standard in 1971 so the U.S. could have more cash to fight the Vietnam War.
Although gold bugs still loved the metal, pushing prices to a then-high of $850 an ounce by 1980, the gold fever didn't hit the mainstream for almost 40 years ... until now.
Gold is a safe haven asset, a trade and a store of wealth but it can also be considered a currency and that theory is gaining steam. Here are three of the primary factors behind golds rising legitimacy.
3. Central Banks Are Now Buyers, Not Seller
Central banks have become net buyers of gold instead of net sellers. Once dumping gold and buying currencies, the central banks are now changing strategies to include gold.
"There has been a fundamental shift in the behavior of central banks over the past few quarters," says Natalie Dempster, head of investment for the World Gold Council.
Since the second quarter of 2009, central banks from emerging market countries have transitioned into net buyers. One of the biggest buyers is China. Over the past five years, the country secretly increased its gold holdings from 600 tons to 1,054 tons. China currently holds only 1.6% of its reserves in gold.
Dempster says that if the continent were to reallocate its holdings to 3%, it would need to buy 1,000 tons of gold. Compare this with the U.S. and Portugal, which hold 70% and 80% of their reserves in gold, respectively. Although if the gold price rises rapidly then China could get the same diversification without buying 1,000 tons, but the amount would still be substantial.
"Some banks," says Dempster, "have been rebalancing as the percentage of gold in total reserves has fallen over time. Others are looking to diversify away from dollar-based assets, and with sovereign debt concerns continuing to grow around the world, gold's attractiveness as a reserve asset that bears no credit risk continues to grow."
In 2010, net central bank purchases totaled 87 tons, according to the World Gold Council, led by Russia, Thailand and Venezuela. According to Alec Young, equity strategist at Standard & Poor's, the dollar is 60% of global foreign exchange reserves, the euro is 25% and the rest is pounds and yen and "gold is being added."
A total shift into gold wouldn't be realistic because the U.S. Treasury market is the most liquid in the world, while gold is still a small one. But the "reaffirmation of gold's role as a part of Central Bank portfolios [says] that gold does offer some form of security," says Philip Kalpwijk, global head of metals analytics at GFMS, a research consultancy firm. Brian Hicks, co-manager of the U.S. Global Investors Global Resources Fund, calls it a "first leg that leads us to some form of bullion being used a monetary asset."
2. Gold Trumps Dollar
Gold has more purchasing power than the U.S. dollar.
In 1975, let's say an inexpensive men's suit cost about $30, meaning 1 ounce of gold would buy about six of these suits. Today that suit costs $125. With $30 worth of 1975 dollar bills you would only be able to buy ¼ of the suit. But that single ounce of gold from 1975 would buy almost 13 suits today.
Your dollars lost 75% of their purchasing power over 36 years.
The U.S. dollar became the world's reserve currency when it was linked to gold. Gold gave the dollar its mojo and without gold, the dollar is struggling. According to CPM Group, the producer price index from 1944 to 1971 rose just 112%, while the dollar was supported by gold, but skyrocketed almost 360% over the next 39 years as the dollar had no shiny anchor to back it up.
Although you can't buy goods with gold, you can buy products with a debit card backed by gold. Utah now recognizes gold and silver as legal tender. If you sell coins you are exempt from the state's capital gains tax and you can reportedly store your gold and silver at the Utah Gold and Silver Depository and get a debit like card
Peter Schiff, president of Euro Pacific Capital, goes one step further. He is planning to open a similar operation overseas. He is in the process of linking a Mastercard(MA) debit card to Euro Pacific Bank, a bank in the Caribbean, where people can store their gold and silver or any other legal tender and have the freedom to spend. The bank will also buy gold for you and is not open to American citizens.
This is not gold being used as collateral, you are not taking a loan out on your gold, but you are using gold to buy goods.
1. Gold in Monetary Policy
The conversation of gold being used in monetary policy is fledging but it's happening.
Robert Zoellick, head of the World Bank, has called for a "Bretton Woods II," which would be a global "co-operative monetary system" involving multiple currencies like the dollar, euro and yen, and also gold. Zoellick said gold should be used as an "international reference point of market expectations about inflation, deflation and future currency values."
Zoellick says that gold is not just old money but that markets are using the metal as a viable alternative to paper currencies. A basket of currencies is another substitute. This would boot the U.S. dollar as the world's reserve currency and instead introduce a basket: U.S. dollar, euro, yen, pound, yuan, to name a few, and gold
Vincent Reinhart, former director of the Federal Reserve Board's Division of Monetary Affairs, who is now with the American Enterprise Institute for Public Policy Research, says "one reason people harken for the good old days of the gold standard is they really worry about the fiscal dominance of monetary policy." This means as deficits gets big, central banks might be forced to buy government paper, bonds, to support the economy and going back to gold is a way to prevent that, it ties their hands.
Reinhart says that a more viable alternative to a strict gold standard is that policy makers include gold prices to inform monetary policy making along with the price of other commodities and inflation readings. "I would use gold in conjunction with many other asset prices to inform the policy decisions. Investors are giving you a reflection of their concern when gold prices are rising ... you should be looking at that signal."
Steve Forbes, chairman of Forbes, says that central banks should set interest rates based on the gold price. If gold prices go above $1,500, for example, the Federal Reserve, tightens. If prices stay below that level, the Fed loosens. As with many "gold standards," Forbes' example poses an issue as then monetary policy would be determined by gold supply and demand fundamentals.
There are still the purist out there, most notably, Congressman Ron Paul, who would love a return to the real gold standard. Where one ounce of gold equals $1,834 and massive fiscal constraint is imposed on governments.
But a true gold standard isn't a viable option.
The M2 supply -- that is the money in circulation plus travelers checks, savings, and small time deposits -- is $9.3 trillion on a seasonally adjusted basis, according to the Federal Reserve.
The U.S. has 8,133 tons of gold worth about $477 billion. In order to cover the M2 supply the gold price would need to hit $35,000, the government would have to drain $8 trillion out of the system or the US would have to buy almost all the 165,000 tons of gold in the world, including jewelry.
For the gold bug purist, this is tough news, but there are hints that gold can be used as money and in monetary policy as world leaders try to get fiscal spending under control.
To see original article CLICK HERE