5-Figure Gold & Central Bank Sales

STOP PRESS! European bank breaks ranks, buys gold...

IT HAS BECOME CLEAR that central banks are Buying Gold for their reserves, writes Julian Phillips for the GoldForecaster.com.

Here is a brief history leading to today – plus the present position of central banks as they turn to buying bullion for diversification, inflation-defense, and sovereign protection.

Massive Gold Sales
From the early 1980s and for the next 20 years, gold was under threat of massive sales from the world's central banks.

Many commentators reported that the overhang of gold above the 'open' market was so great that such sales would eventually lead to central bank reserves in the developed world holding no gold at all.

Central banks had further worsened the situation by loaning metal to Gold Mining companies, through the bullion banks, allowing them to sell their future output at current prices and thus finance gold production to a far greater extent than warranted by the price of gold during that time.

This acceleration in the production of gold allowed the Gold Price to be pressed down $850 to $275, the point at which Britain, at the instruction of today's prime minister, Gordon Brown, instructed the Bank of England to sell the greater portion of its gold reserves. From the turn of the millennium, however, this perspective changed dramatically.

Limiting Central-Bank Gold Sales
In 1999, and with gold sales making international headlines as the price fell, the major industrialized-world central banks met and established the Washington Agreement to restrict "dumping" and stem the plunge.

The 15 signatories announced to the world that it need not fear uncontrolled sales of gold reserves for the next 5 years, capping annual sales to 400 tonnes. While the US and Japan were not signatories, they gave tacit agreement to such a limitation. Since then, neither of them have sold gold on the open market.

Following the end of the 'Washington Agreement' in 2004, a second agreement – called simply the Central Bank Gold Agreement – extended the situation for another five years and with annual limits of 500 tonnes. This agreement now ends on 26 Sept this year.

Sales were limited to the sales previously announced by the signatories, with the exception of Belgium and Spain, who made no prior announcement to their sales. Under the second Agreement's 500-tonne a year limit, the ceiling has not been met. Sales are well below the limit so far.

Halting Central Bank Gold Sales
This slowing of gold sales from European banks in particular has been of great significance. They appear to have lost all appetite for gold sales in 2009.

Indeed, France now looks an unwilling seller, but under Presidential instruction it has been forced to do so. Italy has had no plans to sell any of its gold. Germany had the option to sell 600 tonnes under the CBGA, but it has not taken this option up. Switzerland took some of this German option, but it has ceased selling now.

It would be surprising if the signatories sold more than 150 tonnes of gold this year (Sept. to Sept.), let alone the ceiling amount of 500 tonnes. And next year, with or without a new agreement, we expect no such sales from central banks.

Central Banks Now Buying Reserve Gold
The potential IMF Gold Sales are not yet part of any central-bank gold selling policy. And just as the tide turned in 1999 it appears we are rapidly approaching another watershed in the history of gold in the monetary system.

Countries not seen as an important part of the global monetary system have, in the last few months, turned buyers of gold. Ecuador bought 28 tonnes, doubling its reserves. Venezuela bought another 7.5 tonnes, adding 5% to its hoard. These purchases are not deemed of great significance, however, compared with the big central-bank Gold Buying news.

Russia, at last – and after talking about it for over one year – has begun to Buy Gold aggressively. It was reported that Russia bought as much as 90 tonnes of gold for its reserves in the last 3 months. Previously it held 495.9 tonnes. So this is much more significant, as it is a large figure in the small 'open market' for Gold Bullion.

Prime minister (and former president) Putin is reported to have said that Russia wants to see gold forming 10% of Russia's reserve. Now the process of getting up to that level could have begun. Even so Russia has little influence on global central bank thinking, so such increases are not thought to directly influence the principles behind gold as a reserve asset.

That's not to minimize the impact of such purchases, however. If Russia were to keep up this pace of acquisition, it would be able to buy 360 tonnes a year and have a very significant impact on the Gold Price. But the principles behind gold as a reserve asset are affected far more by the following news.

During the second week of March, reports the European Central Bank (ECB), one signatory to the monetary union agreement actually purchased gold – the first time we have seen them do it. The purchase was not simply of Gold Coin (which has happened before, seemingly just for "housekeeping" reasons at the local mint), but rather of Gold Bullion.

In other words the ranks of central bank selling in Europe have been broken and one has turned buyer!

We feel more positive now in our belief that European central banks – the source of so much supply in the last 20 years – are now unhappy sellers. They look inclined to change their views to the buy side.

The very fact that one central bank in Europe has turned buyer confirms this. There is little doubt in our minds that there are conflicting views now amongst the heads of the leading European central banks on gold.

Middle Eastern Central-Bank Gold Policy
Meantime, according to the World Gold Council's new chief executive Aram Shishmanian, in the Middle East the new monetary union intend to have "gold play a prominent role in Gulf CC economies".

Gold "may play a role in that basket of currencies on which the GCC common currency will be pegged," he says.

Of course, the inclusion of gold in a basket of currencies would simply be for valuation purposes. It does not, of itself, imply that these central banks will Buy Gold for their reserves.

But "Gulf central banks, along with the central banks of Brazil, Russia, India and China, are expected to increase their gold reserves," Shishmanian went on, speaking to the region's Business 24/7. "Central banks with low reserves of gold are looking to increase their reserves. They are trying to analyze what the right balance should be. They are becoming aggressive. Currently the belief is that if more than 20% of a central bank's reserves are in gold, it is overweight, but this perception is changing.

"The metal is becoming an asset class in the region, and Gulf investors are looking at long-term investments in gold as a hedge against inflation."

We are certainly not in a position to contradict what the new WGC chief says. After all, he has the resources and contacts to be authoritative on the matter. And if the World Gold Council's CEO is correct, then he will have confirmed
that 2009 and 2010 will be the year that heralds the return of gold to
the global monetary system.

After nearly 30 years of opposition to gold by central banks and occasionally governments, it is a remarkable turnaround. This tells us that gold is returning to the monetary arena again. Yes, the world of Gold Investment had expected this for a long time. But now it feels a bit like seeing an oasis in the desert!

If right, we expect to see both Russian and Chinese gold production go straight into those countries reserves and not even reach the open market. That could account for nearly 600 tonnes of supply disappearing. Now add to that the halting of sales from European central banks, a perceived 500 tonnes a year. If this trend continues, then gold – as an investment – will be fully rehabilitated.

This is by no means the largest effect that the central banks' change of heart will bring about, however. The recognition by central banks that gold has a role in the monetary system will influence investors, both institutional and individual.

Should that happen – and let's say 5% of funds managed by pension and insurance groups moves into gold – then an amount of $920 billion, in the States alone, could head gold's way. Only a five-figure Gold Price could accommodate that volume of money in the gold market. Now add to that figure the same inclination in the rest of the world.

Any such rise in price will stunt the demand for sure, but be certain that gold is not simply in a bull market.