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The Central Banks and Gold

August 26, 2011


By Doug Hornig

If the mantra of the wise investor is “Buy low, sell high,” then those who run most of the Western world’s central banks must suffer from dyslexia.

These banks sold off their gold reserves for years, right into the teeth of a generation-long bear market. The last year before the sales began – i.e., during which central banks were net buyers of gold – was 1988, when the price of the metal fell from $485/oz. in early January to $410 at year’s end.

From then and right through the end of the century, they continued to sell as gold dropped steadily to its modern low of $250. The banks were in such haste to divest themselves of this disrespected relic – their single tangible asset – that it was deemed necessary to cap how much they could get rid of in any given year.

Thus, the European central banks (the then-eleven eurozone countries plus the European Central Bank and those of Sweden, Switzerland, and the UK) drew up the first Central Bank Gold Agreement (CBGA1) in 1999. In it, the signatories agreed that gold would remain an important element of global monetary reserves, and (presumably in order to ensure that they kept some) that they would limit their collective sales to no more than 400 tonnes a year and no more than 2,000 tonnes over the following five years.

In addition, a number of other major holders – including the US, Japan, Australia, the IMF, and the Bank for International Settlements – informally associated themselves with the Agreement.

This pact was succeeded in 2004 by CBGA2, which boosted allowable sales to 500 tonnes/year and 2,500 tonnes for the next five year period. CBGA3, adopted in 2009, runs through September of 2014 and pushes sales back to the levels of CBGA1.

Whether the correlation of the beginning of gold’s bull run with the implementation of CBGA1 is more than coincidence remains an open question.

To be fair, the banks did recoup some of their losses by continuing to sell as gold finally began to increase in price. But the last year in which net outflows approached the CBGA limit was 2007, when gold rose from around $600 to near $850 and banks dumped close to 500 tonnes. After that, sales fell off dramatically until the central banks became net buyers in the second quarter of 2009… just as gold prepared to go near-vertical:

That trend remains unchanged.

Of course, the CBGA signatories do not constitute all of the world’s central banks; elsewhere – especially in the emerging world – there were plenty of buyers even as sales under the Agreement numbered in the hundreds of tonnes per year.

China, for example, seems determined to become the world’s largest holder of gold as it seeks to preserve the value of the surplus trillions it has amassed in dollars and other foreign currencies. Between 2000 and April 2009 (the last time it published any information about gold holdings), the People’s Bank of China officially nearly tripled its gold reserves – from 395 to 1,054 tonnes. That vaulted it into sixth place on the global list, but the data may be grossly underreported. China, also the world’s #1 producer, is highly secretive in this matter and has apparently been hoarding virtually all of that production. And, since the country reveals its info only once every five or six years, it’ll be a while before we know how much its reserves have grown lately.

Elsewhere, Saudi Arabia more than doubled its gold reserves, to 323 tonnes over the same 2000-09 period. India snapped up 200 tonnes in ‘09, as soon as the IMF put them on sale. Russia has been a steady buyer, turning oil revenues into hard coin as it jumped to seventh place on the world list with 840 tonnes, of which 330 have been added since the beginning of 2009. Mexico bought over 93 tonnes in the first quarter of this year, multiplying its holdings by a factor of 14.

Then there’s Iran, more paranoid than China and not even listed by the World Gold Council as an official holder of gold. Yet, according to a Bank of England diplomatic cable released by WikiLeaks: “Market observers believe Tehran has been one of the biggest buyers of bullion over the past decade after China, Russia and India, and is among the 20 largest holders of gold reserves… with an alleged 300 tons.”

Point is, while the CBGA central banks were selling, others were buying. Now, virtually everyone has climbed aboard the train. So far for 2011, official government purchases have totaled over 200 tonnes. And the actual number is probably a good bit higher.

Historically, the reasons for why and when central banks bought or sold gold could be complex. But the current situation is pretty clear-cut. The desire to hold the metal is strong, and even the most auriphobic central banks have gone from trailing the trend to leading the charge.

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