Gold, Forex Reserves and Diversification

Forex Gold

In February we found out that Canada has sold all its gold reserves or planning to do so in the near future. As of March 2016 Canada held only 0.0022 tonnes (77 oz) of gold. I wrote an article (Canada Sells All Its Remaining Official Gold Reserves) on it in February and updated it in March.

In a CTV News article Don Drummond, a former high-ranking bureaucrat at Finance Canada, sais it hasn’t made sense for Canada to hold gold for a long time. He sais he helped start the policy for Canada to gradually sell off its gold reserves after it was decided there were “better ways to store wealth”. He also adds, according to the article, that Canada can easily diversify its US$81.5 billion in reserves with various foreign currencies.

Canada holds now about 60% of its international reserves in US dollars and the rest in other currencies. Usually other currencies means mostly Special Drawing Rights (SDR) component currencies like the EU euro, British pound, Japanese yen and also some other EU currencies and the Swiss franc. Is this diversification? All fiat currencies are related to the dollar in some form or another.

If we look at the SDR which is a basket of the most included currencies in international reserves, that also includes the US dollar, we can clearly see they all dropped more then 95% against gold since the collapse of Bretton Woods Agreement in 1973. Other currencies not included in the SDR but part of international reserves are pegged to one of the currencies in the SDR. Until recently the Swiss franc was pegged to the euro and still follows the euro closely and the yuan is still linked to the US dollar. Most of the world fiat currencies are linked to the dollar or the euro in some way.

Article 1

Now let’s look at a diversification policy that includes gold as many countries still do. All fiat currencies depreciated versus gold by 1,871% based on a broad basket of currencies and 1,586% against the US dollar since 1970. I think both Russia and China understand better than Canada what diversification really means. Both China and Russia have been adding recently gold to their official international reserves. The two graphs bellow show the performance of a trade weighted basket of world currencies (broad index) and versus a basket of a trade weighted major world currencies mostly dominated or closely related to the EU euro and the Japanese yen, Australian dollar and the Canadian dollar.

The US Broad Currency Index includes the Euro Area, Canada, Japan, Mexico, China, United Kingdom, Taiwan, Korea, Singapore, Hong Kong, Malaysia, Brazil, Switzerland, Thailand, Philippines, Australia, Indonesia, India, Israel, Saudi Arabia, Russia, Sweden, Argentina, Venezuela, Chile and Colombia.

Article 2

The US Major Currencies Index includes the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden.

Article 3

As you can see diversifying among fiat currencies is as efficient as a CDO basket of junk loans that was given a high quality rating based on some statistical diversification formula only to collapse in 2008 to the point of almost collapsing also the whole international monetary system. Fiat currency diversification will not protect in a systemic crisis and collapse of the entire monetary system.

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The UK and Portugal are two examples of mismanagement of official international reserves. One is by the United Kingdom in the late 90s when it sold about 60 percent of its gold reserves at a price of approximately $250 which was right at the bottom of the gold market and Portugal who lent its gold for US dollars for speculation and lost it in the collapse of Lehman Brothers during the 2008 financial crisis. Diversifying currencies with a basket of fiat currencies is no diversification just plain stupidity. It is plain common sense, and the two-thousand-year diversification principle of not putting all your eggs in the same basket, to diversify outside a basket of fiat currencies and into gold. No need for a Ph.D. in statistics and economics to know that.

Gold is the only currency with no counterparty risk and a real asset rather than an “IOU nothing” fiat currency. Holding gold is true diversification and especially in extreme circumstances. It is money and especially in extremis circumstances. It seems this fact escapes the management of the Finance Department of Canada but not to China and Russia or the European Union. The Euro Area still holds 10,788.7 tonnes of gold reserves and the US 8,133.5. This represents 73.3 percent of foreign exchange reserves for the US and 53.7% for the Euro Area. Russia has now 15 percent but China only 1.9 percent if we believe official data. Both Russia and China but also India in a different way are targeting the US and Euro Area of owning approximately 8,500 tonnes of gold.

Bellow is a chart of the Romanian gold reserves since 1900 versus Canada’s gold reserves. I chose Romania to compare with Canada because they seem to be at two extremes. Canada has now zero gold reserves per capita while Romania has one of the largest amount per capita of gold reserves. Romania has today 107.3 tonnes of gold. In 1965 Canada had 1,023 tonnes.

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Sadly, the government of Canada will soon realise its mistake but too late to do something about it. In the end it will be the citizens of Canada who will pay the price not the geniuses in the Canada Finance Department.

The International Monetary Fund (IMF) states on its website that “it (gold) remains an important asset in the reserve holdings of several countries, and the IMF is still one of the world’s largest official holders of gold.

Whatever the outcome of the collapse of the fiat international monetary system and the reset it is evident gold will still play a major role in the reset and in the new system. A foreign exchange reserves diversification policy without gold is no diversification. By selling all its gold reserves Canada went to an extreme no other major country did.