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The Bullion Report - Emptying the Coffers?

 

By Richard Zimmerman

Jun 1 2011 1:27PM
newsletter.berkshireassetmgt.com

   

Presidential hopeful Ron Paul recently made headlines by suggesting that the US sell gold holdings to try to curb debt issues. The government has been butting its head against the debt ceiling, which will likely be raised shortly, so why would selling be a good idea in Paul's eyes? More importantly, what would compel a nation to sell bullion assets and would it be a good idea?


Past performance is not indicative of future results.
***chart courtesy Gecko Software

First let’s dispense with the reasons behind the suggestion. The US is fumbling beneath the weight of substantial federal debt. So heavy is the burden that the country was recently threatened by a downgraded outlook on credit-worthiness. This was no joke, as the idea of one of the globe’s biggest financial machines being downgraded was enough to send most investors running for cover. The debt ceiling of $14.294 trillion has been reached, and as of the middle of May, US Treasury Secretary Timothy Geithner is in a position where he has twice asked for the lid to be lifted. The trouble now is that Congress may have to look at some extraordinary measures to get funds, including federal employee payroll trimming. When the debt reaches its ceiling, the tarnish on our reputation is pretty visible. That is why the outlook for the nation was lowered. Foreign holders of our debt won’t want to take the risk that the US will falter, and the strength of the US dollar comes into question.

In an attempt to resurrect our global reputation, Ron Paul is basically suggesting that the government sell gold holdings to take care of a chunk of that debt. There are other things that the Treasury could sell, including land, but from the congressman’s perspective, the gold in Fort Knox is “just sitting there.” Gold prices are at high levels compared to other dates in recent history which furthers the argument that selling at all would mean selling now when prices are high. Most banks and governments have some form of bullion holdings and the US has oodles. According to IMF data, we hold about 8,000 or so metric tons at least (as of the late 1990s.) Conspiracy theories aside, that is. So why not sell some when prices are over $1,500 a troy ounce?

The answer is a little delicate – how do you know when it is the right time, if at all, for a bank to sell? Famously, some leaders made potential blunders when they decided to sell gold holdings. Australia’s bank famously sold the majority of its holdings in the late 1990s because the bank’s board didn’t believe that prices were going anywhere. They also argued that Australia had reserves they could mine, “vast reserves” which would guard against any need to keep their approximately 167 metric tons under lock and key.  Holdings went from 246 metric tons to 80 in 1997. Unfortunately, the decision was made, and fingers were pointed with many observers pointing out that the sale cost the bank billions of dollars. The thing to remember is that at the time, other assets were performing rather well for the bank and they made the best decision they thought they could based on the information they had at the time. In those years, members didn’t feel that gold would have any role in the emerging global economy and wouldn’t be required if there were a financial crisis. The Bank of England found itself in a similar position when around 395 metric tons of its gold were sold at auction. Gordon Brown was allegedly warned against the sale, which may have cost the UK upwards of 6 million pounds. Of course, officials behind the sales could argue that hindsight is 20/20. The sales also depressed prices, before the actual events by announcing the coming sales and afterwards as confidence in bullion wanes. If the US were to sell some of its gold, announcing it beforehand would diminish the netted value, and afterwards, the price drop would probably erode the dollar per ounce value of the retained assets.

Summary

The biggest problem with the idea of the US selling its gold is that, as we have seen before, there is always an issue when trying to call a potential top to precious metals prices. Current financial issues and inflation risks make upward momentum a viable thing for bullion prices, and the support we have seen on recent dips seems to reinforce that. More importantly, unlike when Australia’s bank sold their gold, there aren’t really any assets for the US to look upon favorably at the moment. The debt is high because the GDP growth has been so poor since the start of the global recession. There is little to no evidence that the country is in recovery mode. It seems to me that trying to remedy that by selling the only thing that has gained or preserved its value is a little like throwing the baby out with the bathwater, if you’ll excuse my cynicism. Gold is the only thing that appears worth keeping, whereas the other payroll cutting and real estate selling measures make more sense. Other central banks appear to understand this – Mexico, Russia, and a host of others have been ADDING to their gold reserves in the recent financial turmoil. Maybe the US government should consider a fire sale on other assets to offset some of their debt, and actually buy MORE gold.

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By Richard Zimmerman
6-1-11

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Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results. © 2011 Berkshire Asset Management, LLC