Commodities | Oct 06 2006
By Greg Peel
Yesterday I reported (“More Pain Before Gain Likely In Gold”) that respected gold market monitor Gold Fields Mineral Services (GFMS) had attempted to put to rest the notion that last week’s dramatic gold sell-off was simply due to European central banks rushing to sell the shortfall in their quotas ahead of the September 26 deadline.
GFMS calculated that total central bank sales came out at 393t – short of the 500t quota. The conclusion drawn by GFMS was that gold’s fall could only be attributed to investor selling. GFMS’s press release did not sit well with many in the gold market.
There has certainly been evidence of hedge fund liquidation of gold since the metal breached support at US$600/oz and failed to hold. But the extent of gold’s fall was enough for observers to suggest there was more going on than just hedge fund selling.
It surprises few in the market that there might be something suspicious happening (except, it would seem, GFMS) as there is plenty of evidence to suggest central banks, and the US Treasury in particular, have been active in covertly selling gold through leasing arrangements and derivative transactions in order to suppress the price for the purpose of supporting the US dollar and other currencies. (In fact, as much has been admitted in the last eight years).
Such transactions go unnoticed by the official gold market monitor – the IMF – and by GFMS. The US Treasury pays out its gold delivery obligations in freshly printed cash. This has the affect of misleading the market with respect to the amount of gold actually remaining in central bank vaults and as to the extent of obligations owed by central banks on the short side of the gold market.
If the market is misled into believing central banks were not selling gold then it is misled into believing the gold market is weak – investors are selling and there’s insufficient buying from jewellery demand or from investors and speculators coming the other way. This paints an inaccurately bearish picture for gold in the short term.
In yesterday’s article I reported that Resource Investor had been tipped off that the clue to the gold price weakness in fact lay in central bank forward sales which would not have been included in the GFMS calculation. While forward sales represent a future obligation, the flow through to the spot market is still immediate.
Last night Britain’s Daily Telegraph reported an accusation from Barclays Capital that the banks had done just that – 100 tonnes had been sold forward in a rush to meet the quota and “disguise” the effect. Barclays is one of the world’s top three bullion traders.
"We have been able to infer this from trading patterns. It has had a major impact on the markets," said Costanza Jacazio, Barclays’ gold expert, "We suspect that the Banque de France has been involved".
"We believe this is actually very bullish for gold because it shows that the sell-off was not driven by investors," said Ms Jacazio.
While there has yet to be any official response from GFMS, both sides of the argument find themselves of a similar view anyway. GFMS has set an end-of-year target for gold of US$750/oz based on its belief that the US dollar is in for a big devaluation as the US economy slows.
This has been a call for some time now, but to date a big fall in the greenback has failed to materialise. The US dollar has held on to its safe haven status in the last month or so, while the reborn Japanese economy appears to have stalled at the starting gate, and the European economy has not fared much better. However, following oil price falls and less hawkish talk from Fed chairman Bernanke, the mood in the US is now that the next interest rate move might in fact be down. This has been enough to send the Dow Jones sailing to new highs.
And just when it was thought Europe might at least go on hold as well, the European Central Bank spoiled the party by raising rates 25bps overnight to 3.25%. Furthermore, ECB president Jean-Claude Trichet indicated in his accompanying rhetoric that the latest increase may not yet be the end of it. The US dollar must now come under pressure against the euro.
This would thus see GFMS’ scenario played out. GFMS chairman Philip Klapwijk is expecting gold to resume its five year bull market.
"Hot money has left the market and we’ve seen chart-based selling as the fall triggered stop-losses. But at this level we are going to see support from miners like Barrick that want to cut their hedge books," he said.
Canadian-based Barrick is the world’s largest gold mining company, and it was reported by Reuters last night that the company has just announced a US$1bn copper-linked debt financing issue. This implies Barrick is not going to raise funds for the purpose of gold mining by hedging gold, but by hedging copper. This removes a big slug of potential gold forward sales from the market.
The Daily Telegraph also reported that the Russian central bank is expected to raise the proportion of gold in its reserves from 3% to 10%. This move alone would soak up much of global mine supply, and that’s before the long-awaited physical buying out of India (much talked about, but yet to make its mark) has its impact.
The gold price rallied US$9.70 to US$571.20/oz overnight following a 1% rally in the price of oil. Oil rallied on the news that OPEC was indeed planning a production cut.
TheStreet.com reports Matt Turner, a commodity analyst at specialist consulting firm Virtual Metals in London, has made note of the recent effects of investment in commodities as a single sector.
"Oil currently dominates the commodity complex, and the metals seem to be moving in concert. We are seeing a new type of investor in these markets that invests in the sector as a whole, rather than in individual commodities."
Because energy makes up such a large proportion of commodity indices, changes in energy prices have a disproportionate impact across the whole sector. As to why gold (a currency) should be included in the commodities complex is by the by. There is no doubt that falling commodity prices imply lower inflation which is, in theory, bearish for gold.
However (and this is where it all gets confusing), commodity prices are falling because the US economy is slowing, which should eventually see the US dollar lower, which should thus be bullish for gold. If the US dollar falls, then commodities are cheaper for foreign buyers (as the US dollar is the dominant currency of settlement) and thus importers can afford to pay higher prices – commodity prices rise.
How this all pans out is no doubt the $64 question, but either way – and it’s becoming almost tiresome to say this – it’s very hard to find anybody who is not ultimately bullish gold, and bullish in a big way.