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 rate.

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 future.

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 purchases.

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 at to hear my conversation with host Pat Beechinor. I was also on Al Korelin’s radio show recently ( 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 own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website ( or contact his publisher at (800) 528-0559 or (602) 252-4477.


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