Official Sector Gold Policies – At a Turning Point
I believe we are now at a key turning point in the modern history of gold as an official reserve asset – a turning point that is very propitious for the metal’s price in years to come.
Central banks attitudes with respect to gold are becoming increasingly positive. After years of persistent net sales by central banks in the aggregate, the official sector may soon become a net purchaser of gold from the market.
In fact, if we include sovereign wealth funds – which are non-central bank government-owned investment institutions – the official sector may already be a net buyer of gold.
On average, the central banks of the world hold about 10 percent of their international reserves in gold . . . but there is great disparity from country to country and region to region.
The major Euro-zone nations together hold about 55 percent of their assets in gold. In contrast, the Asian nations as a group (including India) hold only about two percent of their reserves in gold. China has about one and a half percent of its reserve assets in gold and Russia holds about two percent in gold.
Persistent Sales
For the past three decades beginning in the mid-1970s, gold has been under the threat of massive sales by the world’s gold-rich central banks and by the International Monetary Fund as well. In fact, the official sector has been a net seller of gold each and every year since 1989.
At times, official sales – and the threat of more to come – have contributed to negative sentiment in the marketplace with the price typically falling whenever one or another central bank announced a sales program.
This was seen most dramatically in 1999 when, much to its recent embarrassment, the Bank of England sold over half its official gold reserves at an average price of about $275 an ounce!
Other European central banks – among them Switzerland, France, Italy, Spain, Portugal, and the Netherlands – followed Britain, together selling about 3900 tons in total over the next 10 years.
Central Bank Gold Agreements
Realizing that their gold sales were having a considerable disruptive affect on the market and the metal’s price, the European central banks announced in September 1999 their agreement to limit future gold sales to no more than 400 tons per year over the next five-year period.
This first Central Bank Gold Agreement (also known as the Washington Agreement) was followed by the second Central Bank Gold Agreement, which limited sales by the European signatory nations to 500 tons per year for another five years.
Just a few weeks ago, the European Central Bank and 18 other central banks announced a third Central Bank Gold Agreement that caps the group’s aggregate sales at 400 tons per year for another five years.
All of this may prove to be irrelevant because the European central banks have not been inclined to sell much gold this past year – and my guess is that they will not sell much at all during the next few years.
For one thing, the pattern of sales in recent years suggests that those central banks most eager to sell have already done so. For another, many central bankers are bullish on the metal and don’t want to sell an appreciating asset.
Moreover, central banks that have sold large quantities of gold in the past decade look foolish indeed as the metal’s price has moved higher and the value of their U.S. dollar reserves has declined.
European central bank sales in this final year of the second Central Bank Gold Agreement, ending in just about three weeks, will probably total no more than 150 or 160 tons versus the 500 tons allowed.
Renewed Respect
I believe the decline in gold sales by the European central banks reflects a renewed respect for the yellow metal as a reserve asset and reliable store of value.
The European Central Bank, in announcing the latest Agreement said, “Gold remains an important element of the global monetary system.”
The Swiss National Bank, a signatory to the Agreement, added that it “has no plans for any further gold sales in the foreseeable future.”
Germany and Italy, the two biggest holders of official gold after the United States and the IMF, have both implied they have no intention to reduce their gold reserves.
And, perhaps a harbinger of things to come, the European Central Bank also reported recently that one of its members (and a signatory of the Central Bank Gold Agreement) recently purchased gold, going against the trend of the past decade.
Here Comes the IMF
The International Monetary Fund has also made news with its plans to sell 403.3 tons of gold to support lending to the poorest countries. IMF membership is expected to approve these prospective sales before its annual meeting this October.
IMF strategists have suggested sales might occur gradually over two or three years. Others believe all 403 tons may be sold “off the market” directly to one or a few central banks – with China, Russia, India, Brazil, or the Gulf states mentioned as possible buyers.
Importantly, the new Central Bank Gold Agreement incorporates these sales by the IMF, even though the Fund is not a signatory.
More specifically, the Agreement “recognize(s) the intention of the IMF . . . and noted that such sales can be accommodated within the (Agreement) ceiling.” In other words, total sales by the European central banks and the IMF cannot exceed 400 tons per year or 2000 tons over the five-year term of the Agreement.
To a large extent, gold sales by the IMF are already anticipated and factored into the current price. However, direct sales – off the market – to one or more central banks would be confirmation that central bank attitudes are shifting in favor of gold and would likely have a positive affect on the metal’s price.
Big Buyers – China and Russia
The big news of the past year has been announcements from both China and Russia that they have been buying gold from their domestic mine production – importantly demonstrating that large central banks can gradually buy gold without disrupting the market.
The past April, China told the world it had purchased 454 tons since 2003, bringing its total official holdings to 1,054 tons – still less than two percent of its total official reserves.
I believe China continues to buy gold from domestic production at a rate of at least 75 tons a year – but gold purchases this year have not yet been transferred to the central bank and have not yet been reported as official reserves.
Looking ahead, as China’s domestic mine production rises from year to year, its official purchases may very well increase at a similar percentage rate.
Russia, like China, has also been buying gold for official reserves from its own domestic mine production, which this year should total close to 190 tons. Prime Minister Putin has said that Russia should hold 10 percent of its official reserves in gold bullion versus the four percent that it held at midyear.
Some reports suggest the country has added some 40 to 50 tons to its official reserves so far this year while other reports put purchases this year at 90 to 100 tons.
One More Plus
As our clients and readers know, we are bullish on gold for the next few years, largely because of our reading of the macroeconomic situation – and the high probability of an overly stimulative monetary policy for years to come. But a more positive official section attitude – with some countries wishing to increase the proportions of official reserves held in gold – is simply one more support for a much higher price over the next several years. For a quick review of gold’s positive price drivers see our last post on NicholsOnGold.
