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
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
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 www.resourceworldradio.com
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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