Central Banks Looking to Exit the Dollar

07/31/06 by Doug Casey

In the International Speculator, we’ve often mentioned the inevitable move by central banks to diversify their reserves out of the U.S. dollar. We’ve noted that, apart from the current situation, there is no precedent for any non-redeemable paper currency being held as the primary reserve of the world’s central banks.

That diversification out of the dollar, with a lot going into gold, has begun. A regime change is afoot – though few have yet recognized it.

Recently, Russian President Vladimir Putin ordered the Russian central bank to raise the gold share of its foreign reserves from 5% to 10%. That’s no small matter, given that Russia’s reserves have surged to $247 billion – the world’s fourth largest.

Accomplishing the shift to 10% gold would require purchasing 21 million ounces of bullion, which is about one-quarter of the world’s annual mine production. And thanks largely to oil exports, Russia is accumulating additional foreign currency reserves at a rate of about $100 billion per year. With reserves growing so rapidly, just keeping the gold portion at 5% would require Russia to absorb a big slice of the world’s mine output.

Meanwhile, in China, Monetary Committee member Yu Yongding is not alone in calling for Beijing to diversify its $875 billion reserves into gold to protect against a tumbling dollar. We quoted him last month, saying: “We need to use some of the reserves to buy other assets such as gold and strategic resources such as oil.” More recently, Zhao Qingming from the Chinese central bank’s Financial Research Institute and Luo Bin from its accounting department wrote in a note published in China Money Market that using some of China’s forex reserves to buy gold could “maintain and raise the value of China’s dollar holdings.” That conclusion seems questionable, but the important thing is that more Chinese officials are jumping on this bandwagon. It’s an idea whose time is coming-soon.

Given the trillions of U.S. dollars washing around the world’s monetary system, these are not inconsequential developments. Quite the contrary. They greatly favor gold and other tangibles. What’s the alternative for a dollar-heavy investor or central bank? The Who-Owes-You-Nothing euro? Or the yen, which is the proximate cause of the current bubble? How about the Zambian kwacha or the Vietnamese dong? I think not.

What’s Next?

As explained in the April 2006 International Speculator article, Seasons of Gold, thanks to the traditional seasonal pattern, buying will pick up in August, which should kick gold solidly back into gear. After that, as the wheels start to come off the global economy, I expect gold to gain serious upside momentum. That’s not to say there won’t be corrections, even substantial ones, along gold’s trek to $2,000 and beyond. There will be. But the trend for higher gold prices is firmly entrenched.

While there are many reasons for that trend to accelerate, the most important is the desire to hold the metal. That’s why it’s so significant that investment demand for gold is up 37% over the past year, much of the latter flowing into the more easily accessible and convenient Exchange Traded Funds.

Demand will only rise as the months go by and everyone from central bankers to oil sheiks to hedge fund managers to everyday Joes piles into gold out of distrust of the U.S. dollar…and of the government that purports to stand behind it.

And pile in they will, because money debasement is still very much the name of the game. If you were one of those resource stock investors who started to panic at the depths of the recent gold correction, take heart: the big-picture, fundamental reasons for holding gold – and especially high-quality gold and silver shares – are as much with us now as they were a month ago, and gold’s continuing march upwards is far from over. In fact, I suspect in the historical context, it has hardly begun.

Central banks bailing out of the dollar, the wheels coming off the U.S. economy – the nightmare of every investor – or maybe not. If you invest wisely now, the emerging paper bear market will eventually prove in your favor. As foreign governments look to avail themselves of more gold for their reserves, you should do the same. And investing in gold and other natural resource stocks is a strategy that promises even higher returns… if you pick the right companies.

Editor’s Note: For more than a quarter-century, Doug Casey has traveled across the globe and kicked rocks at remote mine sites. His goal: to find the best opportunities that can generate double and triple-digit returns (and sometimes much more)…usually within 12 to 24 months. Learn more here:
http://www.caseyresearch.com

Doug Casey

Doug Casey of Casey Research, author of the best sellers Strategic Investing, Crisis Investing and Crisis Investing for the Rest of the 90's, has lived in seven countries and visited over 100 more. He has appeared on scores of major radio and TV shows and remains an active speculator in the stock, bond, commodity, and real estate markets around the world. In his spare time, Doug engages in competitive shooting and plays polo.

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