Watch out for central bank sales
May 21, 2004
Even though the gold price in US dollars is primarily
a function of dollar inflation and the dollar’s exchange rate,
many people are still concerned about central bank sales. I was
asked, as an example, what impact potential future gold sales by
the Bank of France would have on the gold price. Another reader,
concerned that governments could demonetize gold and make it completely
worthless quoted Andy Smith (a gold analyst at Mitsui Global Precious
Metals in London): “…more central bank selling could
seal gold's fate as an economic relic of the Old World.” I
also received an email suggesting that the renewal of the Washington
Agreement, with an increase in annual gold sales to five hundred
metric tonnes, would drive the gold price down to $300 an ounce.
Let’s put central bank gold sales in perspective.
While central bank gold sales increased from two hundred tonnes
a year in 1990 to almost seven hundred tonnes last year (a 250%
increase), they had no measurable impact on the gold price in US
dollars. The decline in the US dollar gold price from 1996 to 2001
was entirely due to the increase in the dollar’s exchange
Because gold is an international monetary asset and
not restricted to the United States, let’s look at the worldwide
gold price to see if central bank sales had any impact anywhere
else. I calculated a GDP-weighted average world-gold price (based
on thirty six currencies) and compared that to central bank sales
(see Kitco archives: Central Bank sales and the gold price; December
5, 2003). The average worldwide gold price increased from just under
four hundred units to almost seven hundred and fifty units between
1990 and 2003. Instead of declining, as one would expect if central
bank sales were depressing the gold price, the gold price almost
doubled, yet people still worry that the gold price will decline
following gold sales by central banks.
Nonetheless, because the new European Central Bank
manages the euro, any gold reserves not allocated to the European
Central Bank serve little purpose to the individual European member
central banks since they no longer manage any currencies. Gold,
for them, is therefore less important as a reserve asset, so there
is a high probability that some of the constituent countries of
the European Union will continue to sell their remaining gold reserves.
These sales have not had a measurable impact on the gold price over
the past fourteen years; I doubt they will have any impact in the
Gold is still an important reserve asset in South
East Asia, Japan and China, where huge trade surpluses and foreign
exchange reserves are being accumulated.
The four countries with the largest foreign exchange
reserves are (in order): Japan, China, Taiwan and South Korea. Together
these countries hold more than $1.2 trillion worth of foreign exchange
reserves, mostly in dollars. That’s enough money to buy about
sixty five percent of all the gold in the world at $400 an ounce.
Assuming that these four countries can generate a
nominal two percent return on their foreign exchange reserves, then
the interest alone is enough to buy 1,866 tonnes of gold (at $400
an ounce) every year. That puts the European annual sales of 500
tonnes in perspective.
These four countries share a common problem: they
own too many US dollars. While they may not want to hurt the US
dollar (it would hurt their own exports), they also need to diversify
their reserve asset portfolios. If, for example, they were to sell
dollars and buy euros it would significantly weaken the dollar and
boost the euro. This could help increase their European exports
while they lose ground in the US. At the same time they cannot let
the euro-dollar exchange rate get out of hand because a strong euro
would seriously hurt European exports to the United States, and
could cause a political backlash against them. Another option would
be to dilute their dollar holdings (albeit gradually) with gold
The real concern regarding central bank sales is that
there simply isn’t enough gold to satisfy the demand. The
risk is that those countries with growing foreign exchange reserves
may, one day, want to diversify some of their reserve assets into
an uncorrelated monetary instrument that isn’t anyone else’s
liability. That’s a risk I can live with.
For now the gold price remains a function of the dollar.
When the dollar falls on the prospect of higher interest rates,
the gold price will resume a sustainable upward trend. Until then,
be patient and use this opportunity to buy the physical metal or
gold related equities.
While you wait, I also recommend that you attend the
New Gold Show or the St. John’s conference. Both are excellent
venues to hear the latest opinions, meet people who make things
happen in the world of mining and exploration, and attend my own
talks and workshops. If you like a big conference with lots of people
and plenty of companies to evaluate, go to New York. If you prefer
a more intimate conference, with less people and more individual
attention, go to St. John’s. The details are in the side bar.
The latest issue of Resource World Magazine
(Volume 2, issue 4) includes an article I wrote about the dual deficits.
For your listening pleasure, you can access Resource World Radio
to hear my conversation with host Pat Beechinor. I was also on Al
Korelin’s radio show recently (www.kereport.com).
Al is going to host a panel discussion in New York -- another reason
to come to the conference.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
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