From David Galland in Casey's Daily Dispatch:

For some years now, Doug Casey has gone on record with his view that we’ll know the gold bull market is really picking up steam when central banks stop selling their reserves of gold, and begin buying the stuff.

The following excerpt from a Wall Street Journal article entitled As Gold Hits Record, Central Banks in Focus indicates that this is now happening…

The metal has surged over worries about Europe's debt woes and the slumping value of the euro. Investors in metals and currency markets have been on alert for any sign that the world's central banks, and China in particular, are shifting reserves out of the euro and into gold.

Though central banks typically are coy about investment decisions, there have been signs lately that they might be shifting out of euros and into gold.

Russia's central bank, one of the world's largest holders of foreign-currency reserves, trimmed its currency reserves by $6.6 billion in May, according to data on the bank's Web site, but increased its gold reserves by $1.8 billion.

Last week, an Iranian news agency said the country had begun switching €45 billion of its foreign-currency reserves into gold and dollars, a report that was unconfirmed.

"You won't see major players be blatant about increasing their gold exposure and reducing their euro exposure, but it is a trend we've been witnessing in the past few months," said Kathy Lien, director of currency research at GFT Forex in New York. "For the most part, whether they openly admit it or not, central banks are increasingly worried about their exposure to euros."

Central banks would be joining a buying binge by individual investors who have piled into coins and exchange-traded funds.

Central banks were net buyers of gold in 2009, according to the World Gold Council. India alone purchased 200 tons of gold from the International Monetary Fund. But appetite appeared to wane as gold traded at record levels.

A key point in this discussion has to do with the Central Bank Gold Agreement under which signatories were allowed to sell 400 tons of gold – 14.11 million ounces – annually.

According to the World Gold Council, in 2007 the Central Banks took advantage of the CBGA to sell on the order 484 tons of gold. In 2008 the number began dropping – to 232 tons, followed by a miserly 41 tons in 2009, just 1.44 million ounces, or 10% of that sold two years before.

And, at the same time they stopped selling, they began buying… a net 200 tons last year, and almost certainly more than that in 2010. Thus, we have a swing in demand of some 600 tons, or 21 million ounces annually… an amount equal to about 30% of new mine supply.

This, of course, is a two-edged sword, because, in sum, the central banks, IMF, and the Bank for International Settlements hold some 29,000 tons of gold. If push came to shove and the central banks were forced to defend their currencies by selling off their gold reserves, it could have a serious detrimental effect on the gold price.

Using the struggling eurozone as an example, if you added together the official gold reserves of the European Central Bank, Germany, Italy, and France you’d arrive at a total of 8,791 tons of gold available to be delivered to the market. Converted into a more commonly used, and understood, unit of measure, 8.791 tons equals 310 million ounces.

Now that seems like a lot of gold, and no question it is. Keeping things simple, at $1,000 per ounce, the European central banks are sitting on gold reserves worth $310 billion dollars.

One might be tempted to think that the European central banks could begin to view this very tangible asset as an important part of the solution to the sovereign debt crisis now bedeviling them.

However, when you consider that Italian government debt alone comes to $1.91 trillion, and is closing in on $8 trillion for all the eurozone, it becomes clear that selling their gold would have little real effect. And, of course, selling off their gold reserves would announce for all to see that the sovereigns were nothing more than hollowed-out shells, their currencies dried husks ready to be blown away by the next puff of wind.

Staying on topic, with 8,133 tons of gold in its reserves, the United States rates as the world’s largest sovereign holder. In fact, as of March 2010, gold made up 70% of official U.S. reserves. Pretty good, eh? Now, let’s break it down.

8,133 tons of gold = 287 million ounces.

287 million ounces x $1,000 = $287 billion held in gold reserves.

If $287 billion is 70% of total U.S. reserves, then total U.S. reserves = $410 billion.

Total U.S. government debt, not including unfunded obligations, comes to $14 trillion, so total reserves (of all categories) as a percentage of debt = .029.

And the gold component of those reserves, as a percentage of total government debt = .02.

I think the technical term is a “drop in the bucket.”

Even so, one doesn’t want to be naïve about these things – 29,000 tons of gold is roughly the equivalent of seven years’ supply. Which is another way of saying that it would be a mistake to completely discount the possibility that desperate governments won’t eventually attempt to dump their gold to defend their currencies, as counterproductive as that might be, given that it would send the price sharply lower.

For the time being, however, the central banks are net buyers – and so very supportive to gold’s price.

Crux Note: Each day in Casey's Daily Dispatch, David Galland brings you an informative and entertaining overview of the markets, the economy, and politics... all from his unique and often contrarian perspective. Casey's Daily Dispatch is absolutely FREE and comes right to your inbox, five times a week. To sign up, click here.

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