Central Bank sales and the gold price
December 05 2003
Hopefully I managed to demonstrate in the previous
two columns that gold cannot be analyzed as a commodity. The annual
fluctuations in physical supply and demand are just too small in
relation to the volume of gold trading to influence its price, at
least by any significant amount. Also, a look at producer hedging
shows that it was not the cause of the dramatic decline in the US
dollar gold price from 1996 to 2001 (see last week's article).
What about Central Bank gold sales? The hypothesis
that Central Bank sales depressed the gold price certainly received
a lot of attention during the nineties.
The chart below shows that the average worldwide
gold price (as measured against a GDP-weighted index of currencies)
doubled since the early nineties while Central Bank gold sales increased
almost three-fold. It's therefore obvious that Central Bank gold
sales did not cause a decline in the gold price.
The hypothesis originated because the US dollar gold
price declined thirty-five percent from 1996 to 1999, during a period
of increasing Central Bank sales. But that was entirely due to the
bull market in the dollar. There was, in fact, no bear market in
gold during the nineties.
Along the same lines, the Washington Agreement, where
several European Central Banks agreed to limit their gold sales
in 1999, is considered a key turning point for the gold market.
In reality, Central Bank gold sales did not decrease significantly
after 1999. I suggest, therefore, that the Washington Agreement
was not at all instrumental in halting the decline in the US dollar
gold price, as it had nothing to do with the dollar's exchange rate.
The dollar's increased strength throughout the nineties was the
real cause for the decreasing gold price, in dollars that is.
However, it's no coincidence that the Washington
Agreement was signed near the end of the US dollar bull market,
which, of course, marked the end of the decline in the gold price
as measured in dollars. The gold industry had gained the support
of very vocal groups while gold producing countries were mobilized
to lobby in Europe and the United States for an end to Central Bank
sales or, if not an end, then at least for more transparency of
Central Bank gold sales.
Perversely, when the Bank of England responded to
the calls for transparency, it was chastised for telegraphing its
intentions through its announced gold auctions.
Throughout the nineties, whenever a Central Bank
announced that it had sold some of its gold, the gold price would
decline sharply in response to the announcement yet recover within
a matter of weeks to its pre-announcement level. This implies that
the actual sale did not affect the gold price much, if at all.
Rather the announcement induced speculators to sell
gold on the assumption that continued Central Bank sales would drive
the price down further. While some of these speculators undoubtedly
made a bunch of money, they did so out of pure luck. The decline
in the US dollar gold price had nothing to do with the Central Bank
sales they were monitoring, but with the roaring bull market in
the US dollar.
It surprises me when gold investors, particularly
those who believe that gold is money, denounce Central Bank gold
sales. Central Bank sales are good for the gold market because private
ownership of gold is a pre-requisite if gold is ever to be used
as currency again.
Whenever gold is ubiquitously used as money, the
majority of it is in private hands simply because the private sector,
as a whole, has significantly more capital than governments. Whenever
the world is forced off a gold standard, it is done in conjunction
with gold confiscation. This allows the government to shift to a
fiat currency that it can inflate without giving the citizenry an
opportunity to use gold as a competing currency.
Look at Central Bank sales as a transfer of gold
from weak hands (those inclined to sell, the Central Banks) to strong
hands (those who believe in gold as a store of wealth and inclined
to hoard, the public). This is positive for the gold market, especially
since the sales don't even depress the gold price. It's proof of
just how robust the gold market really is.
I am on record saying that I believe the gold price
will, within a few years, exceed $1,000 an ounce. While that makes
people who are invested in the sector extremely happy (everyone
likes their beliefs affirmed), the truth of the matter is that the
bear market in the dollar is driving the increase in the gold price.
We are not in the midst of a booming bull market in gold any more
than we were in the midst of a bear market during the nineties (look
at the above chart again). What we are facing is a bear market in
That, as I have said many times, has major implications
for gold stock investors. While a lot of money could be made in
this market, I suspect many investors are going to be disappointed
with the performance of their gold stock portfolios.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
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