RUSSIAN GOLD RESERVES RISE IN JUNE; WHY IS RUSSIA STILL BUYING GOLD? / SEEKING ALPHA

Russian Gold Reserves Rise In June: Why Is Russia Still Buying Gold?

By: Hebba Investments                       

Jul. 26, 2015 5:00 AM ET                      

 

 

Summary

• Russia increased its physical gold reserves in June by 800,000 ounces.
• This was one of the biggest additions of 2015 and shows Russia is still interested in accumulating gold.
• In terms of newly mined annual gold supply, this purchase annualized would be a chunky 12% of annual gold mine production.
• Investors should take solace in the Russian government's continual acquisition of gold and remember central banks think long-term.

A few days ago the Russian central bank released its gold reserve data that showed another increase in gold reserves during the month of June.


(click to enlarge)
Source: ShareLynx

Russia added a large 800,000 ounces to its gold reserves in the month of June, which computes to just under 25 tonnes of gold or around $900 million dollars at current gold prices. This was one of the largest purchases this year and continues to show investors that Russia is still interested in increasing gold reserves despite the drop in the gold price.

This is really even more interesting that Russia is still buying because its economy has taken a knock from Western sanctions and from lower oil prices. The "why" is a key question for investors to understand, and at this point it's only conjecture as they haven't officially given a reason for their continued purchases.

Why is Russia Still Growing Gold Reserves?

In this case Russia's decision to continue to accumulate gold is a bit counter-intuitive because (1) its economy is struggling and the country needs to conserve reserves, (2) physical gold is less liquid than US bonds and other dollar denominated securities, and (3) the gold price has been falling for the last few years. All of these things suggest that now is not a good time for Russia to purchase gold - but yet they still accumulate.

The first thing investors need to understand is that central banks do not make investment decisions (in this case reserve allocations) in the same way that the standard investor or hedge fund makes decisions. Central banks make their decisions primarily based on strategic factors, and in this case there are only two strategic factors that would favor continued gold accumulation.

1. The belief that bonds are way over priced and due for a decline
2. An effort to prepare for a weaker US Dollar

For the first factor, there shouldn't be anybody arguing in the negative. Other than short-term traders trying to take advantage of "safe-haven" flows and short-term appreciation, there's really nobody who argues that the current interest rate environment is a good deal for long holders of bonds. Long-term inflation rates are well above all of the world's developed market bonds, and that means if these bonds are held to maturity, investors are guaranteed a loss on their investments. Since central bank reserves are held in too large of a quantity to play the short-term capital appreciation games, it simply doesn't make a good investment for Russian reserves. This factor is hardly controversial.

The second factor though is much more controversial and is really where investors can piggy-back on what a major central bank expects the world to look like down the road.

Gold is the only other world currency that represents a true "reserve currency" other than the US Dollar, and that's why gold tends to move in opposition to the US Dollar. It is a popular argument to say that it moves in opposition to the US Dollar because it is priced in US Dollars, but gold is also priced in every other currency - so why the much stronger relationship to the dollar? It is our belief it is specifically because gold is a US dollar alternative that has properties of a reserve currency - other currencies are more liquid but do not truly represent a reserve role.

Getting back to Russian gold accumulation, the Russians know very well about gold's role as a reserve currency, and the fact that they are buying more of it suggests they are preparing for a world where the US dollar plays a much smaller role. There may be no better proof of this than Russia's recent dealings with China where they have been eliminating the use of the US Dollar in their bilateral trade - these agreements are a clear attempt to move away from the US Dollar.

In a world with a smaller US Dollar role, there's no better currency to own than gold - the reserve currency for most of human history.

What Can Russia Really Do In the Gold Market?

Investors need to remember that 800,000 ounces, or around 25 tonnes, is actually a very large transaction in the physical gold market. That comes out to around 1% of gold mine supply (around 2500 tonnes a year), and if Russia keeps this up on an annualized basis, it would be around 12% of total newly mined gold supply. 12% of total mined gold is a very large chunk of newly mined gold from a single buyer - certainly something anybody following the gold world should note.

Takeaways for Gold Investors

Some analysts have called this purchase a relief for the gold market as it signals that one of the biggest public buyers of gold (the Russian government) is still looking to add to its gold reserves.

David Jollie, an analyst at Mitsui & Co. Precious Metals Inc, recently told Bloomberg, "It's interesting that Russia is still buying because its economy has taken a knock from Western sanctions and from lower oil prices."

We are not as surprised at the Russian government's decision to continue to accumulate gold as their consistent accumulation since 2008 suggests something more than simple "reserve diversification". In our opinion Russia is a strategic accumulation to both hedge against financial calamity and to push the world away from the US Dollar.

But ultimately Russia's accumulation comes down to a single belief - that gold offers the Russian central bank an asset that can preserve the purchasing power of its monetary reserves better than the other currency alternatives. To us that seems like the main reason why the Russian government would decide to transfer liquid, interest yielding, dollar-denominated bonds into less liquid, no-yield physical gold bars - especially as the Russian economy struggles with lower oil prices.

Thus long term investors should take this as a bullish factor and keep in mind the big picture when it comes to gold. We do not see a reason why investors should not consider having a large exposure to gold with positions in physical gold and the gold ETFs (SPDR Gold Shares (NYSEARCA:GLD), PHYS, CEF). Additionally, the miners that have been underperforming gold over the last few months may offer investors considerable leverage to any rise in the gold price. Investors looking for this leverage may want to consider evaluating gold miners such as Goldcorp (NYSE:GG), Agnico-Eagle (NYSE:AEM), Newmont (NYSE:NEM), or even some of the explorers and silver miners such as Tahoe Resources (NYSE:TAHO) (we're not suggesting these companies specifically - only suggesting them for further investor research).

There is a reason why Russia continues to accumulate gold and investors should certainly keep this in mind the next time they read pessimistic research or financial news related to gold.