Gold News

The End of Central Bank Gold Sales

The Central Bank Gold Agreement expires on 26 September 2009...

SOME DAY this crisis will come to an end, writes Dan Denning at The Daily Reckoning Australia.

And when it does, people can go about their lives again in what passes for normal fashion. But before that, some drama has to play out. Much of it will be unpleasant. But not all of it – not if you're standing Ready to Buy Gold.

The big driver of the Gold Price this year will be, as always, weakness in the US Dollar, we believe. Granted, gold is rising against other currencies too (notably the Euro and the British Pound). But it's the large increase in the supply of US dollars that will ultimately catapult the yellow metal higher for everyone, we think.

Keep in mind, though, that the unwinding of the Dollar Standard – by which the US gets to pay its debts in its own currency, thereby printing away its obligations as it sees fit – is not going to be a rapid affair. Too many people have too much to lose from a rapid Dollar depreciation. So we'd expect gold's move to be driven by gradual investor capitulation on common stocks and government bonds. And THAT will be driven by market returns and inflation concerns...both of which should mount as the year progresses.

A key date to watch for is 26th September, 2009. That's when the current European Central Bank Gold Agreement (CBGA) expires. The first CBGA was first signed in 1999, and depending on whom you ask, had a rather ambiguous goal. European central banks agreed to limit and publish their announced gold sales.

The reason, we suspect, was that European Central Banks own gold as a reserve asset. Indeed, the signatories of the first CBGA controlled 43.6% of the world's official gold reserves, according to the World Gold Council. The second CBGA was then signed in 2004 and limited sales to a maximum of 500 tonnes per year over five years (2,500 tonnes over the length of the agreement). And with the expansion of the European Union since then, CBGA signatories now control 46.1% of world-government gold reserves.

So why cap official central bank gold sales? As much as they prefer their own product –paper money – central banks own gold as a crucial reserve asset in their vaults. But ten years ago, in 1999, the Gold Price languished at just $252 an ounce. And for the central banks, this meant the value of a major reserve asset was falling.

With the Gold Market then wary that further central bank gold sales could flood the market with excess supply at a time of lethargic demand, something had to be done to put a floor under the price. So to assure the market that central bank gold sales would not be used to suppress/depress the Gold Price (at least, not publicly), the CBGA was signed.

Since then, it's provided transparency to planned central bank sales of Gold Bullion. (According to the World Gold Council's data, France and Switzerland were large sellers of gold last year, while Russia was a notable buyer.)

So what will happen when the current five-year agreement expires on September 26th  2009? Well, there's every chance a new agreement will replace it. But since we're in the business of looking for Black Swans – those hitherto unimagined facts or events which have simply remained unseen, rather than impossible, so far – let us entertain the opposite possibility.

What if central banks abandon the agreement this year?

Global central banks are also large holders of US dollars and US-denominated bonds, of course. How reliable do you think either of those investments look as reserve assets today? Also keep in mind that gold is now accessible to retail investors in a way it wasn't in 1999. Gold ETFs (if you take them at their word) own over 1,000 tonnes of gold. This makes ETFs the sixth-largest holder of above ground gold (behind the US, Germany, the IMF, France, and Italy). Outright gold ownership amongst private investors has also leapt thanks to innovations such as GoldMoney and the secure, transparent, low-cost service at BullionVault.

So it's not rash speculation to suggest that central banks will prefer to hold on to their gold this year – rather like the increasing (if small) number of private individuals – instead of selling it. As competitive currency devaluations sweep the globe in an all-out effort to fight asset deflation and recession, we think gold will become much more desirable as a reserve asset worth owning, not selling for cash.

Bankers are bankers, after all. Their product is money. But they have Gold Bullion in their vaults for a reason. It was money before paper was money. So September 26th may mark the end of coordinated gold sales by European central banks.

And it may mark the beginning of a new monetary era where gold reasserts its importance as money.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

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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