Central Banks Pushing Up Gold

Gold Prices are finding strong support from a dramatic turn in global central-bank policy...

FOR SOME YEARS now, Doug Casey has gone on record with his view that we'll know the gold bull market is really picking up steam when central banks stop selling their reserves of gold and begin buying the stuff, writes David Galland, managing director of Casey Research.

The following excerpt from a Wall Street Journal article titled "As Gold Hits Record, Central Banks in Focus" indicates that this is now happening...

"The metal has surged over worries about Europe's debt woes and the slumping value of the Euro. Investors in metals and currency markets have been on alert for any sign that the world's central banks, and China in particular, are shifting reserves out of the Euro and into gold.

"Though central banks typically are coy about investment decisions, there have been signs lately that they might be shifting out of Euros and into gold."

A key point in this discussion has to do with the Central Bank Gold Agreement under which signatories were allowed to sell 400 tonnes of gold – 14.11 million ounces – annually.

According to the World Gold Council, in 2007 the central banks took advantage of the CBGA to sell on the order of 484 tonnes of gold. In 2008 the number began dropping – to 232 tonnes, followed by a miserly 41 tonnes in 2009, just 1.44 million ounces, or 10% of the amount sold two years before.

And at the same time the banks stopped selling, they began buying...a net 200 tonnes last year and almost certainly more than that in 2010. Thus, we have a swing in demand of some 600 tonnes, or 21 million ounces annually...an amount equal to about 30% of new Gold Mining supply.

This, of course, is a two-edged sword, because, in sum, the central banks, IMF, and the Bank for International Settlements hold some 29,000 tonnes of gold. If push came to shove and the central banks were forced to defend their currencies by selling off their gold reserves, it could have a serious detrimental effect on the Gold Price.

Using the struggling Eurozone as an example, if you added together the official gold reserves of the European Central Bank, Germany, Italy, and France, you'd arrive at a total of 8,791 tonnes of gold available to be delivered to the market. Converted into a more commonly used and understood unit of measure, 8,791 tonnes equals 310 million ounces.

Now that seems like a lot of Gold Bullion, and no question it is. Keeping things simple, at $1000 per ounce, the European central banks are sitting on gold reserves worth $310 billion. So one might be tempted to think that the European central banks could begin to view this very tangible asset as an important part of the solution to the sovereign debt crisis now bedeviling them.

However, when you consider that Italian government debt alone comes to $1.91 trillion and is closing in on $8 trillion for all the Eurozone, it becomes clear that selling their gold would have little real effect. And, of course, selling off their gold reserves would announce for all to see that the sovereigns were nothing more than hollowed-out shells, their currencies dried husks ready to be blown away by the next puff of wind.

Staying on topic, with 8,133 tonnes of gold in its reserves, the United States rates as the world's largest sovereign holder. In fact, as of March 2010, gold made up 70% of official US reserves. Pretty good, eh? But with total US currency and gold reserves around $410 billion – and total US government debt, not including unfunded obligations, coming in to $14 trillion – total reserves as a percentage of US debt is just 2.9%. And the gold component of those reserves, as a percentage of total government debt, equals 2.2%.

I think the technical term is "a drop in the bucket".

Even so, one doesn't want to be naïve about these things – 29,000 tonnes of gold is roughly the equivalent of seven years' supply. Which is another way of saying that it would be a mistake to completely discount the possibility that desperate governments won't eventually attempt to dump their gold to defend their currencies, as counterproductive as that might be, given that it would send the price sharply lower.

For the time being, however, the central banks are net buyers – and so they are very supportive to the Gold Price.

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