Central Bank Buying Continues To Support Gold Price But Gold Stocks Offer Greater Upside

The Ultimate Safe Haven Asset

Yesterday’s news that the Central Bank of Russia has purchased 90 metric tons of gold so far in 2011 and is on course to buy 100 tons before the end of the year is part of a much larger trend. Global central banks have expanded their reserves of gold in response to the global financial crisis and last year they became net purchasers of gold for the first time in two decades.

According to data from the World Gold Council, the proportion of gold reserves held by emerging economies such as India, Russia, China and Mexico is significantly lower than the proportion held by the likes of the US, Germany and France. Gold accounts for just 1.6% of reserves in China and 8.2% in Russia whereas the yellow metal accounts for 75.4% of the US’s reserves and 72.7% of Germany’s.

I expect central banks to continue to be large buyers of gold as nations take steps to preserve their wealth and safeguard against volatility in financial markets. Buying is likely to be particularly strong among the emerging economies since they are sitting on large foreign currency reserves.

Gold remains on course to take out $2,000 an ounce in 2012 and the bull market still have a long way to run.

Greater Potential Upside

Investors who already have a sizable holding of gold could look to invest in the gold equities. The benchmark of gold stock index, the HUI, has underperformed the metal recently and is therefore undervalued relatively to the metal and presents the opportunity for greater potential upside.

Chart: HUI – Gold Ratio – 3 Year Chart

Chart courtesy of Stockcharts.com

This chart shows the ratio of the HUI gold stock index to the gold price. The chart reveals the relative underperformance of the stocks compared to the metal. The blue horizontal lines show the top and bottom of the 12 month range, and as you can see we are still towards the bottom of that range.

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