IMF Gold Sales
February 04, 2005

The gold price has been weak of late, down ten dollars in the past seven days. Thursday’s decline was blamed on remarks made by the British Chancellor of the Exchequer, Gordon Brown, about a possible revaluation of the International Monetary Fund’s gold reserves, and the possibility that some of those reserves might be sold to provide debt relief to poor countries.

The IMF has about one hundred million ounces of gold which are valued on its books at between $40 and $50 an ounce. To keep the arithmetic simple, let’s say the IMF has one hundred million ounces valued at $40 an ounce. Revaluing that gold at $440 an ounce would instantaneously create $40 billion dollars on the IMF’s balance sheet.

The $40 billion dollars so “created” can then be used to offset some of the debt owed to the IMF by poor nations. Such a revaluation and cancellation of debt does not necessarily involve the sale of any gold -- it can be done with accounting entries.

Another possibility is that the IMF actually sells some, or all of its gold, and uses the proceeds to assist poor countries with their debt. If the IMF sold its gold it could, for instance, buy a basket of sovereign debt and use the interest earned on the portfolio for debt relief. This option could potentially be more detrimental to the gold market. We are talking about a lot of gold: the IMF has 103.4 million ounces, or 3,216 tonnes. If all that gold were dumped on the market at once it could have a negative impact on the gold price. However, it is highly unlikely that the IMF would do that.

It is far more likely that the IMF will use off-market transactions to assist poor countries with high debt burdens, as it did with Brazil and Mexico a few years ago when these countries’ debt payments to the IMF were coming due. Between December 1999 and April 2000 the IMF “sold” 12.9 million ounces of gold to Brazil and Mexico at prevailing market prices and the profit on the sales (market price for gold less approximately $40 an ounce) was placed in special accounts designated for debt relief. Brazil and Mexico then immediately sold the same gold back to the IMF, at the same price they paid for it, to settle their debt payments that were coming due. The net effect was that the IMF still had exactly the same amount of gold on its books. It’s not clear from the IMF’s website how, exactly, Mexico and Brazil’s overall debts were impacted. I assume that their debts were just re-financed in the process, although some of the money created on the IMF’s balance sheet by this revaluation of its gold reserves could have been used to offset the total amount of outstanding debt as well. It is clear, however, that the money created from the revaluation of the IMF’s gold is being used to provide debt relief to poor, and heavily indebted countries.

Such off-market transactions are similar to a pure revaluation of the IMF’s gold and do not involve any gold actually being sold on the market. Since many of the same poor countries that the IMF is trying to help are actually gold producers, and since in many cases these countries’ gold exports account for a large (sometimes very large) percentage of their foreign currency receipts, off-market transactions are far more palatable than actual gold sales.

If we assume that some of the IMF’s gold will hit the market, then we have to consider what impact that will have. For instance, if the IMF sells its gold over a period of five to ten years, the net impact on the gold price should be negligible. In a previous commentary (“Central Bank sales and the gold price”, December 5, 2003) I showed that Central Bank gold sales did not affect the gold price during the period from 1990 to 2003. During that time Central Banks sold roughly 5,500 tonnes of gold -- far more than the IMF has to sell -- and since that did not negatively impact the gold market, I have no reason to believe that IMF gold sales will negatively impact the market either.

The only impact that Central Bank sales did have on the gold market during the 1990s was that they caused speculative selling on the date of the announcement. But the announcements were all made in arrears and the gold price always recovered within a few weeks of the announcements. In other words, the actual Central Bank sales, themselves, did not affect the market. That is also exactly what we saw on Thursday: a comment by the British Chancellor of the Exchequer caused a speculative sell-off in gold -- without an ounce of IMF gold being sold. I expect the gold price will recover within a few weeks, unless something else, like a rally in the US dollar, occurs.

Another thing to keep in mind is that the G7 is split over how to deal with the debt of poor countries. To revalue or sell the IMF’s gold will require an 85 percent majority vote. The United States alone has a 17 percent vote, and could therefore block the IMF from selling its gold.

Given that the IMF needs an 85 percent majority to sell its gold, that actual gold sales would hurt the same countries (gold producers) the IMF is trying to help, and that more benign off-market transactions are also a way to help those countries, I doubt that we are going to see massive IMF gold liquidations in the near future.

What we are likely to see is a replay of the 1990s when Central Bank gold sales were attracting a lot of attention and were blamed for the decline in the gold price while, in fact, the gold price was merely mirroring the US dollar.

With the dollar now declining the gold price (in US dollars) will continue its upward trend and nervousness about IMF gold sales is likely to cause counter-trend corrections, which should turn out to be good buying opportunities.

So I am not worried about this week’s decline in the gold price.

Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477.

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