Commodities | Sep 16 2010
By Greg Peel
Since the Washington Agreement was first signed in September 1999, the central bank “gold year” has begun and ended in September. With this gold year almost at an end, gold consultant GFMS anticipates that global central banks will have net bought around 15 tonnes. The last time the world's central banks were net buyers rather than net sellers was in 1988.
The Washington Agreement was signed between European Union members ahead of the launch of the euro to prevent the indiscriminate selling of gold by any individual member which would impact on the value of the common currency. It has nothing to do with the US, it's just that all members were in Washington for an IMF meeting at the time. And it was important given Europe is by far the biggest holder of gold outside the US – a legacy of thousands of years of history.
The Agreement was also a rapid response to the Bank of England's selling of over half its gold to the lowest bidder (~US$250/oz) on instruction from Washington in order to support the US dollar in the wake of the Long Term Capital Management hedge fund collapse. It is almost laughable to think now that LTCM was the last time a GFC was truly threatened and all for a paltry US$6bn. These days if Timothy Geithner dropped US$6bn out of his pocket on the way up Capitol Hill, he wouldn't bother bending to pick it up. But the eurozone did not want any further such sales to be a possibility, so it imposed a limit.
That limit was a collective 400 tonnes of gold sales per year for five years. In 2004 the Agreement was rolled for another five years with a limit of 500 tonnes, and it was rolled again in 2009 with the 400 tonne limit reimposed. On average, net sales from central banks over the past decade have totalled 442 tonnes. But by 2009, the picture had changed. Eurozone countries in difficulty such as Spain were selling large amounts of gold, but stronger nations such as Germany and France elected to hang on. In previous years, gold had been seen as an anachronism compared to the new world of debt-backed paper currency given it offers no yield. Post-GFC, gold has regained its safe haven status at a time when paper currencies are looking more paper than currency.
The result is very little gold was sold in 2009, and the new 400 tonne limit seemed almost unnecessary. On the flipside, the developing BRIC economies realised they had very little in the way of gold to back their own currencies, or to hold as protection against a wobbly reserve currency. Thus we've seen China move to be a major gold buyer (albeit contained to its own production), Brazil and particularly Russia upping their holdings, and India taking out half of the IMF's available gold in one fell swoop. And Saudi Arabia has also been in on the game, as well as a number of smaller nations.
The European crisis has since hit, and while it may be tempting to the PIIGS to sell some more gold to prop up distraught sovereign balance sheets, now is not a good time to throw away the only asset that might have true value. So it is of little surprise that the world's central banks have now swung from being net sellers to net buyers.
Which is clearly another reason why gold is currently at an all time high (on a nominal basis – in real terms gold hit about US$2300/oz in 1980), alongside the private sector's thirst for gold ETFs and the ongoing downtrend in global new gold production.
Where to from here? Well on the one hand, the level of gold held in ETFs has never been this high, meaning a sudden panic sell-off is not a remote possibility. There is also concern as to whether traditional Asian jewellery buyers will pay up to new highs this season. Occasionally this century they have baulked. But with the ECB propping up European sovereign debt with printed euros, the Bank of Japan now holding down its currency with printed yen, and the Fed threatening to once again start printing greenbacks, it's little surprise GFMS suggests gold can trade at US$1300/oz in the near term.