Have Central Banks Lost Control of the Gold Market?
Source: Julian Phillips, Gold Forecaster††(10/1/10)
"Gold is becoming a vitalónot just importantóreserve asset."
A Brief History of Central Bank Control of Gold
When Eurodollars appeared in Europe, European central banks were not happy and sold them for U.S. gold. Then President Nixon, in his infinite wisdom closed the 'gold window' (after Europe had boosted their reserves after sending around 12,000 tons of gold across the Atlantic into European vaults). In a mutually beneficial but clandestine accord, the world then saw the U.S. dollar rise to be the sole global reserve currency. It has continued to reign supreme because it is the only currency that is used to buy oil, oil that we all need.
After 1971, gold began to rise in earnest as every man and his dog bought some, taking the gold price from $42.35 to $850. This was a public statement that the global investing public did not accept paper currencies with no gold to back them. These had become simply government obligations with no settlement date.
Central banks had to act to ensure the public accepted these currencies and were moved away from gold as money. To do that, the U.S. and by extension the I.M.F. decided on limited (limited because central banks still wanted it in their vaults as an important reserve asset) gold sales through auctions. All the gold sold there was snapped up. The reality of central banks wanting to keep gold then kicked in and the auctions were halted.
Another tactic was then used. This time the central banks, lent gold to gold miners who used it to finance gold production. This caused a huge acceleration in the tonnage of gold coming to the market, too much for the market to absorb. The gold price fell right back to its 1999 low of $275. But the central banks technically still owned the gold as producers repaid their loans with gold from their mines.
At the same timed central banks supplied a well orchestrated campaign that implied central banks may well sell all the gold they owned over time. Markets and analyst swallowed the bait. The job of ensuring the U.S. dollar was the only solid, global reserve currency was then achieved without the interference of gold.
Then the time came for the Euro to enter the market in place of the European currencies, such as the French Franc, the Deutschmark, and the Italian Lira, etc. With the task made easier by the anti-gold campaign that ensured the acceptance of the U.S. dollar, the Euro was quickly established as the world's number two currency. Nevertheless, the fear remained that Europeans would prefer gold, so the European central bankers made, to date, three agreements to sell a limited amount of gold over the next fifteen years (four years still to go). Unexpectedly, this removed the fear that central banks were selling the gold price down still. The gold price turned around, miners over time bought back all their hedged positions (matching central banks sales in the process) and last year both the miners and the central banks let their sales and de-hedging dwindle to almost nothing. (AngloGold Ashanti will still buy 131 tons of gold to close its hedge book.)
Until last year, there was no doubt that the gold market reacted to central bank policy on gold and moved the price accordingly. Let's face it if they did really get rid of over 30,000 tons of gold the gold price would collapse. Central banks knew full well the implications of fears that they may sell gold. It would effectively ensure that hardly any investment in gold took place. This was control too!
Have Central Bank Lost Control Again?
Close to the beginning of 2009, the European central banks let their gold sales dwindle. It became clear to all that there was no more appetite in the signatories to sell gold. The Euro was then fully accepted by all. Central bankers re-established the importance of gold by the cessation of gold sales. But European central bankers had made this clear in the first central bank gold agreement, called the 'Washington Agreement', which made it clear that all the signatories regarded gold as an 'important reserve asset'. Consequently, they have been happy to see the gold price rise too. As Axel Weber, the head of the German Bundesbank said in the past, 'gold is a useful counter to the swings in the dollar.'
By then the "credit crunch" had endangered the banking sector and spread into the Sovereign Debt crisis. The currency world did not seem so solid and gold was holding its highs and looked like rising even more. The attraction of gold to central bankers re-confirmed itself in such a climate.
Why is gold an important reserve asset? In times of international financial stress, gold will settle international financial obligations, when government promises won't. We have now entered the time when financial stress underlies the entire global monetary system. Right now, we are at the door of potentially major, global currency strife. This means that central bankers are no longer in a mood to sell their 'rainy day' gold.
But they don't control the supply of gold anymore. Their control since 1985 only went as far as to undermine the gold price. They have placed themselves in a position where they can't even buy gold for their reserves. To do so may imply that they have accepted that they too are losing faith in paper currencies. That must never happen. So they sit with a firm grip on the 30,000 tons they now have, but have lost control over the gold price. That went the moment they stopped selling.
As the rest of the world emerges and drains wealth and power from the West taking their foreign exchange reserves to unimagined heights, they now see the need to diversify away from the near total dependence they have on developed world currencies. They have so little gold in their reserves that in their citizen's savings that they have embarked on a campaign to build up Chinese gold holding. India has already done that and topped up their reserves with 200 tons from the I.M.F. China in particular has a very long way to go before their gold reserves are adequate for reserve asset requirements.
Russia was the first to announce the intention to increase the gold component of their reserves. Mr. Putin then announced Russia's intention to accumulate 10% of all its reserves in gold. It has taken a long time to even get part of the way there. (See the table below.)
China has made no announcement that it intends to achieve any particular level but is acquiring locally produced gold into an agency that, in time, will pass it to the People's Bank of China and only then will an announcement be made as to what they have bought. This appears reasonable for if China were to announce any target level it would put a rocket beneath the gold price, so, in true inscrutable style they have simply announced increases in gold reserves well after the event. We do believe they are buying gold internationally too. Retail demand in China is way over local production levels: we guess-estimate that around 150 to 200 tons is being imported if not more, as the number of importers has been widely extended. We also know that China began buying gold around 2004 if not before then.
In addition, since last year, the number of central banks that have been buying gold has increased steadily. From the Middle East eastwards, central bankers have come to the gold market. This new tide of demand is unlikely to subside for a decade if not far longer. Eastern demand is in the hands of half of the world's population and the half that has always loved and respected gold as money.
Central Bank Control Lost!
The developed world central banks were able to control the gold market in the days of the gold standard, because they acted in unison and legislated that control nationally (and by extension, internationally). They nearly lost it when Europe was buying it from the U.S. until President Nixon closed the 'gold window'. Then they lost control of the gold market after 1971 until around 1985. Control was then re-imposed by assisting in accelerating production and discouraging demand until 1999. Thereafter, central bankers had limited control through limited sales, which allowed for a steady rise in the gold price, right through to 2009 ($1,200).
The major breakdown of central bank control over the gold market and the gold price came when emerging markets came to the gold markets to buy gold. 'Eastern' central banks are unlikely to cooperate in holding the gold price down because they need gold in their reserves. Central bankers of the world (developed and emerging nations) have vastly different interests. These are unlikely to meet in any accord over gold. Now, with faith in developed world currencies on the wane, gold is becoming a vitalónot just importantóreserve asset. The skill will be in acquiring sufficient volumes of gold, without skyrocketing the gold price.
Global central bankers are divided on gold, with some buying, others holding but almost no central bank selling. Without unity of intent, central bankers cannot control the gold market or its price, any longer. They are almost in competition with each other. Non-central bank investors are jostling central bank buyers for any available gold.
Central bankers have now lost control of the gold market. Can they get it back?
How can they and will central bankers regain control of the gold price?
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