Gold News

A mystery buyer in the gold market

Has a major central bank done just as BullionVault wondered they might before Christmas...and started buying gold instead of selling it?

"Euro-banks have bought gold before," reports The Telegraph in London, "but past purchases involved coins under a scheme run by the Greek national bank...The latest purchase refers to bullion reserves, suggesting one of the euro-zone banks may have broken ranks."

This mystery buyer amongst Europe's big central banks turned up in the gold market at the end of December, it seems. Their purchase amounted to around two tonnes of gold.

But not so fast, replies a spokesman for the ECB. He claims that the purchase was purely for "technical reasons".

"We would be cautious about this," adds Nikos Kavalis, an analyst at the GFMS Ltd consultancy in London. "These [central] banks have a duty to uphold monetary stability. They're not hedge funds."

Central banks buying gold

What would it matter if a central bank was indeed buying gold? After all, central banks in Asia, flush with US Dollars in exchange for all the cheap goods they ship across the Pacific each day, have been buying gold. So too have several oil-producing nations. Russia's official data says it grew its gold holding by 2.2% in 2006. Unofficially, many analysts believe secret gold purchases by Asian and oil-rich central banks to be much larger.

But a member of the European Central Bank actively buying gold? That would really mean something big. The Washington Agreement of 1999 capped gold sales at 500 tonnes per year. It aimed to stop central banks dumping the 'barbarous relic' en masse in exchange for each other's paper promises, if only to give Britain a clear run at selling 400 tonnes of gold from the UK's reserves.

Should a major European bank now swap Dollars or Euros for gold, it would start a flight out of paper currency and into gold by other investors too – exactly what central bankers don't want. It would undermine the validity of the paper money they issue for a living!

"This has the gold market abuzz," notes Dennis Gartman, editor of the eponymous Gartman Letter. "[Gold is] becoming a flight-to-safety instrument once again," adds Kevin Kerr, co-editor of Outstanding Investments, "as more and more uncertainty builds with Iran and just what global economic impact it will have."

Central banks' current gold reserves

Let's remember, however, that two tonnes is not very much gold at all – not in the bigger scheme of things. Worldwide, central banks are estimated to hold some 30,000 tonnes. The gold-backed equities such as GLD in New York and Lxyor GBS in London now have around 750 tonnes between them.

What's more, demand from jewelers makes up the vast part of the annual gold market, some 592 tonnes in the summer of 2006 according to GFMS data. Jewelry demand accounted for 72% of total gold demand between July and September.

Next comes industrial & dental demand. It totaled 114 tonnes in the third quarter of last year. Investment demand over that period – or rather, investment demand identified by GFMS – came in at 110 tonnes.

So a two-tonne purchase really is peanuts compared to the total market. After just 18 months of operation, BullionVault's clients already hold more than that between them. And given gold's price in December, this mystery buyer amongst the European central banks spent a mere $50 million.

To put that in perspective, it would cover barely 6 hours of the United States' ongoing trade deficit!

But something certainly is afoot in the gold market, we believe. Just this week, a leading gold analyst in Mumbai, India, forecast gold in 2007 will rise above $850 per ounce, its previous all-time high for US Dollar investors.

Central bank gold sales and producer hedging

Speaking at an investment conference on Wednesday, Si Kannan, head of research at Sharekhan Commodities, said that the lack of growth in gold mining supply – plus the launch of new exchange-traded gold funds (ETFs) for Indian investors early this year – could send the price soaring.

India is already the world's largest market for gold jewelry. Its consumers bought one ounce in every five sold for personal adornment worldwide last year. And India's retail investment demand leapt 31% higher in tonnage terms in the third quarter of 2006. In cash terms, Indian investors spent an extra 49% on gold. But as yet, Indian investors face the same problems in accessing gold investment direct as did US and European investors before 2005.

"The launch of the [Indian] gold exchange-traded funds in the first quarter will skew the price curve upward," Kannan says. (BullionVault would of course offer Indian investors a better price, with greater security and for lower dealing costs.)

Central bank buying could also become a big factor in driving investment demand for gold higher, as BullionVault reported before Christmas. “Our studies indicate," said Credit Suisse in a note of 13 Nov. 2006, "that gold supply in the long term is inexorably falling behind demand as the diminishing number of new reserves fails to compensate for dying mines. This has been happening for some time but, until recently, the effect has been masked by Central Bank sales and producer hedging.

Central banks to become net buyers of gold?

"However, Central Bank sales will likely whither, and Banks could become net buyers of gold. This transition, together with expected increased investment demand, jewelry consumption and diminishing mine supply, will be when the supply-demand imbalance heats up the gold price. We believe this has already begun."

Structural shifts in the make-up of the global gold market had a huge impact on gold prices in 2006. Dehedging by the big gold mining companies coincided with the spike to $730/oz in mid-May. It came just as Barrick Gold Corp. was buying back 3.0 million ounces it had sold forward. AngloGold Ashanti Limited squared up 1.0 million ounces of its hedge book last spring, and Newcrest Mining was also trying to buy back a "sizeable amount" according to analysis in the Mitsui Report.

So while gold is getting hosed right now, the current set-back in gold prices may well come to look like a last chance to buy before the next leg of this bull market begins.

Gold's now trading below $630/oz according to the free gold charts here at BullionVault. For Sterling and Euro investors, it's almost back where it started last year.

If you've ever loved a bargain in the New Year sales, you might just come to love gold at today's prices.

Adrian Ash

Adrian Ash, BullionVault Gold News

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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