Gold Mining: Rising Costs and Limited Cash Flow

CENTRAL BANKS
should be "building gold reserves" alongside other non-Dollar and
non-Euro assets, according to a new study from gold-market development
organisation the World Gold Council.

"The financial crisis and
subsequent sovereign debt crisis have heightened reserves manager
attention to the need for increased diversification," write Ashish
Bhatia and Natalie Dempster of the Government Affairs division.

Looking
at asset volatility and correlations – and seeking to spread and reduce
the risk of sharp losses – assets in Chinese Renminbi, gold, and the
Australian Dollar "emerge as the most important for diversification."

But
China and Australia's markets in government bonds – usually seen as the
lowest-risk assets in any particular currency – are only of "limited
size", says the World Gold Council's report, Central bank diversification strategies: Rebalancing from the Dollar & the Euro.

Deciding to buy
gold
is therefore the "dominant" choice for diversifying risk, it concludes,
recommending "an optimal allocation to gold" by central banks of around
8%.

Reported central-bank reserves worldwide have risen from $2
trillion in 2000 to over $12 trillion last year. Gold prices also rose
6-fold during that time. The level of gold holdings as a percentage of
total central-bank assets in both 2000 and 2012 was 13% by value. But
while Euro-denominated assets rose from a 16% to 22% share, central
banks globally cut their allocation to US Dollar assets from 62% to 54%.

According
to separate World Gold Council data, the two largest central banks –
the People's Bank of China and the Bank of Japan– currently hold just
1.7% and 3.2% respectively of their reserve assets in gold.

"Compared
with China's $3.3-trillion foreign exchange reserves," said Yi Gang,
deputy head of China's central bank at a conference on Wednesday, "the
size of the gold market is too small.

"More gold is always an option,
but that requires profound judgment," Yi explained.

"We need to take
into account both the stability of the market and gold prices."

Chinese
households are now the world's second-largest private buyers of gold
each year, growing their demand to buy gold by 350% in the last 5 years,
and buying more gold since the end of 2011 than the People's Bank
reports in its entire official reserves.

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