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As Central Banks Shun the Dollar for Gold, UK Fails to Seize a Golden Opportunity

Wednesday, June 26, 2019

It’s no secret that Britain and the US have a convoluted relationship with gold. In the 1970s, the US abandoned the Bretton Woods system in order to float the Dollar - double-digit inflation ensued. The UK equally made a blunder in 1999, selling off a significant portion of its gold reserves (remember “Brown’s Bottom”?).

You might think that the end is nigh for gold, given the Anglo-American reluctance to buy gold. This is too simplistic a reading to make. As the World Gold Council can attest, China and Russia’s central banks have gone to great lengths to secure a slice of gold while they still can.

To finance this, both countries have reduced exposure to the Dollar, by selling up their holdings in US treasuries. In one fell swoop, they have diversified and managed to strengthen their position, opting for tangible assets over assets from a sovereign nation reliant on fiat currency.

Yet change may be afoot in the US, at long last. Judy Shelton, a long-time advocate for a return to the gold standard, is being eyed up by the Trump administration for a possible role in the Federal Reserve.

A paradigm shift?

As noted, Russia and China’s central banks have been greatly increasing gold holdings. China now boasts a haul of as much as 1,885 tonnes of gold, while Russia can claim to hold as much as 2,168 tonnes. To put this into perspective, Russia has managed to double its gold holdings in just five years flat.

In marked contrast, Britain’s gold reserves have remained static, at just over 310 tonnes, or 8 per cent of total foreign exchange reserves. The 1999 sell-off is largely responsible for such a small figure here. Britain appears fairly ambivalent to the need to acquire gold, but China and Russia appear to be leading this new trend of increasing demand for gold.

Do the Chinese and the Russians know something we don’t? Perhaps they see this current period as a golden opportunity to shift the axis of the global financial system. The era of US/UK financial hegemony might be almost over.

The US and gold - love it or hate it

The American relationship with gold is seemingly a love/hate one. Under Bretton Woods, the Dollar was fixed to gold, at a rate of $35 per troy ounce. Since the 1970s, the US has allowed the Dollar to become fiat currency, floating freely, while the Federal Reserve, just like the Bank of England, has printed fresh currency.

This money printing accelerated in the aftermath of the global financial crisis in 2008. This expansion in the supply of currency has been greatly supportive of gold. Now, the White House seems like it is considering a long-time gold standard advocate, Judy Shelton, to be considered for a job at the Federal Reserve.

Ms Shelton has made a name for herself, likening the Federal Reserve to Gosplan, a USSR government division that managed the bloc’s economic development during the Cold War. Ms Shelton being considered for such a job is an indication that there could be something of a change in economic thinking taking place, towards a more gold-friendly orthodoxy.

Britain facing summer of stress

A return to a more gold-oriented financial system would have profound implications for Britain, with its small gold reserves and its host of political and economic problems. As it was during the financial crisis, gold has shown great potential for strong performance during Britain’s long-running Brexit saga.

Brexit is likely to remain unsolved until late 2019 at the earliest, putting pressure on Sterling and other British-based assets. Gold could benefit greatly from this uncertainty, serving as a tangible asset that has retained much value over the years.

The gold price remains elevated in recent times, close to its 2011 peak in Pound Sterling terms, at £1,100 per troy ounce as of late June 2019. Ironically, when Britain sold its gold in 1999, the market was just bottoming out. Since then, gold has appreciated multiple times, losing the country a significant sum of money in potential reserves.

Even now, as the price of gold remains close to an all-time high, Britain’s gold reserves remain static, suggesting they have much to learn from their fellow central banks in Russia and China.

Safe haven for the future

A new gold standard might be a long way off if it is even viable. Even so, the significant sums that central banks around the world have acquired in recent years reflect the constant truth about gold: that it remains a tangible means with which to store wealth, amid turbulence and crisis.

With the potential for a deepening trade war that could have great repercussions here in Britain, coupled with the continuing Brexit dilemma, which doesn’t seem like it’s near its completion anytime soon, gold prices have a great deal of support at present.

To demonstrate the potential for gold to really shine this summer, one need only look at the performance of gold priced in Pound Sterling back in 2015-16. Over a year-long period, covering the run-up to the EU referendum and its volatile aftermath, gold prices jumped 50 per cent.

Like a coiled spring, gold has the potential for great returns to the upside at short notice. The next big leap in prices could potentially see gold hit all-time highs in Pound Sterling terms if it is anywhere near as large as the previous rally in 2016.

Past returns are never a perfect predictor of future performance, but if the simple act of voting to leave the EU contributed to such a return, the potential for a rally in the event of a chaotic resolution to Brexit could make the summer of 2019 one of the most consequential summers to buy gold in the history of the British gold market.