Central Banks are awash in liquidity...mostly US greenbacks

"Central Banks eye asset as well as FX shift."

LONDON (Reuters) - Central Banks around the world are looking to invest more of their $4.75 trillion foreign exchange reserves in equities at the expense of bonds, but the implications for currencies are far from clear.

The issue of reserve diversification re-emerged late last year as the dollar fell against major currencies, hitting multi-year lows against the euro and sterling.

ARTICLE Highlights…on the ballooning Central Bank stash of fiat foreign reserves:

-- Of the $4.75 trillion total, the currency composition of $3.151 trillion is known. And of that, $2.07 trillion is in U.S. dollar-denominated assets.

-- Central Banks are starting to behave more like yield-hungry, market-savvy institutional investors and many are setting aside chunks of their reserves for specific investment vehicles.

-- David Bloom, head of global currency research and strategy at HSBC in London, notes that Central Banks are so flush with reserves that they barely know what to do with them. They are buying a wider range of currencies than ever and diversifying across a wider range of asset classes than ever before too.

-- Jim O'Neill, chief global economist at Goldman Sachs, agrees that "the clearest implications" of Central Banks seeking higher returns on their ballooning stash of reserves is "good news for equities and risky assets at the expense of more liquid ones." But he reckons the dollar could suffer as a result. Although the implications for currencies aren't clear, "presumably it's not great for the dollar, as most of these (liquid) assets are in dollars," O'Neill said

-- The monetary authorities of Singapore, South Korea and United Arab Emirates are also thought to be considering raising the risk profile of their existing investment vehicles.

-- This broad trend comes against the backdrop of key developments concerning the world's reserves behemoth: China. Reserves held by the People's Bank of China have topped the staggering $1 trillion level. PBOC Governor Zhou Xiaochuan has said the bank is looking at diversifying that stash across currencies and asset classes. The composition of China's reserves is unknown but many observers reckon around 70 percent is in dollars, almost all of that probably in Treasuries and T-bills.

Here is the entire article:

"Central Banks eye asset as well as FX shift."

http://today.reuters.com/news/articlenews.aspx?type=reutersEdge&storyID=2007-01-09T142800Z_01_L0945935_RTRUKOC_0_US-MARKETS-RESERVES-DIVERSIFICATION.xml&from=business

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THIS critically vital report begs the crucial investment question:

WILL any portion of world Central Banks' $4.75 trillion total paper foreign reserves be converted into hard money like GOLD?

CLEARLY, any FOREX Investment-101 student is obliged to say YES, because Central Bank Directors would be recklessly derelict in their fiduciary responsibility if they did not acquire more gold to back their growing mountain stash of paper US Dollar reserves (ie U.S. dollar-denominated assets), which grows relentlessly year after year after year.

Bank on it !! Indeed Central Bank on it !!

Consequently, there will be constant positive pressure to raise the POG going forward...as Central Banks accumulate the shiny yellow. Needless to say there will be temporary corrections from time to time (when the POG rises too much too fast), but on-balance currency risk diversification dictates Central Banks will be methodically buying gold with a portion of their burgeoning US dollars reserves…a relentlessly growing product of yearly Trade Surplus with the USA.

Central Banks hold $4.75 trillion in foreign reserves

I believe this number holds vitally important ramifications for the POG vis-à-vis world Central Banks desire (indeed need) to diversify their foreign currency risks in the shadow of a falling dollar.

Since 2001 the greenback has been hammered down -30% (121 to 85). AND THERE IS ZILCH on the horizon to suggest the dollar decline will not continue for the foreseeable future...and all Central Banks know this !! In fact not a few FOREX experts are looking for the Dollar Index for fall to at least 76 early this year. Obviously, this would equate to another 11% depreciation in the greenback. Subsequently, world Central Banks cannot and dare not continue to suffer these horrific exchange rate losses...especially since the POG has risen over +140% ($256-$615) since 2001.

US$ (2001-2007)

http://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=7&mn=0&dy=0&id=p43741832029

GOLD(2001-2007)

http://stockcharts.com/h-sc/ui?s=$gold&p=D&yr=7&mn=0&dy=0&id=p43741832029

Even a cretin Central Banker knows the humongous difference between an excruciatingly painful -30% and an eye-popping +140%.

TO BE SURE in light of the above, ALL Central Banks are (or will be) cautiously dumping greenbacks (and US Treasuries) to reduce their risks to FURTHER CURRENCY LOSSES via a falling US$. Inevitably, this will further pressure the greenback down. Without a doubt much of Central Bank liquidity will go into the Euro and other strong currencies, however, some of Central Bank liquidity will be used to build their gold reserves.

Ramifications of a fraction of foreign reserves being converted to gold

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I believe the total amount of above ground gold existing in the world holds great impact ramifications for the POG vis-à-vis world Central Banks' desire (indeed need) to diversify their foreign currency risks in the shadow of a falling dollar.

Since 2001 the greenback has been hammered down -30% (121 to 85). AND THERE IS ZILCH on the horizon to suggest the dollar decline will not continue for the foreseeable future...and all Central Banks know this !! In fact not a few FOREX experts are looking for the Dollar Index for fall to at least 76 early this year. Obviously, this would equate to another 11% depreciation in the greenback. World Central Banks cannot and dare not continue to suffer these horrific exchange rate losses...especially since the POG has risen over +140% ($256-$615) since 2001….while the value of the dollar inexorably declined by 30%.

US$ (2001-2007)

http://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=7&mn=0&dy=0&id=p43741832029

GOLD(2001-2007)

http://stockcharts.com/h-sc/ui?s=$gold&p=D&yr=7&mn=0&dy=0&id=p43741832029

Even a cretin Central Banker knows the humongous difference between a +140% and a -30%.

TO BE SURE in light of the above, ALL Central Banks will cautiously be dumping greenbacks (and US Treasuries) to reduce their risks to FURTHER CURRENCY LOSSES via a falling US$. Inevitably, this will further pressure the greenback down. Much of Central Bank liquidity will go into the Euro and other strong currencies, however, some of Central Bank foreign reserves will be wisely used to build their gold reserves.

To delineate the bullish ramifications of the new central bank policy of seeking higher return investments, we need to verify the (present) value of the world's inventory of existing gold based upon the following numbers.

My research indicates there were about 120,000 tonnes (long tons) of above ground gold in early 1997. Moreover, the total world gold production from mines averages about 2,600 tonnes per annum. Consequently, the world's total gold inventory today probably approximates 150,000 tonnes.

Conversion Tables show there are 32,150 troy oz per tonne. This translates to 4,823,000,000 oz. And assuming a price of $620/oz, the total value of the world's above ground gold is very close to $5 trillion.

As mentioned above world Central Banks are awash with $4.75 trillion in foreign reserves (but for the sake of our simple illustration we will round that off to $5 trillion). In this regard Central Banks have publicly declared they seek higher returns on their burgeoning foreign reserves. Therefore, they can ill afford to ignore the exemplary investment performance of gold bullion since 2001. Specifically, the price of gold soared 140% during the past six years, while the US Dollar plummeted 30%.

In seeking higher returns on their idle foreign reserves Central Banks will certainly convert much of their US dollar foreign reserves into the euro and other major fiat currencies. However, they will also most certainly buy hard asset gold due to its intrinsic value. The real question is what AMOUNT OF FOREIGN RESERVES MIGHT BE CONVERTED TO GOLD, and what impact might this have on the price of the shiny yellow. Let's be ultra-conservative by assuming these Central Banks will allocate Only One Percent of the $5 trillion stash to purchase gold….that's $50 billion. This begs the question how much gold can one buy at a constant price of say $620?

Before answering that question, let's look at the world's annual gold production from mining operations. Last year the total gold mine production was about 2,600 tonnes. The value of a year's production at $620 is about $51 billion (but let's round that off to $50 billion).

Something to really think about

If Central Banks ONLY allocate 1% of their total foreign reserves stash , they could only purchase a paltry 2,600 tonnes….IF IT WERE POSSIBLE TO BUY ALL AT $620/oz. But there's a real big fly in the ointment. As we all know it's impossible to buy up a year's supply of gold production without exponentially running up the price. And if it were the intention to allocate more than 1% of its foreign reserves to acquire gold in any one year, the price of the shiny yellow would skyrocket. Therefore, it's reasonable to assume Central Banks will slowly and methodically buy gold --- thus putting a constant upward price bias due to the non-traditional increase in demand. FOLLOWING this strategy it will necessarily take years to accumulate the right amount of gold…especially since Central Banks' total foreign reserves increase YEARLY.

Conclusion

The POG will most likely reach a new all-time each year for the next five years. And based upon existing gold fundamentals and my Technical Analysis of the POG trajectory, I estimate the POG in 2007 may well challenge the heretofore all-time high of $850/oz (established in January 1980). This will be followed by record gold prices during the next five years, marred occasionally by temporary periods of consolidations.

Historical POG:

www.gold-eagle.com/charts/35yeargold.html

The writing is on the wall…The Great Wall of China…for years to come: