Commodities | Sep 03 2009
By Greg Peel
It’s been dullsville in the world of gold these past few months as the yellow metal has oscillated in a tight range around the US$950/oz mark. But while a sudden break-out last night (gold shot up over US$20 to US$978/oz without much impetus from the US dollar) is not necessarily a harbinger of a long-expected charge into quadruple figures, it might be a good time to review a couple of recent developments in the gold market.
As noted in this morning’s Overnight Report, the May-August period is traditionally a weak one for gold as it represents a seasonal buying drought between the two big periods of Asian jewellery demand – late in the year and early in the year – which coincide with wedding seasons in India and holiday seasons in China and the Middle East (in which gifts of gold are a tradition). September, however, is historically the strongest month for gold, given jewellery makers re-enter the market to accumulate raw material ahead of rising jewellery demand.
There are no guarantees jewellery demand will be quite so spectacular in 2009 as it has been in the past, for the simple reason gold has refused to behave historically over the May-August period but instead remained stoically stuck between US$900-1000/oz. In past years, the seasonal drop in the gold price has brought forth eager demand at what seems a “bargain” price. Each year there has been a ceiling price for jewellery demand – a price at which your typical middle class or lower class Asians decide they simply can’t afford buy at. This ceiling has nevertheless ratcheted up over the 2004-2008 period in line with the growing wealth within emerging economies.
That growth took a stumble last year, but with the Chinese and Indian stock markets having made solid gains in 2009, and oil having bounced back to US$70/bbl, one presumes the emerging economy wealth-boost might encourage buying at the US$950 level nonetheless – perhaps.
But jewellery markets aside (which typically represents some 75% of demand for fresh gold production), September is also an important month in the central bank calendar as far as gold is concerned.
The vast bulk of the world’s non-jewellery gold is held by the International Monetary Fund and the US Federal Reserve, followed by the central banks of Europe. The reason for Europe’s extensive holdings is a simple one of history dating back to colonial conquests. The reason the US Fed is the biggest central bank holder can basically be attributed to the Second World War, in which America saved everyone’s behinds and emerged as a global superpower and creditor nation to both the vanquished and the victorious. After the Second World War the legacy central banks signed the Bretton Woods agreement, which saw European currencies pegged to the US dollar which was in turn pegged to gold, and everyone’s gold was held in custody at Fort Knox.
President Nixon ended the Gold Standard in 1972 after the US went broke fighting the Vietnam War, and ever since currencies have floated at will. In so doing, Nixon set in train what was to ultimately become the Global Financial Crisis of 2008, but that’s another story.
In the period since the Second World War there have been many recessions. On occasion these have provided spikes in the price of gold (1980 being the most memorable) and thus opportunities for European banks to offload some gold as backing to fiscal deficits. Central bank gold selling reached a peak in 1998 when the UK divested of half its gold reserves (under instruction from the US) in order to prevent a surge in the gold price stemming from the collapse of hedge fund LTCM, which went under short gold. A surge in the gold price would mean a collapse in the US dollar, and given Britain was still paying back the last of its War loans at that point Gordon Brown, then Chancellor, obliging bent over.
This frustrated other European central banks, given at that point gold reached its lowest levels for decades – around US$250/oz – undermining central bank reserves. Thus in 1999 all parties met in Washington and signed the Central Bank Gold Agreement (also known as the “Washington Agreement”) which limited net central bank gold sales from signatory banks to 400 tonnes per year over five years. In 2004, the Agreement was re-signed for another five years, with an increased net allowance of 500 tonnes. Each “year” ended in September.
Hence September is again important in the gold calendar, because it usually represents a time by which any central bank wishing to sell gold has already done so and is now waiting for the “new year”. This leaves a hole in the traditional supply-side.
However, in recent times, and particularly over the last couple of years, European central banks have not been quite so keen to off-load their “safe haven” gold on a net basis. There has been some notable selling, particularly from a debt-ridden Spain, but the big shakers of Germany and to a lesser extent France have backed right off. Switzerland has been a seller, but only to readjust to its reserve portfolio weightings following gold’s strong price run. Indeed, of the net 2500 tonne limit imposed between 2004-09, only 1867 tonnes have been sold.
September 2009 ends the latest Agreement. Early in August, the central banks re-signed yet again, but this time they again lowered the permitted net sale volume to only 400 tonnes. Given this implies 2000 tonnes can be sold in 2009-14 but only 1867 tonnes were sold in 2004-09 anyway, it’s hardly the stuff of excitable headlines. But is does represent another influence in what has become a new trend. In the Agreement year 2009 (to date), a total of only 140 tonnes of gold has been sold.
The World Gold Council suggests the total gold held by Washington signatories now stands at 11,992 tonnes. This total represents, on average, 55% of each central bank’s reserves. By contrast, Russia’s gold reserves represent only 2% of its total, while China carries (as far as anyone can determine) only 1.5%.
Mineweb reports specialist gold analyst Jeff Nichols as suggesting the world may have now reached a “turning point”, at which central banks have moved from being net sellers of gold to net buyers.
Emerging market economies have been complaining about the US dollar as the world’s reserve currency since the GFC began playing out, given excessive US debt undermines the value of those central banks’ US Treasury bond holdings. Aside from suggesting alternative currencies or reserve currency baskets, emerging economies have signalled their intention to accumulate more gold as a proportion of reserves. Russian Prime Minister Vladimir Putin has, for example, suggested Russia should aim to increase its gold reserves from 2% to 10%. As Mineweb notes, that represents potentially “considerable” purchases.
In the meantime, the world had been waiting for China to either announce its intention to buy more gold or appear to be doing so, until suddenly last year China announced it had accumulated a total of 454 tonnes of reserves since 2003. The reason no one noticed is because over the same time China’s domestic gold production level rose to be the greatest in the world. The central bank simply accumulated a proportion of its country’s own production, and no one outside China was any the wiser.
It would thus seem China will continue as a “closed shop” in its influence on the global benchmark gold price, surreptitiously buying its own gold without affecting any movement on the Comex exchange. But while China may not appear in the global market as a buyer, the central bank is removing Chinese production from the mix that might otherwise have satisfied local jewellery makers.
Nichols suggests that the combination of emerging economy buying and the apparent reduction in European desire to sell is sufficient to call the “turning point”. Whereas for decades central banks have kept a lid on the gold price (and supported their fiat currencies) by selling their gold, now their net influence will be bullish for the gold price.
The only sticking point is the IMF.
The IMF was created out of the Bretton Woods agreement as an emergency fund to be used to provide support to distressed small economies, and while over the years the list of contributing countries has grown to include both developed and developing economies, the IMF is still very much a puppet of the US. For years the IMF has been petitioning the US Treasury to be allowed to sell some of its vast holdings of gold to prop up its coffers, but the Treasury has always refused such permission until such time as the IMF streamlined its unwieldy and costly bureaucracy.
That is now deemed to have satisfactorily occurred, and with the onset of the GFC and particularly the threat posed to Western European banks by the possible collapse of Eastern European economies, the IMF has been granted permission to sell 403 tonnes of gold over the next few years.
So realistically what the Washington Agreement central banks won’t be selling, the IMF will be. However, the US Treasury has allowed the IMF its sales quota only as an inclusion in the net Washington Agreement limits. Therefore, while the IMF is a new player on the block it must fit in with the new net 400 tonne per year Washington Agreement limit.
Moreover, notes Nichols, as the IMF includes amongst its members the very same central banks who are apparent buyers of gold, in-house transactions could easily occur which would never see the open market.
So the net result of all of this is yet another argument, beyond the simple argument of secular reserve currency weakness, to be longer term bullish gold.
