April 18, 2007

Central banks and their gold

After months of steady decline for the U.S. Dollar when measured against other floating currencies, the battle against the world's oldest currency is now escalating.

It is a battle for the hearts and minds of much of the world's population as an alternative to the dollar is sought - choose another country's paper money or go with the world's oldest money.

In years past, central bank selling of gold could always be relied upon to stop the flight away from paper money - when investors swapped their fiat money for gold bars, then saw the price of the metal drop as central bank bullion was dumped onto commodity exchanges, the metal's price would plummet and a lesson was learned.

This has gone on for decades, but with more central banks in developing economies now buying bullion and with organizations such Germany's Bundesbank balking at any future sales (apparently not having forgotten the lessons of their Weimar days 84 years ago), this may be coming to an end.

For years, commodity bull Jim Rogers has stated that the reason he views the yellow metal as just another commodity is because the world's central banks have too much of the stuff - they can continue to sell into the market to depress the price for many years.

Well, that may no longer be the case.

The current year of the European Central Bank Gold Sale Agreement allowing the sale of 500 tonnes looks like it will come up short again, this year by about 150 tonnes. Recent-seller France is rumored to be about done with what they had planned to unload and no other big sellers are on the horizon.

France is still number four on the list of official gold reserves, behind the U.S., Germany, and the IMF and with no real possibility of sales from the U.S., attention has been increasingly turned to the IMF stash, purportedly a convenient way for them to balance their books.

The proposed sale of 400 tonnes has been supported by the U.K. Chancellor of the Exchequer and future prime minister Gordon Brown after being proposed earlier in the year.

UK's Brown Sees More Support For IMF Gold Sales
Speaking at a press conference after a meeting of the Fund's International Monetary and Financial Committee, Brown said more countries were coming into line with plans to sell off some of the IMF's gold.

"What I found encouraging today was that there are countries which previously had not been prepared to consider gold sales but were prepared to do so now," Brown said, adding there was "no doubt" that gold sales were potentially part of the IMF's likely future financing.
Despite the more positive sentiment towards IMF gold sales, the plan is likely to meet some opposition from countries such as the U.S. and Germany, as well major gold-producing nations fearful of a fall in the commodity's price.

Finance minister Koji Omi of Japan now supports the plan also, once again demonstrating the profound lack of both independence and appreciation for history on the part of the Bank of Japan.

Japan's Omi Recommends IMF Sell Gold Reserves
"Japan has told (the committee): 'Why not sell gold?'" Finance Minister Koji Omi told reporters after attending the International Monetary and Finance Committee's spring meeting in Washington.

Omi's proposal is in line with Japan's long-held stance as well as recommendations made earlier this year by a high-level panel at the IMF. In late January, the panel, chaired by Andrew Crockett, president of JPMorgan Chase & Co. (JPM), urged the fund to sell some of its vast gold reserves and invest the proceeds to raise income.

Meanwhile, the issue of Gordon Brown's 1999 sale of half the Bank of England's gold reserves has led some to believe that the other half may not still be in the bank's vaults.

Fears over Treasury losing control of gold left in its vaults
As Gordon Brown prepares for a grilling in the Commons over his fire-sale auction of Britain's gold at the bottom of the market, concern is mounting that the Treasury may have lost control over the small amount still left in its vaults.

Peter Hambro, head of Britain's largest pure gold mining company, said he believed the Bank of England may have leased out its bullion to earn extra yield.

"The real risk is that the Treasury has lent out the remainder of the gold. It is very important to know whether the bank's gold lending is on a secured basis," he said. The concern is that counter-parties could default in a crisis such as the LTCM-Ashanti affair in 1998.

"The whole point of gold is that it's not somebody else's paper currency. It's the stuff that keeps you alive when everything else goes wrong," he said.

Well, if there's nothing left in the vaults at the Bank of England, let's just hope that everything else doesn't go wrong.

Eight years after-the-fact, everything seems to have been wrong with Gordon Brown's gold sales as recounted in this comprehensive story that appeared prominently in The Times (a commenter suggested "Goldflinger" would be more appropriate for the title).

Goldfinger Brown’s £2 billion blunder in the bullion market
GATHERED around a table in one of the Bank of England’s grand meeting rooms, the select group of Britain’s top gold traders could not believe what they were being told.

Gordon Brown had decided to sell off more than half of the country’s centuries-old gold reserves and the chancellor was intending to announce his plan later that day.

It was May 1999 and the gold price had stagnated for much of the decade. The traders present — including senior executives from at least two big investment banks — warned that Brown, who was not at the meeting, could barely have chosen a worse moment.

In the room, just behind the governor’s main office, they cautioned that gold traditionally moved in decades-long cycles and that the price was likely to increase. They added that even if the sale were to go ahead, the timings and amounts should not be announced, as the gold price would plunge.

Well, a plunging gold price was perhaps just what was intended. Gold dealers now call this period the "Brown Bottom", and at $256 per ounce it marked the beginning of the eight-year ascent in price to near $700 today.

Whatever the motivation for the sale, having cost the UK Treasury over $4 billion, this is not something that is easily forgotten, especially in light of the Chancellor's enthusiasm for IMF gold sales.

As for the gold laying around in Fort Knox, you never hear a peep about that. Last audited in the 1970s, it is as if no one knows and no one cares whether the stuff is still there.

That will likely change someday.

For now, it's more than a little amusing to see the powerful bankers of the world scrambling to find someone willing to part with some of their reserves so as not to embarrass the whole lot of them as the gold price soars during an era of "low inflation".