Montreal, Canada

Central banks have historically ranked as the worst investors in the currency and gold markets.

In the United Kingdom, Prime Minister, Gordon Brown, who was Chancellor of the Exchequer in 1999, wins the booby-prize for the dumbest of dumbest trades; Brown sold 395 metric tons of Her Majesty’s gold at $275 an ounce ten years ago – just ahead of the great bottom. Other central banks, including gold-producing countries like Canada and Australia unloaded gold at the same time. Central banks have the worst track record when it comes to speculating.

Between 2000 and 2002 several central banks in the Persian Gulf purchased U.S. dollars – just ahead of the peak in late 2001. With the exception of 2004 and 2008, the dollar has posted a cumulative decline since 2001.

Now we have emerging market central banks accumulating gold while major economy central banks continue to hold their stash. The biggest gold-bugs remain the United States and Germany – two major central banks that did not sell gold in the 1990s. Yet the biggest buyers now aren’t advanced economy central banks; it’s the emerging market central banks.

India’s 200 metric ton purchase in late October at around $1,050 draws questions about market-timing since fabrication demand in that country collapsed long ago when gold hit $750 an ounce.

Still, the Reserve Bank of India is bullish even at $1,050 an ounce. China purchased a substantial amount of gold this year, though I question its official numbers.

So have emerging market central banks triggered a contrarian sell signal for gold?

The way I see it, it is different this time and for several important reasons.

The emerging market central banks are doing the right thing. These guys are loaded with depreciating and debt-infested U.S. dollars as a result of booming trade surpluses this decade. Worldwide, central bank reserves now hold their lowest percentage in dollars in history at just 65% or so.

If you were a Chinese or Indian central bank would you honestly sit on 100% dollar reserves today? Only an idiot would.

Secondly, and most importantly, Mr. Roubini must have tremendous faith in the Federal Reserve and other fiat central banks to drain this avalanche of liquidity from the financial system ahead of inviting inflation – serious inflation.

No doubt I have the utmost respect for Roubini; but his self-proclaimed bearishness on gold implies he likes the dollar. And aside from a short-term rally, the dollar has nowhere to go but down. The current rebound this month for the dollar will be short-lived. 

Bernanke will continue to print his way out of this muck. The odds of the Federal Reserve over-stimulating the economy or excessively flooding the system with too many dollars, is almost a certainty. Need proof? Just look at the Fed’s track record since inception in 1913. The dollar buys almost nothing.

Basically, I have great confidence that the Fed will bungle monetary policy and fail to drain the mountain of excess reserves in time to avoid inflation and some sort of monetary or debt crisis. Once banks start lending again inflation will accelerate. Gold can only excel in this scenario.    

Lastly, it would seem only logical to hold and accumulate gold even north of $1,000 an ounce into the next decade because wars have historically been highly inflationary. Coupled with a new healthcare bill and skyrocketing budget deficits it seems very plausible to me that the government has opened the door to inflation. I believe it wants inflation.

This month the United States is boosting its financial commitment to Afghanistan. It won’t win that war and it won’t win in Iraq; yet the spending binge continues despite Obama’s rhetoric to the contrary last year. War spending is what triggered the first wave of inflation following an escalation in Vietnam in the mid-1960s and the eventual demise of the gold standard by August 1971 under Nixon. A similar fate awaits the dollar and the United States.

Buy gold on weakness.