By Sean Hyman

As I often say, it’s always good for currency traders to watch where money is flowing around the world. If you know where investment money is flowing, you know which currency is about to get a windfall.

The same can be said about gold.

Only when you’re talking about gold holdings, it’s better to look at who’s buying and selling their gold. Just look at the IMF…

Earlier this year, I told you of the IMF’s plans to sell about 403.3 tons of gold. The G-20 officially approved the sale this past April.

The IMF claims they’re selling gold to help “the world’s poorest countries.” Indeed, it is possible that some of those funds will go there. However, the #1 reason why they’re selling is because they need to raise some cash to meet their own budget deficit!

You see, the IMF owns a ton of gold…but it’s not like gold earns interest or produces dividends. Therefore, they are “gold rich” and “cash poor.” So every so often, the IMF must sell some gold to pay their bills.

I bring up this point because I want to ensure you that they aren’t selling gold because they believe it to be overvalued. On the contrary, they’re selling gold because it’s their most valuable asset.

It’s similar to how the largest investment banks and hedge funds sold off their gold holdings to try to balance their books in 2008. (In fact, that’s one of the main reasons why gold prices were relatively flat last year.)

But you know already know that gold is a valuable asset. Recently, several central bankers have shown they agree…

Forget the IMF. Look Who’s Buying Gold…

This year, China has continued to boost its gold reserves. In fact, their gold reserves have mushroomed a full 76% since 2003.

China’s latest gold purchase was no small sum either. The Chinese added 454 tons to their reserves. That alone is more than the IMF is selling. It also brought the Chinese gold reserves to 1,054 tons. That just edges out Switzerland’s holdings of 1,040 tons.

It’s no surprise to me that China is doing this. Their foreign exchange reserves have blossomed six-fold in six years. They have $2 trillion in reserves to spend. The Chinese recognize that long-term the dollar is in trouble so they are buying “undervalued commodities” as they put it.

So far, it’s paid off well for them. As you know, the dollar has been on a downward slant since March. As the Chinese load up on more undervalued commodities like gold, it helps to buffer their reserves from any depreciation in the dollar.

You can be sure they’ll be buying more too. They’ve got a $200 billion sovereign wealth fund just to invest in things like these undervalued commodities.

So in my mind, when it comes to gold reserves…China is probably the most important one to watch. It’s not that they hold the most, but in my opinion, they have the biggest ability to buy the most if they choose to do so.

Also, remember that China is now the world’s biggest gold producer, surpassing South Africa and Australia! Therefore, keep your eyes on China when it comes to gold.

So here are the world’s top holders of gold reserves. The U.S. takes the top spot by far, at a whopping 8,134 tons. (By the way, the U.S. NEVER sells its gold…which is interesting.) Germany is a distant 2nd place at 3,413 tons. The IMF has 3,217 tons. France has 2,487 tons and Italy has 2,452 tons.

But it’s not just China that’s gobbling up the gold!

But there are others that are ratcheting up their gold reserves for fear of dollar weakness coming.

For instance, Venezuela’s government has mandated that any gold they produce must be offered to their central bank FIRST. They’ll only sell to everyone else after the central bank takes in what they want.

So their government mandated that 70% of their gold must be sold locally and 60% of that 70% must first be offered up to their central bank. Then the other 30% can be exported.

This is a huge change in their government’s policies. The government used to say only 20% had to be offered to their central bank. Huge difference between 20% and 60% huh? I think it’s safe to say their stance on gold buying has changed dramatically.

Russia said it recently “increased its international currency and gold reserves to $391.3 billion from $385.9 billion.”

So why are all of these central banks “scampering” for more gold? Because they all have two commonly held beliefs, in my opinion: 1) They fear a further drop in the U.S. dollar is coming (which I agree). 2) They believe that gold is undervalued (which I also agree with).

Gold in “2009 dollars” Could Climb Well Above $2,200!

See the inflation-adjusted gold chart below. You see, when investors look at the historic highs for gold, they don’t always figure in inflation. For instance, 1980’s highs for gold are thought of in “1980’s dollars.”

However, even just adjusting for inflation through 2007, will show you the actual high for gold in 1980 was closer to $2,145. There are some that argue that in “2009 dollars” the number is well above $2,200. You can see this all on the chart below…

Yet right now, gold is comfortably consolidating in the mid $900 range. Therefore, I think in the near term (coming months), you will see gold hit $1,300 but ultimately, it could easily go up to $2,500 in my opinion.

So in short, I agree with the central bankers. Gold is still grossly undervalued. Watch for gold to soar later this year…

Happy Trading!
Sean Hyman, Professor FX

P.S. My colleagues and I recommend holding 5% to 10% of your portfolio in gold. Recently, our friends at The Sovereign Society have discovered a key technical indicator that allows you to predict the next upsweep in gold stocks. You can read all about it in the latest FREE Sovereign Society special report here.