Since 2009 we have seen the signatory central banks of the Central Bank Gold Agreement cease selling their gold. We have stated many times in the past that the entire exercise of selling gold by these European central banks was to support the birth and establishment of the euro. They felt this was achieved by 2009, 10 years after the launch of the euro.
In the same year we saw the arrival of emerging nation’s central banks into the gold market as buyers. Since then they have set a pattern of buying gold that continues as a driving force behind the gold price even today. In this article we look at these events and other monetary developments in the gold market to see what to expect in the days and months ahead.
Which Central banks are buying gold and why?
As you have seen in our newsletter in the Table of central banks buying and selling gold it is the emerging nation’s central banks, whose reserves have been growing strongly that have led the way in buying gold for their reserves. Their aim is to diversify away from the U.S. dollar and other leading world currencies and to buy gold as a counter weight to those currencies.
These central banks are based in Asia, the Middle East, South America, etc. They include:
Russia – Bangladesh – Philippines – Saudi Arabia – Thailand – Belarus – Venezuela – India – Sri Lanka – Mauritius – Mexico – Bolivia – Colombia – South Korea – Turkey – Kazakhstan – Tajikistan – Serbia – Ukraine – Mongolia – Malta – Greece - Argentina.
The underlying reason why all of them are buying and why the European signatories to the Central Bank Gold Agreement stopped selling is because they all consider gold to be an important Reserve Asset and as the head of the Bundesbank put it, “gold is a counter to the swings of the dollar”. Neatly put, but isn’t there more to this than simply countering the swings of the dollar. Since gold was at $300 an ounce in 1979 right through to 2005 gold has been at that level or higher. Now it is at $1,660 five and a half times higher and the dollar is not five and a half times lower than other currencies. Gold has risen in all currencies including the euro which was well below €300 to an ounce of gold and is now at €1,321 more than four times higher than then. It has risen from $35 an ounce since the sixties a rise of 47 times!
Clearly, gold adds further ingredients to national reserves as these numbers demonstrate in part. The emerging world is as aware of gold’s value in their reserves as are the developed world’s central banks and are doing something about it before there are potentially devastating developments in the global monetary system.
Why do the central banks of the U.S., Germany, France and Italy hold 70%+ of their reserves in gold?
Having stated that they were sellers of gold from 1999 onwards through until now, Europe’s signatory central banks to the CBGA gave the impression before 1999 that their gold holding weighed heavily above the gold market. This combined with accelerated mining of gold then as the price was dropping, forced the gold price down and pushed the developed world to more and more dependence of the dollar then the euro. But in reality central banks were not trying to get rid of their gold holdings. Some aimed at selling 20% of their reserves in total, while others like Germany, did not sell any of their gold, despite being signatories to the agreement. Some like the U.K. and Switzerland appeared to gullibly sell half of their reserves.
Then in 2009 all the signatories stopped selling except for small amounts for the minting of gold coins. This left the holding of European banks at these levels:
For such an archaic reserve asset, it is doing very well in terms of its price moves. But the governments of the developed world knew that if their 40-year long experiment with un-backed paper money were to go wrong then gold could come to their rescue and, my goodness, it has!
The now incumbent money managers may well feel surprised at the way we have described currencies [as an experiment?], but since Nixon cut the link of gold to currencies back in 1971 that’s what we’ve had. Now, the money experts and leaders of the world, looking at the way governments across the developed world have abused this paper money and particularly national debt levels, they too can see the sinking level of confidence in such money both inside and outside the developed world. What can pull them from the brink of disaster if confidence in the two leading developed world currencies [and leading reserve currencies] collapses? What can pull the world’s leading commercial banks, particularly those fused at the hip to government [in their asset portfolios], from collapse?
Having watched the credit crunch morph into the Eurozone debt crisis and potentially return across the Atlantic by year’s end to see the U.S. once again fighting over-indebtedness, developed world central and commercial banks realize that whatever their dislike of the discipline of gold and its unmanageability, it will allow them to harness a confidence that currencies are failing to do. Gold is also facilitating loans and liquidity that goes far beyond its price.
The structural benefits of gold are now showing clearly in gold and the need to side-line it from the monetary system is now proving a dangerous handicap for the monetary system. Hence Basel III discussion taking place now, to be implemented from January 1st 2013.
Basel III Discussing Lifting the Accepted Value of Gold on Commercial Banks Balance Sheets from 50% to 100%
Part of the side-lining of gold from the monetary system was through either taxation on its sale (in some countries) or by undervaluing it as an asset.
When the 2007 credit crunch hit hard, the loss in value of so many paper assets forced the sale even of those assets that did manage to retain both value and liquidity. Individual investors often sold gold, silver, and the like to cover margin requirements that screamed to be topped up in the hope of retaining assets that were losing value. That’s why asset values on so many fronts declined so markedly. Even assets whose market fundamentals remained solid were sold down only to recover when the storm passed. Gold and silver were among those.
At banking level, the pressure to go against investor logic was due to the regulations of the system. With gold a Tier II asset in bank’s balance sheets, only 50% of its value could be credited as an asset to that balance sheet. So its real market value could only be given meaning when it was sold. By selling gold and using the proceeds to buy Tier I assets, such as Treasuries, the bank ensured that their balance sheets benefitted fully from its value. Even when the gold price fell 20% it was worth selling, so that at least 80% of its former [,200] value could be credited to the bank’s balance sheet instead of just 50% [or 40% at the value after a fall in the price of 20%].
As the value of assets of various governments and potentially U.S. bonds are threatened by over-indebtedness, commercial banks are left little recourse except changing the situation by changing the rules for the banks. Hence, the current discussions on its definition in the bank’s balance sheets. If gold is redefined as a Tier I asset, then when any future loss of asset value of paper assets occurs, there will be no need for banks to sell gold to compensate for such falls. And, as gold has amply demonstrated, the gold price is more than likely to rise in such situations, proving to be a ‘counter to all paper assets’ on the bank’s balance sheets.
Such a change will do a great deal to remove the shock to the solvency of so many commercial banks in credit crunches and the like.Will the change happen? We believe so and expect this to take effect on January 1st 2013.
Why Clearing Entities Are Accepting Gold as Collateral
LCH.Clearnet is a clearing house for major international exchanges and platforms, as well as a range of OTC markets. As recently as 9 months ago, figures showed that they clear approximately 50% of the 8 trillion global interest rate swap market and are the second largest clearer of bonds and repos in the world. In addition, they clear a broad range of asset classes including commodities, securities, exchange traded derivatives, CDS, energy and freight. The development follows the same significant policy change from CME Clearing Europe, the London-based clearinghouse of CME Group Inc., announced recently that it planned to accept gold bullion as collateral for margin requirements on over-the-counter commodities derivatives. Both C.M.E. and now LCH.Clearnet Group have decided to allow use of gold as collateral from 28th August. It is likely that they too have the same concerns about the possibility of another ‘credit crunch’ and the danger forced asset sales can have on liquidity. They too see the benefits of treating gold as money and collateral.
LCH.Clearnet Group Ltd. said it will accept ‘loco London’ gold [0.999 or 0.995 quality gold] as collateral for margin-cover requirements on OTC precious-metals forward contracts and on Hong Kong Mercantile Exchange precious-metals contracts starting Aug. 28. ‘Loco London’ gold is London ‘Good Delivery’ Bars (roughly 400-ounce or 12.5 kilograms gold bar) held with LBMA members within the London bullion clearing system. The clearing house has already been using gold bullion as collateral since 2011 but now will accept ‘loco London’ gold as collateral.
Additionally, Intercontinental Exchange Inc. too has allowed the use of gold as collateral. LCH.Clearnet limited the amount of gold that could be used as collateral to no more than 40% of the total margin cover requirement for a member across all products and at a maximum of 0 million, or roughly 130,000 troy ounces, per member group. David Farrar, Director, LCH.Clearnet said at the time that “market participants want greater choice when it comes to assets that can be used as collateral. Gold is ideal; as an asset it typically performs well in times of financial stress, remains liquid and has a well-established pricing mechanism.”
Thus the commercial banking system is and has prepared to treat gold as full-bloodied money because of its invaluable liquidity virtues and its acceptability even under pressure.
We believe that the markets have yet to catch up to what’s going to happen. But the current gold price breakout is not because of this aspect of gold; it’s because of both Technical and seasonal factors. When gold is a Tier I asset and commercial banks appear in the market place, then the gold market will also see a new driving force behind the gold price. There is still a considerable distance to go before the gold price really does discount these potential changes.
In summary, the banking system, overall, is moving toward where gold will be an active, confidence-building monetary asset.
Will ‘Powers that Be’ Continue to Allow Citizens to Own Gold?
With gold moving back to such a pivotal position in the monetary system, won’t the private sector interfere with the ‘stability’ of the gold market, chasing its price up just as the Hunt Brothers tried to do in the days of yesteryear? This is possible, but this time the gold price will not be at a fixed price as it was under the gold standard. By ‘floating’ the gold price, every time it rises in price, it will benefit bank’s balance sheets and liquidity levels, countering volatile markets. The reverse is true if the gold price falls and other assets rise in value as the markets seems to believe will be the case.
Overall there will be a ‘value anchor’ as Mr. Zoellick, the last head of the World Bank, advocated last year.
If these changes are instituted, there is a danger of interference in the gold market price by the public, but on the upside not the downside. After all, it will be in the interests of the monetary system to see higher gold prices rather than lower prices that the powers-that-be appeared to want between 1985 and 2005. But they will want to see a level of stability consistent with that of currencies and other monetary assets in that situation. Their desire for this can be overwhelming, as we saw in 1933 when U.S. citizens were banned from holding most forms of gold in the interest of the nation’s monetary system. It was not until 1974 that they were again permitted to do so; however, this permission came with the proviso that owning gold from then on was a “privilege, not a right” as though to warn us all that things could change again. Even though governments attempted to write gold out of the system, they made it clear that they considered gold as part of their domain.
This is a real danger and one that should not be overlooked by us all in all the nations of the world. Any government that feels it is in their interests to take their citizen’s gold will do so even if it means changing their laws.
Get the rest of article:
- Will ‘Powers that Be’ Continue to Allow Citizens to Own Gold? (cont.)
- How to Protect Yourself against Gold Confiscation
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