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
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
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
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
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 the dollar.
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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