The great gold redemption

The most puzzling part of the investment business is seeing how the vast and largely economically illiterate masses interpret any given piece of news. Take the recent gold selloff: Many large players were motivated to sell by news that Cyprus will have to liquidate its gold stockpiles to pay off acute debt obligations. But just a moment's reflection shows this reaction to be knee-jerk.

The real story behind Cyprus' deal has much more profound ramifications — and they are positive for gold.

The Right Lens

The reaction to Cyprus' forced gold sale re-affirms my belief that most Western investors remain in a state of extreme anxiety. This leaves no room for the kind of nuanced analysis that leads to wise long-term investment decisions.

The important point is not that Cyprus has to sell €400 million worth of its gold reserves, but rather the circumstances of the sale and the potential buyers that will emerge.

Gold Demanded, Not Divested

After all, this isn't a strategic investment decision by the Central Bank of Cyprus to divest itself of the yellow metal. In fact, local officials have gone on record saying any gold liquidation is a last resort. Cyprus wants to keep its gold — as has every nation in the West since the fiat money system started breaking down in the mid-2000s.

The only reason a gold sale is being proposed is that Cyprus finds itself at the height of its sovereign debt collapse. It has a long line of creditors but scant capital to pay them back. Gold is among the island nation's only liquid assets available to be repossessed. This is, in fact, a ringing endorsement of the enduring value of gold when a banking system disintegrates.

Won't Hit the Market

Still, some may be concerned about the price effects of gold sales by sovereigns. After all, Cyprus is just the tip of the iceberg. Lower down, the iceberg contains many European nations that are well-stocked with gold but that have debts orders of magnitude more hefty than Cyprus, e.g. Italy, France, Portugal and Spain.

Again, when viewed correctly, this reality is at worst neutral for gold investors.

When a sovereign is forced to sell its gold, the reason is to pay other sovereign creditors. With regard to the spot price and global marketplace for the metal, that sale is "off the books." It merely cancels some IOUs, and the gold is shifted between central banks. It is not that this transaction has no market effects, but at the end of the day, the impact on gold's trading price is minimal.

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