The insight from this article below seems to suggest that this time around, the gold rally is prompted by Central Bank purchases as much as a declining interest rate trend. POTUS inclination to seek a lower dollar only serves to shoot himself in the foot because foreign ownership of US treasuries will only get lower from here and how would he continue to expand the economy , including building his WALL, if fewer people would want to buy his debt- China which holds about 17% of US treasuries will slowly over time be liquidating their USD holding position (in fact they are already swapping USD in exchange for variety of acquisitions in strategic resource projects globally including in Africa) [ It may well be that China has stopped buying US Treasuries and slowly disposing it that is the real worry for US ] . The nature of a reserve currency is for it to be strong (as all past Presidents favour) , in time the USD will lose its reserve currency status and when that happens, we can only expect more chaos. As the saying goes, people who live in glass houses should not throw stones at others.
An extract from Richard Mills (aheadoftheherd) Why are Central Banks Buying Gold and Dumping Dollars?
Clash of currencies?
Trump’s comments re Draghi in Europe and his continual belittling of Jerome Powell - the president reportedly sought a way to fire him for keeping interest rates too high - is actually nothing new.
They are part of a larger plan by the Trump administration to keep interest rates and the dollar low. This is a shift from his predecessors in the White House who have lobbied for a strong dollar.
But for Trump, a low dollar is the way to bring jobs back to the US after many were exported abroad to take advantage of lower labor costs, and therefore rebuild the US manufacturing sector, primarily, through cheaper exports. He’s particularly targeted China for competitively devaluing its currency, the yuan, to dump cheap exports into the US.
Here’s what Trump said on the campaign trail in 2016: “You look at what China is doing to our country in terms of making our product. They’re devaluing their currency, and there’s nobody in our government to fight them… they’re using our country as a piggy bank to rebuild China, and many other countries are doing the same thing.” “Our country’s in deep trouble. We don’t know what we’re doing when it comes to devaluations and all of these countries all over the world, especially China. They’re the best, the best ever at it. What they’re doing to us is a very, very sad thing.”
The question is, have we moved from a trade war to a currency war, and if so, what would that mean? Trump’s comments about Draghi appear to suggest a hardening of his stance against competitive devaluations. (The ECB chief responded, by the way, by saying “We don’t target the exchange rate” of the euro)
But as one commentator writes, Trump is playing a dangerous game that could lead to a currency war, in which countries keep slashing the value of their money in order to gain a trade advantage ie. lower-priced exports.
“Any economy that is suffering from a prolonged bout of undesirably low inflation is likely to favor a weak currency,” Jane Foley, a senior foreign exchange strategist at Rabobank, was quoted by CNN Business. “If several economies find themselves in the same boat coincidentally, the prerequisite conditions for a currency war are set.”
A communique from a G-20 meeting earlier this month states that finance ministers and central bankers have agreed that a currency war is in no country’s interest, and reaffirmed a commitment to refrain from competitive valuations.
However Trump, never one to bow to convention, could easily break the toothless commitment. A Bloomberg article on the subject notes that if the euro keeps dropping it may incite Trump to follow through on a threatened tariff on imported cars and car parts from the EU. Presumably the same spiral of currency devaluations and tariffs could apply to the China-US trade war, if China decides to devalue the yuan to gain an advantage over the US.
Central Bank gold buying
Along with the expectation of a looser economic policy, ie., lower interest rates, the gold price is also currently being supported by major central bank buying. The buying is taking place at the expense of US Treasuries.
Why are they buying? Gold prices usually go up when real interest rates turn negative, in other words, when interest rates minus the rate of inflation go below zero. While we aren’t there quite yet, taking a look at the 10-year benchmark Treasury yield reveals a rate of interest that has been dropping for some time.
Central banks purchase US Treasuries to bulk up their foreign exchange reserves. They do this especially during periods of unrest, or when the economic forecast is bleak. Gold’s role as a safe haven is well-documented. Of course Treasuries are as much or more sought-out by investors in a crisis or pending crisis, but lately, Treasuries have become much less popular as a means of storing wealth.
The reason is simple: T-bills don’t offer a good return, and neither do other sovereign debt instruments - as mentioned, five important central banks are offering negative rates.
Looking at the 10-year yield chart, we see the yield starting to go down last November, falling steadily all the way to its current 2.02%. Subtract 1.8% inflation and the yield, just 0.22% begins to look pretty skinny.
There’s an old saying on Wallstreet “Six percent interest will draw money from the moon.” And it’s true, but what is also true is 1. As long as real interest rates are below 2% gold is in a bull market and 2. Real interest rates below 2% draws investors to gold.
Central banks know this, so do educated gold buyers.
With Treasury notes paying such low net yields, gold becomes an attractive investment. And while the precious metal offers no yield, its status as an inflation hedge and store of value not subject to fiat currency manipulation are good reasons for central banks to purchase gold.
It doesn’t take an economist to see what’s happening here. Central banks see Treasury yields slumping and real yields low, and likely on their way negative, so they are backing up the truck for gold. They see gold continuing to increase in value. According to the World Council, central banks are continuing a buying spree that stretches back to 2018. A total of 651 tons of gold was accumulated last year, 74% more than 2017 and the highest amount since the end of the gold standard in 1971.
So far in 2019, central banks have squirreled away 207 tons in bank vaults, the highest year-to-date purchases since central banks became net gold buyers in 2010. (before that they were net sellers, selling more gold than purchased).
On a quarterly basis, central banks bought way more gold in the first quarter of 2019 than Q1 2018. The WGC reports first-quarter purchases were the highest in six years, rising 68% above the year-ago quarter. It was the strongest start to a year for gold buying since 2013.
Russia and China were the top two purchasers, particularly Russia which has been trying every means available to diversify away from the US dollar - such as selling US Treasuries and signing energy deals with China whereby the transactions are in yuan or rubles, not USD. The Central Bank of Russia loaded up on 274 tonnes.
China has increased its monthly gold purchases by nearly 50%, to 15 tonnes a month, according to *****, with the Philippines’ central bank announcing plans to buy up to 30 tonnes of bullion a year. Other leading purchasers were Turkey, Kazakhstan, India, Iraq, Poland and Hungary, the World Gold Council report states.
The annual survey also said none of the central banks plan on reducing their exposure to gold over the next year from May, with 18% saying they plan to increase their bullion holdings.
The 2018-19 gold-buying spree is being driven by the de-dollarization of countries like Russia, China and Turkey which have an axe to grind with the US. They want to get out from under the thumb of Uncle Sam. Forbes notes central banks’ motivations for buying gold are different than they were in previous decades when the financial system was back-stopped by gold: In the distant past, central banks had to buy gold because of its vital role in the global financial system. Now they are choosing to do so because they are worried about the dollar. In other words, they've been scared into this bullion buying binge.
For more on this subject read How central bank gold buying is undermining the dollar
Jeff Christian, managing partner at CPM Group, a New York-based commodities consultancy, agrees. “Today central banks are buying gold to diversify their monetary reserves,” says CPM's Christian. “Most central banks want to diversify away from the dollar.”
He gives the example of Russia where, as Forbes reports, the change may be partly driven by the need to ditch dollars and unentangle their countries from the US banking system.
Dumping Treasuries
Central bank gold buying is only one half of the equation we are presenting. The other half is the buying and selling of US Treasuries. Is it safe to assume that if central banks are buying gold, they are also selling, or buying, less Treasuries? If only it were so simple.
Russia and China certainly fall into that category. The Central Bank of Russia sold 85% of its Treasuries last year while at the same time loading up on gold. China resumed adding gold to its reserves last December (and has continued to do so) while at the same time it dumped $69 billion in Treasuries in 2018.
However, foreign investors of US debt, including central banks and private companies, reportedly raised their holdings of US Treasuries between April of last year and April of this year, by $253 billion, to a total of $6.43 trillion.
Here’s where it gets complicated. Wolfstreet tells us that over the same period, the US national debt climbed by $960 billion to around $22 trillion. So the share of the debt held by foreign investors actually dropped to 28%, from 34%.
That means some other entities must have bought the $707 billion difference ($960B minus $253B). According to Wolfstreet, of the $22 trillion national debt, foreign investors including central banks only own $6.4 trillion. The majority of US government paper is held by US government entities, which piled on $102 billion, and American institutions and individuals, which bought a whopping $876 billion in T-bills, year over year until April 30. This latter group represents $7.6 trillion of the national debt, or 34%. The remaining $5.8 trillion is held by US government entities, with the Federal Reserve owning just $2.1 trillion.
The two takeaways here, are that since 2015, foreign debt holders have been gradually moving away from T-bill purchases. Whereas the percentage of the national debt owned by foreign entities rose almost every year from 2001 to 2015, since then, it has gradually dropped, to 28%. And second, it’s American institutions and US citizens who own most of the country’s mounting pile of debt, not central banks or the Federal Reserve.
Conclusion
The US dollar is the most important unit of account for international trade, the main medium of exchange for settling international transactions, and a store of value for central banks.
Yet central banks no longer consider the USD the “gold standard” of foreign exchange. As large Treasury holders like China and Russia “de-dollarize” in favor of other debt instruments that don’t tie them to the US banking system, the dollar is losing its “exorbitant privilege” we have written about before. Gold is the beneficiary of this change.
Central banks backed up the truck for gold in 2018, buying 651.5 tonnes versus 375 tonnes in 2017. That’s the largest net purchase of gold since 1967. And the buying spree appears to be continuing.
Wednesday’s spike in the gold price shows that gold is the play for investors right now. We know that gold prices go up when real interest rates go negative. The net 10-year yield hasn’t yet gone below zero but it’s pretty close, currently 0.22%. Central banks have some very smart people working for them. They see real yields dropping, a yield curve inversion predicting an energy spike (war with Iran) and gold climbing. Why buy a bond that pays you 0.22% real interest, or possibly going to a negative rate of interest?
As we see it, things are only going to get worse for Treasuries and better for bullion. Think about it. We have a number of indicators pointing to an economic slowdown, both globally and in the US. We have an inverted yield curve on 10-year/ 3-month Treasuries); inversion presages a recession within 14 months with almost 100% reliability. There are several hot spots in the world that boost safe haven demand, like Iran, the South China Sea, Yemen, just to name a few. We have an unresolved trade war with China and a revised NAFTA agreement that has yet to be ratified. A trade fight between the US and the EU over autos is also brewing. Central banks are dumping Treasuries and buying gold. There’s a global movement afoot to increase stimulus to goose flagging economies, evidenced by low inflation. If the Fed does go ahead and lower rates, the dollar will follow suit. It may keep falling if a currency war ensues, which becomes more and more likely the longer we go without a China-US trade deal.
Unless something drastic happens, like Trump finding religion in “Xism”, or backs off on Iran (Iran shot down a US drone, the US is going to retaliate), or the Fed reverses course and raises interest rates, it’s the perfect storm for gold.
By Richard (Rick) Mills www.aheadoftheherd.com
