On Tuesday, the Dow Jones Industrial Average briefly climbed above 13,000, its highest level since May 2008. Many rejoiced at the psychological milestone as the index has nearly doubled from March 2009 lows. Central banks around the world have flooded the financial system with liquidity in an effort to stave off a deepening financial crisis. As a result, asset prices on stocks and commodities have surged in recent years. However, investors should pay closer attention to relative performance and the increasing demand for gold by central banks.
According to data from Bloomberg and Diapason Commodities Management, central banks have injected almost $7 trillion into world markets in the past four years. This action has devalued currencies and boosted nominal stock prices. Among other things, central banks are trying to create a wealth effect, which is the idea an economic recovery will form as people increase spending because they feel wealthier, due to their portfolio balances rising. However, this is a flawed idea. Rising stock prices are failing to keep up with even faster rising hard asset prices such as gold. According to Zero Hedge, even though the Dow is back at May 2008 levels, the Dow priced in gold is down a staggering 50 percent. While the Dow was busy getting back to a nominal break-even point from May 2008 to February 2012, gold prices surged from $900 to $1,750 per ounce. During the same period, silver prices increased from $17 to $34 per ounce.
Don’t Miss: Record High Gold Prices Fail to Curb Global Demand
The wealth effect is also struggling to take hold because consumers are being squeezed at the pump. The average gasoline price in the United States reached a record high for the month of January. In fact, the national average for a gallon or regular gasoline has already surpassed $3.52 this year, the earliest the average price has ever hit the $3.50 mark. I’m expecting the national average to float dangerously close to $4 a gallon,” Patrick DeHaan, GasBuddy.com’s senior petroleum analyst said. “We are on course to break through $4 nationally. Some of these major metro areas could hit $4.50 or even higher. This year we may have a run for the money in knocking down the record from 2008.”
Central banks are not oblivious to the fact that paper assets are failing to keep up with real assets. According to the latest data from the World Gold Council, central banks purchased a net total of 440 tonnes of gold in 2011, compared to only 77 tonnes in the previous year. It was the largest amount of net purchases by central banks since 1964. This does not include another 63 tonnes of gold that were added to Turkey’s balance sheet as a result of a policy change, which allows the central bank to accept gold in reserve requirements from commercial banks. Russia, which slashed its holdings of U.S. Treasuries by half since October 2010, increased its gold holdings by around 95 tonnes in 2011.
Investor Insight: Will Gold Cleanse The World From Dirty Fiat Currencies?
The Federal Reserve, European Central Bank and others have failed to do anything but kick the can down the road. The Dow hitting 13,000 and the wealth effect is insignificant because prices on hard assets are greatly outperforming paper assets. Other central banks such as Russia’s are realizing this and taking appropriate actions. As paper assets continue to underperform, wise central banks and investors will protect themselves with precious metals, the time-tested method of preserving wealth. The WGC explains, “The trend in central bank buying is expected to continue given the lack of decisive action in dealing with the underlying issues both in Europe and the U.S., as well as the low relative allocations to gold among emerging markets.”
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The article was first published by Wall St. Cheat Sheet and does not represent the views or opinions of International Business Times.