Commodities | Nov 04 2009
By Greg Peel
The biggest official (central bank) holder of gold in the world is the US, with around 8,000 tonnes. Next in line is Germany with about 3.4kt, followed by the International Monetary Fund with 3.2kt. Then come France and Italy before China slips in ahead of Switzerland and Japan.
The gold “owned” by the IMF was contributed by the US and the legacy European central banks on the establishment of the Bretton Woods agreement after World War II. The agreement saw currencies pegged to the US dollar, which in turn was pegged to gold, and also saw the establishment of the IMF. The specific role of the IMF is to provide low-interest loans to poor nations suffering economic hardship. As one might imagine, demands on the IMF have leapt since the GFC hit as countries from Iceland to Pakistan stuck their hands out for assistance.
IMF membership has grown since World War II to include many more secondary and emerging economies. However voting rights are still very much biased toward the founding members, with the US firmly in control. Even before the GFC hit, the IMF had petitioned the US on several occasions to be allowed to sell some of its extensive gold holdings. The last time the IMF sold gold was in 1999 following the Asian Currency Crisis.
But each time the US refused. The reason it refused was because the IMF had become fat and lazy, building up a substantial cost base without increasing its activities to match. The Fund did not need to sell gold to fund some economic bail-out or other, it needed money to cover its expense account. The US instructed the IMF that it would only be granted permission to sell gold if and when it got its house in order. And under a new director, it did.
Which was just as well. No sooner had the new director taken up office but the GFC hit and the switchboard lit up like a Christmas tree. Again the IMF asked for permission to sell gold, and this time it was granted. Clearly the money was now needed for its intended purpose. The announcement was made earlier in the year that the IMF would sell 403t of gold, or one eighth of its holdings, and sale permission was ratified by members only last month.
The amount of 403t initially sparked some nervousness in the gold market, which feared the IMF would dump gold on a volatile market. But under the rules, the IMF could only sell gold in a phased manner over time in the general market, or sell it off-market to central banks. In the latter case, sales still had to be at market prices irrespective of volume, so not to upset gold prices and subsequently currencies.
In order to ensure the “phased manner” of sales, the 403t amount was to be included within the 400t per year quota of allowable gold sales under the Washington Agreement. The European central banks – collectively the world’s largest holders of gold – are signatories to the Agreement. This meant it might even take five years for the IMF to ease out its 403t.
But speculation was soon rife that the 403t might simply go in one hit. China surprised the world earlier this year by revealing that since 2003, when its reported gold reserves were 600t, the central bank had acquired a further 454t without anyone knowing by buying only from domestic sources. China only recently became the world’s biggest producer of gold. What’s more, China’s desire to buy gold did not stop there.
Despite the increase, China’s gold reserves still only represent around 1% or so of total foreign reserves, of which around 70% are held in US dollar-denominated assets such as Treasury bonds and agency debt. Since the GFC hit, China has been the most vocal critic of excessive US government debt and its effect on the value of the dollar. But with so much invested in US dollars, China cannot afford just to pull the pin.
Instead, it has attempted to diversify away from the US dollar by buying assets in other currencies such as the euro when reinvesting its export receipts. It has also enacted cross-currency deals with the likes of Brazil and Russia for long term energy supply, cutting out the reserve currency altogether. And it has bought gold.
China would like to buy more gold. That’s why the gold market fairly quickly assumed China would simply stick up its hand for all of the IMF’s 403t in one hit. The race would indeed be on, because Russia had publicly stated its intention to increase its ratio of gold reserves from 2% to 10% and Brazil was sniffing about as well. But in the end it was the forgotten BRIC that moved first.
The announcement last night that the Reserve Bank of India had purchased 200t of the IMF’s 403t suddenly sparked up a gold market previously very nervous about a bounce in the US dollar. Gold has recently rushed back through the US$1000/oz mark and beyond on ongoing US dollar weakness, but most recently it has wavered as the dollar has stalled. Last night’s revelation saw gold shoot up around US$30 to around US$1085/oz – its highest ever nominal price. (Note that the 1980 previous high of US$850/oz represents more than US$2000/oz in today’s dollars.)
India is no stranger to gold, being the world’s largest private commercial buyer of the metal for the purpose of jewellery making, which in turn is driven by India’s two annual gold-giving festivals. Of all the gold produced in the world each year, around 80% becomes jewellery. While 200t is a lot of gold, and certainly a very large volume to exchange hands in one hit, it still only represents 8% of average annual global production.
Indeed, at US$6.7bn in value the amount pales in comparison to the sort of money governments across the globe have been throwing at bank rescues. Only last night Royal Bank of Scotland accepted another injection of US$31bn from the UK government. Warren Buffet’s Berkshire Hathaway offered to buy the Burlington Northern Santa Fe Railroad for US$34bn. As Gold Anti-Trust Action Committee secretary Chris Powell suggested this morning, the amount “seems like peanuts”.
That hasn’t stopped the world speculating on what might happen next.
The general opinion is that the transaction is positive for the gold price going forward as it crystallises the intentions of the BRICs and other countries beyond that which to date has been mostly chatter in relation to gold purchase plans. The bulk of the world’s gold lies in the “Old World” of Europe and with the WWII saviour, the USA. Countries elsewhere across the globe have either sold a lot of the gold they once had, such as the UK and Australia, or simply never had much in the first place. The latter includes Asia, the Middle East and, ironically, South America (which had a lot once but had it stolen). With the reserve currency threatening to continue into a long devaluation phase, gold is the perfect foil.
As long as you can buy some without moving the market too dramatically. China was able to do this by buying only domestically, and sellers were no doubt under pain of death not to divulge. India has now been able to do so as well because the IMF hasn’t a decent load to sell off-market. But while conducted off-market, the 200t was sold to India over a two-week settlement period which ultimately achieved a price average of US$1045/oz – the market price required by the IMF for such transactions.
In the week ending October 23, Bloomberg reports, India’s foreign exchange reserves increased by US$684m to US$285.5bn, including currency assets of $268.3bn and gold reserves of US$10.3bn. At 3.6%, India’s gold ratio would appear to have more room to move. And that’s just what some are speculating.
A senior Indian finance ministry official told the Wall Street Journal the RBI may seek to buy more gold from the IMF directly. “It makes sense to buy gold as it will appreciate against the US dollar,” he said. But an economist noted that India had little need to enact a major rebalancing of its US dollar asset holdings given most of India’s external debt is also denominated in dollars.
If India was going to buy more from the IMF, why did it stop at 200t? Is it because China, Russia, Brazil or anyone else might also be negotiating for the balance? The IMF will not comment. Either way, given India’s move it is unlikely the remaining 203t will last long.
But GATA’s Chris Powell will not rule out another motive for India’s gold purchase, beyond that of simple foreign reserve diversification. It “must be suspected”, suggests Powell, that India intends to use the gold in an emergency intervention into currency markets in order to prop up the US dollar or the rupee. The Indian rupee is partially pegged to the dollar, which brings with it inflation implications.
In such a case the RBI would directly sell into the market the gold it bought indirectly in the off-market, thus affecting the gold price and currency movements. But again we note that US$6.7bn is not exactly a staggering amount, as Powell previously noted.
So the world is more likely to assume India’s purchase is part of a greater world-wide shift back towards gold as a storage of wealth. Indeed, the seventh greatest holder of gold in the world, one place ahead of Switzerland, is now “the world”, at least as far as the SPDR gold exchange traded fund holdings represent. The popularity of gold ETFs has surged in recent times.
It’s a gold rush.
